Friday, July 31, 2015

WMIH Corp: KKR Controlled NOL Shell

A simple and brief investment idea today, it's been teased and mentioned a few times in earlier posts on other NOL companies.  WMIH Corp (WMIH) is the remaining shell of the former subprime lender Washington Mutual which became the largest bank failure before most of its assets were sold via the FDIC to JPMorgan Chase in September 2008.  What remains in the old corporate shell is approximately $6B in net operating losses, a small reinsurance business that's in runoff, and $600+MM in cash set aside for a future acquisition.

KKR is effectively in control of the company via the $600MM convertible series B preferred stock issued in January of this year, the proceeds of which are in an escrow account.  KKR is one of the original leveraged buyout shops and gives WMIH Corp access to deal flow and an experience management team.  SPACs and "platform companies" are a current rage, add that with the M&A reputation of KKR and any WMIH acquisition could be met with investor enthusiasm.

Valuation
WMIH Corp has cash of $670MM to use for an acquisition, $600MM in escrow and $70MM at the corporate level (I'm ignoring the cash and investments inside the runoff reinsurance company).

Let's assume KKR will just use the escrow funds and leave the $70MM for liquidity, they could make an acquisition using half equity, half debt for a $1.2B operating company generating $200MM in pre-tax earnings.  Using a 10% discount rate and assuming 3% annual growth rate in the pre-tax earnings the NOL could be worth an NPV of ~$750MM.  That's probably on the low side, 1) KKR will likely make a larger initial acquisition and raise capital via a rights offering (similar to GRBK, PARR, RELY) to bring forward the NOL value, and 2) there will be additional bolt-on acquisitions over time that will increase earnings at a faster clip than 3%.  But to be conservative, let's use the $750MM value for the NOL.
Assumes 3% earnings growth rate
WMIH Corp has also granted warrants for 61.4 million shares at an average exercise price of $1.38 per share which will raise nearly $85MM.  Add that with the $670MM in cash, plus the $750MM NPV of the NOL, totals $1.5B for WMIH.

The current share count doesn't include the dilution of the various warrants and convertibles in WMIH Corp's capital structure.  KKR's series B preferred stock will convert to equity at the time of an acquisition at a price of $2.25 creating 266,666,666 shares, add in the 1 million shares of Series A convertible preferred stock and the warrants will add another 61.4 million shares to the current outstanding 202.3 million, or a total of 531.4 million shares.  Using the $1.5B valuation number, that works out to $2.82 per share versus about $2.50 today.  So you're merely getting an okay deal today for the shell, but the incentives and potential leverage in an acquisition are such that there could be substantial value creation once a deal is commenced.

Risks/Other:
  • KKR is unable to find a suitable acquisition, pays the wrong price, or just simply takes too long creating an opportunity cost for investors.
  • At the time of an acquisition, there will probably a rights offering, so keep that in mind when sizing a position.  Trading around deal announcement, rights offering, and deal closings have been extremely volatile in these NOL shells, so even when there is good news, could be a wild ride.
Disclosure: I own shares of WMIH

15 comments:

  1. Hey buddy, this is going to sound really stupid but I once told someone that I had a typed up a short report on a great idea. After a few hours, I got a frustrated email back from this guy "why did you say it was a short when you clearly think this is a long?" Now I use the word brief instead of short - too many guys in this business with ADHD.

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  2. There may be a "hidden asset" here...

    Read this: http://www.sec.gov/Archives/edgar/data/933136/000119312515239575/d948466d8k.htm
    and read this: http://www.sec.gov/Archives/edgar/data/1545078/000090951815000241/mm07-3115_8ke991.htm

    It is not easy to decipher/ascertain exactly how much more could come WMI's way from this Trust and also near-impossible to figure out if there is a possibility of gains from future litigation by the Trust.

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  3. Do you mind explaining your math on the value of the NOLs you've calculated in the table?

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    1. Sure, the left hand column is the starting pre-tax earnings, I increased the earnings 3% annually, used a 35% tax rate and then discounted it back to present using 8%, 10%, and 12% discount rates. Under all scenarios the NOLs were burned off before they begin to expire so there was no adjustment for that.

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  4. On Monday WMIH will start trading on the NASDAQ, the official reason given is an agreement made to list on a national exchange pursuant to the KKR capital raise, but it could be signally a deal is on the horizon.

    http://www.sec.gov/Archives/edgar/data/933136/000119312515327424/d38203dex991.htm

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  5. Hi MDC -

    Did it bother you at all that this company spent so much money in the quarter on a deal that didn't close? $10M+!!
    They dont disclose who got the fees...Blackstone or KKR? That's $3.3M per month. I have been on the corporate side and find this egregious.

    Does it bother you that KKR charged a fee acting as a placement agent for the money that they invested in WMIH?

    The two guys that they brought on as CEO/COO at WMIH have been part of other KKR deals as well... now they are getting paid half a million each plus bonus plus stock for doing nothing. Is this KKR's G&A being offloaded on WMIH?

    I could be wrong about all this but it seems that WMIH might have become KKR's piggy bank with its cronies doing its bidding.

    I understand the NOLs and what not "value" argument but it seems like it mostly belongs to KKR now, and the rest of us are just there with a hope and prayer to make money alongside. Meanwhile, KKR is making money.. now.

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    1. I did see that, and I had a similar although more muted reaction but it does seem egregious. I wouldn't automatically jump to something nefarious is going on, but they clearly need to be more cost conscious. This must have been a pretty big fish, not sure how many of those are around and what this does to the acquisition timeline, probably pushes it out another 6 months minimum, where they'll incur more expenses and reduces the NPV of the NOLs, actually surprised the stock hasn't move down more. Still holding here, maybe that's a mistake.

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    2. Any updates on this one? Seems like they just can't get a deal done.

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    3. No update really. It almost seems like the huge NOL is almost a determent, limits their M&A opportunity set, they need something fairly big that could also lead to additional acquisitions.

      Talks of lower corporate rates does impact the valuation of the NOL, but the recent selloff seems overdone to me.

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    4. Book value is about $1.29. This could keep drifting lower until deal is announced. I'm not sure what happens if no deal happens one year from now when the preferred shares need to be redeemed.

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    5. You may want to check out Pendrell (PCO)... backed by Jim Dondero/Highland Capital (same team responsible for NHF/NXRT)... $172m cap with $176m in cash and another $30m note receivable coming in over next 12 months...

      They have $2.6bn in NOLs and are searching for an acquisition... In this case however, you get the negative EV as well!

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    6. I've looked at PCO in the past, like it, don't own it, would like to own it but seem to always have more actionable ideas than waiting around for an NOL shell to finally do something. But I must have missed that Dondero was involved with it as well, makes it interesting, but I'd caution that he's a bad guy, I know people that have worked with him in the past, had a lot of people reach out to me after my NXRT posts as well. He likes to change the rules to his benefit and screw his investors/employees/service providers is the main takeaway. Doesn't mean you can't make money with him, but look for how he's going to screw you, he's going to, just depends how bad.

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    7. Also reminds me to look at RAIT, that's another where Highland is pushing for action.

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    8. Dondero is involved but not in control... Telecom billionaire Craig McCaw controls voting shares along with Bill Gates...

      I know "waiting around" doesn't sound enticing but CEO Lee Mikles takes almost all pay in long-term equity as opposed to cash salary... whatever that's worth, I think he has some incentive to get something done...

      At worst, I think it's a decent trade up to net cash (call it $200m or $7.45/share)...

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