Tuesday, April 8, 2014

BioFuel Energy's Reverse Takeover

Greenlight Capital and developer James Brickman are proposing that BioFuel Energy (BIOF) purchase JBGL Capital, a residential developer and homebuilder controlled by the two, for $275 million in a reverse takeover transaction to take advantage of the failed ethanol producer's $178.2 million in net operating losses.

BioFuel Energy was founded in 2006 in the middle of the ethanol craze.  The company operated two ethanol plants, one in Nebraska and one in Minnesota, which produced ethanol and related products for the company until this past November when they turned their assets over to the lender in a foreclosure.  After the foreclosure, BioFuel Energy is now a shell company with two assets, $10.8 million in net cash and the aforementioned $178.2 million in NOLs.

At year end 2013, hedge funds Greenlight Capital and Third Point owned 35.4% and 17.4% respectively of the company, one that's a rare investing black eye for each.  The NOLs are clearly valuable, otherwise the company would be liquidated and the $10.8 million would be distributed to shareholders, but the NOLs are only valuable if they can construct a transaction where there isn't a change of control in the mind of the IRS.  In comes the home builder transaction where Greenlight is already the lead investor.  There isn't much available about JBGL Capital on their website, but Greenlight would only choose an asset that would throw off taxable income to utilize the NOLs, so its reasonable to assume its fairly profitable.   I tend to like the residential real estate sector right now and think home builders will have the wind at their back for some time as we're still far below historical new home starts in the US.  The millennials generation will one day move out of their parents basement and start buying homes, just might take longer than most expect due to the financial crisis hangover and student loan debt.

Transaction Details, $275 million for JBGL Capital, compensated by the follow ways:
  1. $150 million in debt financing provided by Greenlight, 10% fixed interest rate for a 5 year term with a 1% prepayment penalty during the first two years.
  2. A rights offering of at least $70 million, with each holder able to purchase shares at 80% of the 10 day average closing price following the official registration statement.  Maximum price is $5.00, minimum is $1.50.
  3. Equity issuance to Greenlight/Brickman, this will ensure that Greenlight owns 49.9% of the shares following the rights offering and James Brickman will own 8.4% of the shares.
  4. Cash of $10.8 million currently held by the company
The debt is the most concerning of the above; 10% is awfully high in such a low rate environment, but I view this as Greenlight's preferred return for choosing the asset and being the company sponsor.  But after a few quarters of profitability, you'd assume the company could refinance the loan, but with Greenlight/Brickman being the lenders, would they be conflicted in facilitating a refinancing?

However everything else sets up pretty nicely, post transaction, David Einhorn will become the Chairman of the Board and James Brickman will be the CEO and join the board as well.  So Greenlight will remain the sponsor and presumably a long term shareholder of BioFuel in order to retain the NOLs, any "change of ownership" would disqualify the NOLs in the eyes of the IRS.

At the current price of about $5.30, you get around $2 per share in cash and the market is valuing the NOLs at $3.30 per share or only ~$17 million.  That's a reasonable valuation without any specific details of JBGL Capital which should come with the rights offering and subsequent filings.  BioFuel Energy, probably due to its name, former industry and low float, seems to now be on the radar of unsophisticated momentum traders which could make for a wild ride until the transaction is completed, but I took a very small starter position in the name (with the intention to participate in the rights offering) as I think there could be substantial upside once the dust settles.

Disclosure: I own shares of BIOF


  1. You close the $BIOF position during the runups?

    1. Yes, I closed my position on 4/21 at $8.15, the trading activity just didn't make sense to me and broke from reality: http://clarkstreetvalue.blogspot.com/2014/04/momentum-traders-and-biofuel-energy.html

      Also interesting - today they got a delisting notice because it's a public shell company with no operating assets (no news here to anyone who has read any of the SEC filings) and the stock dropped significantly after hours. Its clear that most people trading in this have little clue what it's actually worth. But, I'm still interested at the right price.

  2. What do you think is the end game here for Einhorn? I mean why dick around with a $30M market cap shell co unless he sees outsized upside? Its one thing for a $9B fund to have tiny residual position like BIOF but filing 13Ds with proposals is really getting involved.. Also, wondering if per proposal, his combined 58.3% (49.9%+brickman 8.4%) position might not taint the NOLs? Any thoughts?

    1. Well he's already the lead investor for JBGL Capital, the asset they're proposing merging with BIOF, so the end game for Einhorn is to use the NOLs and shield JBGL from taxes, so it's just moving JBGL from the left hand to the right hand (and extracting some gains in between) for immediate jump in valuation now that JBGL won't pay taxes.

      I would also point out that JBGL might not be the only asset that ends up in the BIOF shell, they'll likely need to make additional acquisitions to use up the NOLs in a reasonable time frame.

      As for the NOLs, I think that's entirely the reason for the rights offering and the poison pill they issued before the rights offering was announced, I would guess Einhorn and team have fully vetted the tax ramifications before making the proposal.

    2. That is my feeling too (on vetting tax ramifications) but I would imagine that they will need to get an opinion from the IRS before moving forward.

      I am befuddled by NOL shells, I mean, how some of them work (INSP now BCOR, WMIH) whereas others, with $billion NOLs are simply liquidated (SCMR).

      BTW, I disagree that NOLs are the entire reason for Einhorn's proposal. Turning a shell into an opco is the main reason as the former trades with little value and the latter will trade at a multiple of revenues/earnings. NOLs are important but secondary to the story in my opinion.

    3. Thanks for the comment, I forgot about SCMR, looked at it a few years ago so I'll have to revisit the story. As for your last point, if the NOLs weren't the reason for the proposal, why wouldn't Einhorn liquidate the company? It was trading for under net cash for months. If it weren't for the NOLs, he could have just liquidated, taken the cash and IPO'd JBGL separately (although at presumably a higher overall cost than the current proposal).

    4. NOLs definitely play into the plan but I think this was a unique situation given that Einhorn has been involved in BIOF for years (actually since 2007) and can avail NOLs without tainting them via ownership change rule.

      What I meant by my comment of value was that NOLs, at the most (at 35% rate) are worth ~$60M, un-discounted for time value. On the other hand, a potential $1 in EPS for an opco at a reasonble 10 multiple could be worth upward of $400M if you do the math on a RO and share issuance at $5.

      BTW, I really appreciate the discussion here because I have seen the half-wits on Twitter trading this name, they haven't a clue.

    5. True, I agree. But without knowing how much JBGL makes on an unleveraged basis, can we really assign a definitive value to it? I thought it was worth a small speculative position in the low-mid $5, probably still is in the low $6s too.

      Great discussion, I'm definitely paying close attention to how this transaction turns out.

  3. Any idea of the ROI of BIOF since you profiled the name?

    1. I've traded in and out a bit before the rights offering, but to make it simple let's say you bought 1000 shares at $5.30 on 4/8/14, and then fully subscribed on 10/17/14 for another 2,244.5 shares, you would have spent a total of $16,522.50, and those shares would be worth $23,782.19 today. That's a 44% return on your cash invested, but the timing of the cash flows throws off a basic NOI a bit, so its close to a 240% IRR.