Saturday, February 25, 2017

Tropicana Entertainment: Buyback Plan Ramping, Tender Coming?

Tropicana Entertainment (TPCA) is the Icahn Enterprises (IEP) controlled regional gaming operator with 8 casinos and related hotels, bars, restaurants, and entertainment venues.  I've covered it a few times on the blog and have owned the stock since early 2013, to summarize the story:
  • Carl Icahn (through IEP) owns 72.5% of the shares and has a solid track record of investing in gaming throughout the cycle.
  • Given Icahn's ownership, Tropicana's free float available to the public is small and the shares trade rather infrequently on the pink sheets which limits the number and size of potential investors despite TPCA being an $810MM market cap company.
  • Tropicana's balance sheet is unlevered with minimal net debt, fairly unique in the regional casino industry where most peers are heavily levered and its not uncommon to see leverage over 5-6x (especially when including operating leases).
  • Tropicana's flagship casino is located in Atlantic City, a market that has seen a precipitous decline since the recession (which pushed Tropicana into bankruptcy) as competition has destroyed Atlantic City's once gambling monopoly on the east coast.  Since 2014, the number of casinos in Atlantic City has dropped from 12 to 7 with the latest casualty being Icahn (but not TPCA) owned Trump Taj Mahal which closed in October.  Tropicana has been able to capture increased market share in Atlantic City as a result of the closures and Caesars underinvesting there due to their prolonged bankruptcy.
  • The shares trade at a significant discount to peers.
The 10-K was posted today, Tropicana doesn't host conference calls or issue press releases targeted at investors, so the SEC filings are really the only place to gain insight on the company.  Business results continue to steadily move along -- Tropicana primarily targets drive-in markets and focuses on slots as they have more consistent results and require less staffing, with the goal being more predictable results -- nothing in there was too worthy of an update until I got to the share repurchase section.

Share Repurchase Plan
Tropicana initiated a $50MM buyback program in July 2015, but given the limited free float and low trading volume it was a bit head scratcher to determine how the company would execute on that plan without significantly impacting the share price.  Over the following 15 months the company only purchased ~$6MM of shares, but then something happened during November and December of 2016, Tropicana bought over $37MM worth of shares at an average price of $27.62.  What changed?  The election?  Hard to tell, but given the undervaluation and how long the shares had been languishing around $15-18/share, it appears the company decided it should be its own catalyst.
Additionally, if you look at the fine print, on 2/22/17, the board authorized an additional $50MM buyback authorization for a total of $100MM, with about $57MM left remaining.

As of 12/31/16, there were 24,634,512 shares outstanding, of which Icahn Enterprises owns 17,862,706, so while the market cap is about $810MM, the free float is only $222MM, the remaining share repurchase authorization is then over 25% of the non-Icahn shares outstanding.  The company has $240MM in cash, more than the free float, the company could continue to buyback shares and effectively take itself private while bringing their capital structure more inline with peers as they go.

Icahn Enterprises each quarter puts out an indicative NAV, questionably they don't use the market value of their TPCA holding, but instead put a private market value on it given its low trading volume.
IEP marks their ownership in Tropicana at $877MM or $49/share which is 8.5x EBITDA as of 9/30, shares closed today at $32.90.  If Icahn believes in this valuation, continued share repurchases make a lot of sense and would be accretive to IEP's NAV.

While the stock price has about doubled over the past 12 months (now we know why) without a significant change in the business, given the company's appetite for their own shares, Tropicana Entertainment continues to be a very compelling opportunity.  At some point, I wouldn't be surprised to see Icahn Enterprises conduct a tender offer for the remaining shares like it recently did with Federal-Mogul.

Disclosure: I own shares of TPCA

Actelion: J&J Deal Offers a Free R&D Spinoff

Catching up a bit here after a busy few weeks, so not breaking any news here, but again I like putting my positions in writing.  I don't understand biotech, but I've been looking for ways to get a free look or a small merger security in a biotech that could be used as a tracker position, enough to keep me interested in following their development pipeline.

On 1/26/17, Johnson & Johnson (JNJ) won the bidding war against Sanofi for Actelion (ALIOY), a Switzerland based biotechnology company led by Jean-Paul Clozel whose main drug is Tracleer which treats aterial pulmonary hypertension.  Johnson & Johnson is paying $30B or $280 per share ($70 equivalent for the ADR), but the interesting aspect is immediately before the deal is completed, Actelion will spinoff their R&D pipeline of 14 products, most of which are years away from potential commercialization.

Often in biotech or pharmaceutical mergers the bid-ask spread is wide because the target believes in their R&D pipeline far more than the acquirer is willing to pay for it.  This problem is often solved with a contigent value right (CVR) that pays off if a drug in development meets certain targets, the CVR bridges the valuation gap.  The spinoff (or demerger as they're called outside the U.S.) contemplated by the Johnson & Johnson/Actelion deal functions very similar to the a CVR, Jean-Paul Clozel believes in his product pipeline far more than Johnson & Johnson was willing to pay for it.  Per the offer prospectus that was released last week, the spinoff was essentially a condition of sale for Actelion:
On October 18, 2016, Mr. Gorsky sent a second letter to Mr. Garnier in which J&J proposed to acquire all Actelion Shares at a revised price per share. On October 25, 2016 the Board of Directors, together with representatives of Niederer Kraft & Frey, Wachtell, Lipton, Rosen & Katz (“Wachtell Lipton”) and Slaughter and May, met to discuss the revised proposal and, after thorough consideration of the revised proposal, determined that the revised offer price did not reflect Actelion’s intrinsic value. In particular, the Board of Directors believed that the revised proposal continued to undervalue Actelion’s preclinical discovery and clinical pipeline business, and that, while Actelion would be willing to engage in discussions concerning a transaction with J&J, Actelion would require a higher indicative offer price before engaging further. Following the meeting, Mr. Garnier conveyed this decision to Mr. Gorsky. 
Mr. Garnier and Mr. Gorsky remained in contact in late October and the first half of November 2016. Mr. Garnier continued to express to Mr. Gorsky the Board of Directors’ concern that J&J’s prior proposals failed to provide adequate value for Actelion’s preclinical discovery and clinical pipeline business. In order to bridge the valuation gap, Mr. Garnier proposed the Demerger as part of an alternative transaction structure, in which Actelion would spin off its preclinical discovery and clinical pipeline business prior to Actelion’s acquisition by J&J. The representatives of J&J expressed their willingness to consider the Demerger structure, but indicated that the complexity of the Demerger, as compared to straight-forward acquisition, would require additional time to negotiate.
The spinoff, currently dubbed "R&D NewCo", will be capitalized with CHF 420MM in cash from Actelion prior to the spinoff and Johnson & Johnson will contribute another CHF 580MM in the form of a convertible loan, part of which will convert immediately to a 16% ownership in R&D NewCo with the other 84% owned by prior Actelion shareholders.  The remaining loan will be convertible to another 16% of R&D NewCo by Johnson & Johnson at any time for 10 years.  So while R&D NewCo will be independent, they'll have a built in partner in Johnson & Johnson to advance their pipeline to commercialization.

I don't know much about R&D NewCo's pipeline, but I'd encourage anyone interested to watch Actelion's CEO Jean-Paul Clozel's remarks in the deal announcement press conference:

He owns 3.6% of Actelion, Johnson & Johnson is paying $30B for the company, he's set to get paid over $1B in cash for his shares, yet he's going to R&D NewCo and sounds excited to get back to early stage research and be relieved of the sales and marketing overhead of running a commercial pharmaceutical company.

Deal Risk
There was report in the days following the merger announcement that Actelion's Uptravi drug was linked to 5 deaths in France, but those concerns have seemed to be pushed aside as it came out that Johnson & Johnson knew of the issue ahead of time and the European Medicines Agency (EMA) recommend on 2/10/17 that the drug could continue to be used despite the probe into the deaths.

The Material Adverse Effect clauses seem fairly standard to my novice eye:
A Material Adverse Effect means a reduction of:
(i) the annual consolidated earnings before interest and taxes (EBIT) of CHF 98.3 million – which is an amount equal to 15% of the consolidated EBIT of the Company and its Subsidiaries in the financial year 2015 as per the Company’s annual report 2015 – or more;
(ii) the annual consolidated sales of CHF 204.5 million – which is an amount equal to 10% of the consolidated sales of the Company and its Subsidiaries in the financial year 2015 as per the Company's annual report 2015 – or more.
When determining whether a Material Adverse Effect has occurred with respect to the Company and its Subsidiaries, taken as a whole, the following changes in circumstances, events, facts or occurrences shall not be taken into account, individually or together:
(i) any circumstance, event, fact or occurrence in the industries in which the Company and its Subsidiaries operate or in the economy generally, except to the extent (and only to the extent) that such circumstance, event, fact or occurrence disproportionately affects the Company or any of its Subsidiaries relative to other participants in the industry in which the Company and its Subsidiaries operate; or
(ii) any circumstance, event, fact or occurrence that arises from or relates to R&D NewCo, the R&D Business or any of the Transferring Business Assets or Assumed Liabilities, in each case as defined in the Demerger Agreement, except to the extent (and only to the extent) such circumstance, event, fact or occurrence affects any other aspect of the Company or its Subsidiaries; or
(iii) any circumstance, event, fact or occurrence that arises from or relates to the commencement of sales of a generic form of Bosentan (marketed by the Company as Tracleer) in the United States. 
Johnson & Johnson has a lot of cash overseas, this deal helps solve some of that problem as we all wait for the new administration to change repatriation tax laws.  This deal seems fully vetted by both sides and fairly safe to close, the offer prospectus puts the earliest close date at 5/5/17, but seems likely that might get pushed back to June based on the initial guidance.

The ADRs which represent 1/4th a share currently trade for $67, representing a 4.4% absolute return to the $70 offer price, the spinoff is worth something, let's call it $1B for another $2.30 per ADR or ~$9 per Actelion share traded on SIX in Switzerland.  Add in the spinoff, and the current spread represents an 8% return by the end of June.  I could also see R&D NewCo being sold off indiscriminately after the deal closes as it's rather tiny compared to the overall deal and traditional arbritrages don't want to hold a development stage biotech longer than needed.  So this could be a two staged investment, capture the deal spread, and then reinvest some of the proceeds into R&D NewCo.

Disclosure: I own shares of ALIOY