Thursday, September 12, 2019

Syncora Holdings: Operating Business Sold, Cash and NOL Stub

Syncora Holdings (SYCRF), through its subsidiary Syncora Guarantee ("SGI"), is a provider of bond insurance that ran into a whole bunch of trouble following the financial crisis.  Like the other bond insurers, Syncora branched out beyond municipal insurance (to be fair, they did also suffer with Detroit and Puerto Rico) to subprime RMBS, CDOs and other toxic securitizations of the pre-crisis era.  During and following the recession, many of the supposedly AAA structured securities were impaired and Syncora was called upon to make good on their guarantee which forced the insurer to the brink of insolvency.

In the decade since, Syncora has been in constant litigation (they scored several huge settlements with banks that issued subprime RMBS) and restructuring mode.  Previously a bit of a black box, Syncora last month sold SGI to an affiliate of credit manager Golden Tree Asset Management for $392.5MM with a go-shop period through September 13th.  It then re-struct the sale price higher with Golden Tree this past week to $429MM plus the assumption of some preferred share pass-thru securities that wasn't originally included in the deal after receiving an unnamed unsolicited offer (the go-shop was also cancelled).  Once the transaction with Golden Tree closes in Q4/Q1, Syncora plans to distribute the sale proceeds to shareholders, all that will remain is $30+MM of cash and miscellaneous assets (valued at $45-60MM total including the cash) plus around $300MM of net operating losses.

Syncora has 87 million shares outstanding, assuming about $20MM in leakage and other deal related expenses, the company will likely distribute cash back to shareholders roughly equaling today's $4.70 share price.
Assumes no value attributed to the NOL
What is the company going to do with the stub after the SGI deal closes?  Anyone's guess, it will be a tiny shell with a few random assets (waterfront raw land in Detroit, 80% of Swap Financial), management claims to be in active conversations with their advisers on a transaction, but the NOL monetization dream is elusive for many if not nearly all similar NOL shell stories.  So maybe the 30% discount to NAV needs to be a touch higher, at a 50% discount I come up with a 16% IRR, still an attractive situation.

Disclosure: I own shares of SYCRF

Wednesday, August 21, 2019

Avenue Therapeutics: Two-Step Merger with Cipla, CVR

Avenue Therapeutics (ATXI) is a one product development stage biotech with a binary investment outcome (let's be honest, most small biotechs are binary, this one just more explicitly so) related to their Stock Purchase and Merger Agreement with a subsidiary of Cipla, an India based global generic pharmaceutical company.  On 11/12/18 (closed in February), Cipla (via their U.S. subsidiary InvaGen) announced the purchase of 33.3% of Avenue for $35MM or $6/share (where it trades today) and agreed to purchase the remaining shares for $180MM or $13.94/share conditional on the FDA approval of IV Tramadol as a Schedule IV drug for post-surgery pain relief.

Tramadol is a fairly common pain reliever (~40th most prescribed medication in the U.S.), it has been around for decades internationally and was first approved in pill form in the U.S. in 1995.  Tramadol is an opiod, but it's considered a weak or a non-conventional opiod, most of the conventional opiods are classified as Schedule II controlled substances by the DEA, which essentially means they're highly susceptible to misuse and abuse, Tramadol contrastingly is Schedule IV (DEA's schedule is a I-V ranking, I being the most dangerous/no medical use).  Given the growing awareness of the opiod epidemic in this country, there's an opportunity for a painkiller that sits somewhere between Schedule II opiods like morphine or Vicodin and over-the-counter drugs like Tylenol and Advil.

Tramadol is currently only approved in oral/pill form in the U.S., Avenue (via their controlling shareholder Fortress Biotech - FBIO) owns the exclusive license to develop and commercialize an intravenous ("IV") version of Tramadol, IV Tramadol is widely approved and used (~10% of IV painkiller market share in Europe) internationally but hasn't been approved for use in the United States.  Avenue has already completed two Phase 3 studies of IV Tramadol with positive results, for moderate to moderately severe pain IV Tramadol has generally performed as well as morphine (don't need something as strong as morphine if you're only in moderate pain, something weaker does the job just as well).  Currently the company is putting together their new drug application ("NDA") to submit to the FDA for approval.

The conditions of the merger specify:
  1. Final FDA approval of the Product on or before December 1, 2020, if as of such date there are no pending queries from the FDA with respect to such Product approval, but if there are such pending queries from the FDA as of such date, then such FDA approval shall have been obtained on or before April 30, 2021;
  2. Labelling for the Product containing an indication as moderate to moderately severe (post-operative) pain, not restricted to any specific type of surgery; and
  3. Classification of the Product by the U.S. Drug Enforcement Agency (“DEA”) as a Schedule IV Drug under applicable Legal Requirements; 
The timeline for FDA approval is typically about a year, 2 months of a preliminary review that justifies a full 10 month review of an NDA.  If Avenue is able (the company says they're on track) to complete and submit the NDA by the end of November, the 12/1/2020 deadline shouldn't be an issue.  By doing two Phase 3 studies (one for tummy tucks and one for bunion surgery) Avenue is going for the broad label and given IV Tramadol's widespread use, should have a good case for it.  The wildcard might be the Schedule IV classification, we are entering into an election season and opiod litigation is heavily in the news, if the DEA changes Tramadol to a Schedule II drug alongside the conventional opiods, that could blow a hole in the merger agreement.

If the merger is completed following FDA approval, Avenue shareholders will get an additional kicker in the form of a CVR tied to the sales of IV Tramadol with a $325MM annual revenue threshold with a favorable graduated tier scale above that.  One similar example to look at is IV acetaminophen (Tylenol), it is both a success story we can point to where it was approved in oral form for many years and then was only recently (well, 9 years ago) approved in IV form, but a quick Google and there's a lot of dispute whether the IV form is any different from than oral, especially hard to justify given that Mallinckrodt has done a series of price increases.  In 2017, IV acetaminophen did $300MM in sales, still below the CVR threshold for Tramadol many years after IV acetaminophen was commercialized.  But again, Tramadol might have a better chance of filling that pain gap than acetaminophen considering it's a weak opiod, either way, the CVR's value is likely many years off and not worth underwriting.

Avenue is an interesting binary outcome, the market is pricing in a less than 50% of chance of the merger with Cipla being completed, despite what appears to be a mostly straight forward FDA approval process (at least to this clueless retail investor) considering the drug is already approved in a different form in the U.S. and in the same form in many other developed markets.  Why is it mispriced?  Management answered this question by pointing to the lack of investor relations and promotion, they don't need additional financing after the deal with Cipla to complete the FDA approval process, so no need to promote the stock.  Makes some sense to me along with the relatively low float given the large stakes owned by FBIO and Cipla.  Additionally, I think people don't like such explicitly binary outcomes and general loss aversion keeps people away despite the seemingly favorable odds.  Thanks to "Ben's Jamin" who mentioned Avenue in a comment section a while back.

Disclosure: I own shares of ATXI

Industrial Services of America: Tiny Liquidation, Assets Sold to Nucor Sub

Another small personal account type idea:

Industrial Services of America (IDSA) is a nanocap ($9MM market cap but trades on the NASDAQ) metal recycling and auto salvage business headquartered in Louisville, KY doing business as ISA Recycling.  On August 19, the company announced the sale of substantially all of their assets to River Metals Recycling, a subsidiary of the large steel producer Nucor Corporation (NUE), for $23.3MM and following the sale, the dissolution of the company with proceeds being distributed to shareholders.  IDSA's balance sheet is a bit of a mess and the company was facing de-listing, but following the liquidation, IDSA expects to distribute $1.15-$1.35 per share, with the stock trading at ~$1.10 that's an attractive 13.5% spread to the mid-point.

The sale is expected to close late 4th quarter or early 1st quarter 2020, IDSA will likely need to reserve some cash following the sale to handle any final wind down expenses and other contingencies but I would expect the bulk of the distribution to happen alongside the asset sale with River Metals.  River Metals is a subsidiary of The David J Joseph Company which is Nucor's scrap metal recycling business, they're in the same business as IDSA so this deal makes plenty of strategic sense, clean tuck-in transaction.  IDSA is heavily owned by insiders including over 20% of the shares owned by the former CEO's family trust, perhaps the family was disinterested and wanted to cash out?  IDSA shareholders will need to approve, but again, it is a fairly tightly controlled company.  It's worth mentioning there is also a closing contingency around a storm-water drain, hard to handicap that.  Anyway, seems like an attractive situation, any thoughts welcome.

Disclosure: I own shares of IDSA

Wednesday, August 7, 2019

Extended Stay America: Rejects Split-Up, Underlying Value Here

Extended Stay America (STAY) is the last remaining public company of size that is an integrated hotel operator and owner of their real estate in the United States (other than Hyatt which is family controlled).  As their name suggests, they compete and are the largest player within the extended stay lodging segment where the average guest stays anywhere from a week to several months.  Demand for the extended stay segment is typically not leisure driven, but rather temporary business assignments, training, relocation bridge housing, medical, or other needs that could span a few weeks.  Extended Stay America has a unique corporate structure where the publicly traded STAY is a "paired" stock, underlying STAY is a hotel management company ("Extended Stay America Inc") and a REIT ("ESH Hospitality Inc"), this structure provides most of the tax benefits of a REIT without the conflicts that can arise between OpCo and PropCo.  ESH Hospitality is 43% owned directly by shareholders via the paired stock structure and 57% owned by Extended Stay America Inc which pays corporate taxes on the dividends received from the REIT.  In the summer of 2018, the company announced it was exploring strategic alternatives with most assuming either a true spinoff or a sale of the management company to one of the hotel brand aggregators with a simultaneous spin of ESH Hospitality (similar to LQ/CPLG/WH last year).  Today, along with earnings, the company announced that it had concluded its strategic review and was going to maintain the status quo, the stock fell 5-10% on the news.

It had been over a year now since that strategic alternatives announcement, the first quarter conference call got a little chippy and some fatigue had built up in the investor base.  Given the relative size of the franchising business and where multiples in the sector are today (especially on the REIT side), I think the company made the right move and event driven sellers (along with the general slide in the market) are providing an opportunity to pick up shares of STAY at a discounted price.

Most of the value is in the real estate and not the management company (unfortunately), as of 6/30, the REIT owned 554 hotels with 61,500 rooms, the management company managed an additional 73 hotels for third parties with 55 more in various stages in the pipeline.  By maintaining the status quo, it allows the franchise side of the business to build up with new construction or conversions, plus ESH plans more asset sales to third parties.   But eventually, the company will succumb to pressure and split the company somehow.  How might that look?

Just to give an idea how STAY is valued today, it essentially trades at the bottom end of the limited service lodging REITs group despite not having to pay a third party management company for its owned properties and having a small franchising business.  Sure there is some tax leakage with the pair structure compared with a pure REIT, but the optionality (it's going to happen someday) on the sale of the management business should make it more valuable than REIT peers, not less.
The extended stay business model is fairly high margin (no frills, rooms cleaned once a week) and STAY generates a decent amount of free cash, roughly $325MM on their current asset base using a maintenance capex of 7% of revenues.  At today's prices, that's a 12% free cash flow yield to the equity.  Looking at it another way, using $80MM of maintenance capex on $564 in EBITDA, STAY is trading at 10x UFCF when they've been selling hotels at ~17x that metric over the past few years.  Management did caution today not to assume that 17x multiple on future asset sales, the next round will be their lower performing hotels, but it's still a useful read through to the disconnect between private and public multiples in real estate today.

Back to what a split might look like: ESH Hospitality would be another economy-midscale REIT similar to CorePoint Lodging (CPLG), it would have the most keys of any lodging REIT but a relatively small market valuation.  If we assume that STAY puts a similarly egregious management and franchise contract on ESH Hospitality as Wyndham/LQ did to CorePoint (I don't think this will be the case since most of the value is in the REIT) with a 5% management fee and a 5% franchise fee, I come up with the following back-of-the-envelope breakout between the two:
Sticking with the LQ/WYN comparisons, if we value the management company similarly to Wyndham Hotels (WH) at 12x and the REIT at 9x similarly to CorePoint Lodging (CPLG), STAY would equate to a combined value of $17+/share versus $14.50 today.  Again, I think this is the worst case split scenario as hopefully management has learned a lesson from CPLG and wouldn't put that management contract on the larger piece of the business.  If the market slowdown passes without a recession we could additionally see multiple expansion back to where lodging REITs traded in 2017-2018.  If the management company were sold versus split off, there would be additional upside as the G&A would essentially be wiped out, perhaps $20+ per share in total under that scenario using today's multiples.  To be clear, this split isn't happening in the near term, but it shows the underlying value in their operations and I believe it's only a matter of time before the market really forces management's hands.

Other thoughts:
  • Just one example of the benefit to STAY's management company being part of a larger brand, as a one-brand entity, Extended Stay's loyalty program is small (under 3 million members), plugging the brand into a larger rewards program could prove valuable to people who are on a temporary work assignment and can use their points on a resort vacation versus another sterile Extended Stay property off the side of the interstate.
  • Labor costs are really squeezing hotel operators at this point in the cycle, unemployment rates are so low that they're having a hard time recruiting labor and are mostly unable to pass that additional cost onto customers.
  • STAY increased their buyback authorization, they have $263MM remaining which is roughly 10% of share outstanding, on the conference call they made it clear they intend exhaust the authorization this year.  Alongside a ~6% dividend yield and that's a compelling total "shareholder yield".
  • Their numbers can look a little messy on a year-over-year basis as they've been selling hotels to third parties, to normalize the 2019 EBITDA vs 2018, you would need to add $21MM for the sold hotels.
  • Management also talked about what a recession might do to their results, anywhere from a $50MM hit to EBITDA in a mild downturn to $100MM hit in a more severe recession, taking those haircuts off of current EBITDA means it would be trading at 9.5-10.5x, certainly not a high valuation considering lodging REITs were trading for 11-12x not too long ago.
Disclosure: I own shares of STAY (continue to own CPLG and WH too)

Empire Resorts: Going Private Offer, Possible Bump?

Empire Resorts (NYNY) is a one property newly built casino resort ("Resorts World Catskills") located about 90 miles from Manhattan in the Catskills region of New York.  The Resorts World branded casino cost ~$1B to build and opened in 2018, it has struggled to ramp up in the year or so that it's been open.  Empire Resorts is 86% owned and controlled by Malaysian billionaire KT Lim, chairman of the Genting Group, via a family trust ("Kien Huat").  On August 5th, Kien Huat made an offer of $9.74 in cash per share for the remaining 14% it doesn't already own, shares are trading for ~$9.25 today (shares are pretty illiquid).  While that's not a tremendous return -- a 5.3% spread (but still good enough) -- this has the possibility of following the path of similar controlled buyouts I've written about in TRK and VLTC where to placate the independent directors (and perhaps save them from shareholder lawsuits) the controlling shareholder bumped up the bid once or twice before entering into a definitive agreement.  From a 10,000 foot view, this feels a bit opportunistic, the resort just opened, casinos often take a little time to season and develop a loyal clientele, sports betting is being rolled out in New York state, and the corporate structure is a little strange as it probably makes sense for this property to be wholly controlled under the Genting umbrella.  Just all feels a bit opportunistic and maybe leads to a small bump.

Disclosure: I own shares of NYNY

Thursday, July 25, 2019

Gannett: Rumored Deal with New Media

Gannett (GCI) is the publisher of the USA Today and about one hundred other midsized and smaller daily publications, newspapers are clearly in secular decline and have been for some time.  Newspaper publishing is an industry that went through a period several years back when there was a trend of spinning off the newspaper business from TV broadcasting or other media businesses (current GCI was a spinoff of the original Gannett that was renamed TEGNA).  I participated in several of those breakups and was lucky to make a little bit of money despite the backdrop of the industry, so why not give it another try with two companies I've written about previously potentially merging.

Last week, the Wall Street Journal reported that New Media Investment Corp (NEWM) was in talks to purchase Gannett in a cash-and-stock deal.  New Media is similar to Gannett, just without the USA Today, they own a bunch of small town newspapers and a couple midsized ones.  New Media is externally managed by Fortress Investment Group (now owned by Softbank), NEWM is one of the few operating businesses (non-REIT/BDCs) I know of that is externally managed, it was a spinoff of Newcastle (now Drive Shack) originating as the result of Fortress buying the debt of local newspaper publisher GateHouse Media (the entity WSJ references as the buyer) within Newcastle and later taking control of the post-reorg GateHouse.  Fortress has since used New Media as a vehicle to roll-up the distressed local newspaper industry at low single digit EBITDA multiples and then pay an out sized dividend to attract retail investors (standard externally managed playbook type stuff).

This deal has a hint of HPT buying SMTA's master trust to it, Fortress gets paid a management fee of 1.5% off of New Media's equity, Gannett is a low-quality asset but represents a way for Fortress to roughly double their management fee with one of the last large willing sellers (the other publishers are mostly controlled/family owned) at a price that both could claim victory with given the synergies at stake.  As an asset gatherer, New Media will be aggressive in pursuing Gannett and will likely get a deal done.

As a little recent background on Gannett, earlier this year they fended off a hostile takeover and later a proxy fight from PE owned MNG Enterprises (dba "Digital First Media"), the owner of the Denver Post and the San Jose Mercury News among other publications.  MNG Enterprises offered $12 per share for GCI (currently trades at ~$9.60) but the hostile bid and lack of committed financing led Gannett management to dig in their heels and resist the effort.  While this was happening, Gannett's CEO stepped down in May and the company has been without a named successor since.

How could this be a win for all three parties (Fortress, New Media, Gannett)?  The Wall Street Journal references $200MM of potential synergies being discussed in the deal, which sounds like a lot compared to Gannett's $290MM EBITDA guidance for 2019, and it is, but there is a lot of overlap between the two's footprint and $200MM is roughly 25% of Gannett's run rate G&A expenses, I think there is some reasonableness to the synergy number that a PE manager could extract from the operations.  New Media's stated acquisition criteria is to buy publishing assets at 3.5x-4.5x EBITDA, GCI trades for 5.6x standalone EBITDA of $290MM (mid-point of 2019 management guidance).
New Media can buy Gannett for "4x EBITDA" using a post-synergy number of $490MM and all three parties can claim victory: 
  1. Fortress gets to roughly double their management fee; 
  2. New Media gets a large acquisition within their stated price target to bleed for continued dividend yield, and given NEWM trades at a premium to the industry (due to the high dividend yield) it would be accretive to shareholders; 
  3. Gannett gets a higher price with credible financing than what they turned down earlier this year justifying their actions
Speaking of financing, New Media's debt is primarily a term loan that is owned by CLOs.  The leveraged loan industry is under a microscope at the moment, primary issuance is down considerably year-over-year as investors prepare for lower interest rates (loans are floating rate products) and loan mutual funds have seen 30+ months of outflows.  However the demand for CLOs has kept a strong bid under loans and have essentially created forced buying of risky debt.  New Media is already a familiar name and present in dozens of CLOs, they could presumably finance a bid for Gannett through this channel.  Fortress is a strong PE sponsor and an active CLO manager in their own right.

So how might a cash-and-stock deal look like?  New Media has conventional debt of $450MM against a $180MM LTM EBITDA, or 2.5x levered, if they added the $490MM (let's save EBITDA addback math for another time) and kept leverage roughly the same they could raise enough financing to pay $6-7/share in cash and then issue the rest in NEWM stock.  I'm also including Gannett's pension shortfall in EV, NEWM likes to exclude their capital leases and pension liability from their leverage numbers so maybe they could justify paying on the higher side of my back-of-the-envelope estimates.  Anyway, I think this deal crosses the finish line as Gannett is floundering and doesn't have a controlling shareholder, New Media wants to gather additional assets for its external manager, it's a win-win for a dying industry.

Disclosure: I own shares GCI (and a few calls as well)

Friday, June 28, 2019

Mid Year 2019 Portfolio Review

The calendar can sometimes play tricks on the way returns look, now in hindsight 12/31/18 was a tough determination date skewing my 2018 results to the downside and now is skewing my 2019 results to the upside.  Through the end of the second quarter my blog portfolio is up 58.3% versus 17.9% for the S&P 500, the big first half has pulled up my lifetime-to-date IRR to 22.5%.  Outsized winners this period included KAR and SMTA due to sizable call option positions and then to a slightly lesser extent big wins in CZR, HHC and MMAC.
Often when I post an idea it's sort of an initial indication of interest, usually starting with a 3-5% position for me, and then in the comments section I get more bullish or bearish on an idea.  KAR Auction Services (KAR) was one of these, I liked the idea and the spinoff of IAA in January, posted on it, received some feedback so when the company conducted an odd conference call in February and the stock subsequently sold off, I was ready to act.  Ended up buying a large (for me at least) position in call options that paid off handsomely, although I sold too soon (last week) given the price movements today on the first day of regular way trading.  IAA looks fully priced to me.  KAR looks potentially cheap depending on how you value TradeRev and RemainCo's closest public peer, BCA Marketplace in the UK, was sold this week to private equity for 12x EBITDA.

Other Closed Positions:
  • Caesars Entertainment (CZR):  Eldorado Resorts (ERI) and Caesars inked their cash and stock deal earlier this week with a headline price of $12.75 per share, with much of the cash coming from VICI Properties (VICI) via the sale leaseback of three casinos.  The deal price isn't too far off of what I paid in 2017 for my initial position in CZR through CACQ, but it is a big move from the 4Q lows when the world was potentially falling apart, what a difference 6 months can make in the markets.  Now seems like a good time to back away from the gaming sector, I'm interested to see how the industry does through the next recession, especially with the PropCo/OpCo model that's all but rolled out across the entire group.  I suspect we'll see some opportunities and dislocations there in the future, but for now I'm going to wait on the sidelines. 
  • Spirit Realty Capital (SRC): When the news broke that SMTA had sold the assets in their master trust to HPT, I took the opportunity to exit SRC and roll some of that into SMTA.  SRC will be a vanilla net-lease REIT by the end of the year and it'll probably trade up a bit higher from here as the multiple plays catch-up, but an acquisition by one of the larger net-lease names is likely off the table.  There are enough net-lease properties in private hands that there's no reason for someone like Realty Income (O) to buy SRC, they could issue their expensive shares in a secondary and buy cheap assets directly without the headache and expense of a merger.
  • Mitek Systems (MITK): Mitek Systems ended up dropping their strategic process, they have new management that presumably wants to create value independently (and not lose their jobs), the company has a strong niche, but investing in a small software growth stock wasn't my initial thesis so I sold it for a small gain.
  • Hamilton Beach Brands (HBB):  I was still holding onto a stub position in HBB as a result of its 2017 spinoff from NACCO Industries (NC), ended up selling it as I just didn't have conviction enough in the company meeting its long term revenue goals in the face of increasing pressure from Amazon.  Amazon's advertising model to get into the top of the search results is going to pressure margins going forward.
  • OncoMed Pharma (OMED):  Mereo Biopharma has been a disaster since the reverse merger with OncoMed, it's notably tied up in the Woodford Patient Capital Trust mess and likely has an overhang as a result.  Celgene also decided not to exercise their option on a drug that was 2 of the 3 CVRs in this transaction, chalk this one up as a loss.
  • Voltari Corp (VLTC):  This tiny NOL shell ended up being a home run for those small enough to get into it, the final price was $0.86/share versus the initial $0.58/share offer Icahn made to start things off.
Portfolio as of 6/30/2019:
CVRs: GNVC, INNL, MRLB, OMED
Disclosure: Table above is my blog/hobby portfolio, I don't manage outside money, it's a taxable account and a only portion of my overall assets.  The use of margin debt, options, concentration doesn't fully represent my risk tolerance.