Quick Post on PHH Corp

The PHH Corporation story is pretty well known at this point.  Before two weeks ago, it operated in two unrelated businesses: mortgage origination/servicing and fleet management leasing.  At the insistence of an activist campaign (which the activist curiously exited last week) the company sold off it's fleet management business to Element Financial Corporation for $821MM net of taxes ($1.4B pretax) to create a purer play on mortgage origination and mortgage servicing rights.

The mortgage origination business is struggling in the current environment, refinances have mostly dried up as those who could refinance already have and the home purchase market has yet to really show signs of strength as consumers are struggling with debt and stagnant wage growth.  The servicing side of the business however should become more valuable as interest rates rise and fewer mortgages are refinanced stretching out the length of time borrowers maintain their mortgage and increasing the servicing fees collected by PHH.  The business is at a cyclical low, layoffs are in the thousands across the industry, sentiment is low, and that creates a potential opportunity when teamed with the sale of the fleet management business.

The market cap of the company is only $1.4B, so the sale of the fleet management business represents a large cash infusion, PHH laid out it's plans in a recent investor presentation:

PHH is planning on repurchasing up to $450 million in stock over the next 4-5 quarters, including $200 million shortly after the 2nd quarter earnings release, or a total of ~32% of the market cap.  PHH's shares trade at 0.75x proforma tangible book value (with the optionality of the mortgage servicing rights value increasing in a rising rate environment) and within a few weeks there will be a large indiscriminate buyer in the market scooping up shares.  Approximately 30% of the shares are short, and 40% of the shares are in the hands of Hotchkis & Wiley, PIMCO, Citadel, and DFA, plus another 10% in index funds, sets itself up for a potential small short squeeze rally.  So in the end, you get a business that's retooling itself for the next stage of its business cycle at a cheap price with a near term catalyst.

Disclosure: Long a small amount of PHH

CBS Outdoors Americas: Split-Off, Exchange Offer, and a REIT Conversion

Following up on the REIT conversion theme that is ever so popular this year, there's an interesting exchange offer giving CBS shareholders the opportunity to swap CBS shares for CBSO at a 7% discount.  CBS Outdoors Americas (CBSO) is another REIT conversion that split-off of CBS Corporation (CBS.A/CBS) earlier this spring via an IPO of 19% of the company on 3/27/14 (CBS retained the remaining 81% stake).  

CBS Outdoors is a billboard and out of home display advertising company that operates over 350,000 billboards throughout the United States, Canada, and Latin American.  The company generally owns the physical billboard assets but leases the underlying sites from property owners.  Their advertising revenue contracts are usually short term in nature, however billboard advertisements are seen as DVR proof (or as the company puts it "always on") and their popularity has increased in recent with advertisers as print and other forms of advertising have suffered.  The company is focusing its capex efforts on converting select billboards to a digital format which brings in 3-4x the revenue as engagement improves and advertisers can be more targeted (night versus daytime, etc).  It's an established business that's relatively stable, although is subject to the cyclical nature of the economy as advertising dollars ebb and flow.

The main reason for the split-off is so CBS Outdoors can convert their corporate structure to a REIT and eliminate most corporate level taxes.  Unlike some of the other conversions I've been highlighting, CBS Outdoors has already secured the private letter ruling (PLR) from the IRS back in April which is why the pre-REIT discount isn't as significant here.  But because CBS still owns 81% of CBSO, it cannot formally convert to a REIT until after the exchange offer is complete, which it plans to do immediately.  The conversion purging dividend isn't a big issue here, estimated at $500 million, $100 million of that will be in cash (or ~$0.83 per share) and the other $400 million will be in shares, or roughly 12.4 million (+10% to the outstanding) in additional shares.

CBS Outdoors has two pure play display advertising rivals in the US: Lamar Advertising (LAMR) and Clear Channel Outdoor Holdings (CCO).  Lamar is also pursuing a REIT conversion, Clear Channel is a little murkier as it has a complicated private equity structure that makes comparasions more difficult.  They're all valued roughly the same at 11-12.5x forward EBITDA, but that's still a moderate discount to the REIT universe that trades for 15-20x EBITDA.

From an AFFO prespective, CBSO earned approximately $2.00 last year, so proforma for the purging dividend its trading at 15x trailing AFFO.  Not screaming cheap, but still a slight discount to traditional REITs.

I tend to look for opportunities that don't screen well, CBSO doesn't look attractive on a traditional P/E basis (~22x), even though the REIT conversion is well known, it will take some time for REIT investors to become familiar and comfortable with the outdoor sector.  One risk to note is CBSO will not be included in any well followed indexes after the exchange offer is completed which may increase the time it takes to gain acceptance in the REIT sector.

As a way to get an even better valuation, CBS shareholders can exchange their shares for CBSO shares at a 7% discount.  The exchange essentially works as a buyback for the parent CBS as it will retire the shares that are offered in the exchange.  There is an odd lot provision where holders of fewer than 100 shares of CBS will not be subject to proration provided they tender all their shares.  No fractional shares will be issued, and there is an upper exchange limit of 2.1917 CBSO shares for each CBS share.  The offer expires on July 9th, so if you want to participate you need to act quickly.  After the exchange is completed, CBS Outdoors will have the right to keep the CBS name for 90 days before rebranding, and they'll have up to 18 months to rebrand the 350,000 billboards which sounds like quite the endeavor as well.

Overall, CBS Outdoors Americas is a moderately undervalued security that is made more attractive via the exchange offer.  I purchased 99 shares of CBS, to avoid the proration, and have submitted my shares for exchange effective next week.  I don't anticipate making it a long term holding (few weeks to a few months), but I'm comfortable participating in the exchange offer and accepting the market risk given CBSO's relative undervaluation compared to REIT peers.

Disclosure: I own shares of CBS, going to fully exchange for CBSO

Mid Year 2014 Portfolio Review

In my year end 2013 portfolio review,  I planned to do this quarterly, but I don't think I'll have enough commentary or trades to give a full update each quarter.  Going forward, I'll do a portfolio performance review semi-annually.  Onto the results (there were no deposits or withdrawals into the blog portfolio during the period):

The first half of 2014 has been great, just about all of my ideas have been working, but I don't have any visions of this continuing at the current pace.

However, a lot of value investors get too caught up in the macro picture, trying to outsmart the market by holding large cash positions, tweeting links to examples of excess in the market, and attempting to call a market top.  It always sounds clever to be bearish and pessimistic, but it's not productive unless you're trying to build followers.  I'd rather focus on finding a handful of mispriced securities than constantly worrying about when the next market correction is going to happen, it will at some point, but for smallish investors it leads to bad decision making.

Current Portfolio

 Positions Closed

You'll see I disposed of the thrift/mutual bank conversions, I still like the strategy and will continue to highlight conversions I find attractive, but for now I'm going to pass until I increase the size of the portfolio or macro conditions change.  I'm finding too many other opportunities available that don't have 2-3 year opportunity costs like a thrift conversion.  I also work for a large bank and I'm fully aware of the headwinds facing the entire industry, especially those highly weighted towards net interest margin like small community banks.

There are so many spinoffs happening right now it's hard to keep them all straight.  Despite the value creation being fairly well known at this point, spinoffs still outperform as a group.  I'm going to try to identify a few that I find interesting in the back half of the year.  Then exploiting them either by buying a call option if I believe the spinoff is actually the more attractive asset (like OIS/CVEO), or wait until regular trading occurs and buy the spinoff if its the orphaned business that gets sold indiscrimately.  I also like the REIT conversion trend, curious to see if these conversions and tax inversions acquisitions will finally spark some corporate tax reform in Washington.

Position Thoughts/Updates

Howard Hughes Corporation
Lots to like at Howard Hughes Corporation, they're aggressively investing in their "strategic assets" which will make their way into operating asset bucket over the next few years.  At some point in the future, it doesn't make sense to have these stabilized operating properties in a C-Corp structure, so another REIT spinoff could be in the offering once the NOLs are used up.  I like this company as a long term compounder, they have quite a few levers to pull and a capital allocation/shareholder focused management.  At a recent investor presentation, management quipped that an analyst's $200 price target was too low, I would agree.

MuniMae
It's balance sheet has uncovered most of the hidden real estate value due to accounting consolidation rules already creating a quick gain.  The question is what's next?  I like the share repurchase program, but that doesn't really help the fact that they're too small to be a public company, and they're only breaking even on an operating basis.  MuniMae has an incredible amount of NOLs, they should be initiating a rights offering and buying an operating business that throws off taxable income.  It's no longer a screaming buy, but I'm going to hold and let the situation play out more.  However, it's towards the top of the sell list if I need cash for a better idea.

Ultra Petroleum
The Uinta Basin purchase is a nice bridge asset, its going to be cash flow positive right away and gives management and analysts something to focus on while waiting for natural gas to resume its climb up.  There's still a huge spread between natural gas prices in the United States and what it fetches in foreign markets.  Given the recent news about oil exports being allowed for the first time in 40 years, more LNG export terminal approvals might be in the offering as well, long term this spread should narrow.

Disclosure: Table above is my blog/hobby portfolio, its a taxable account, and a relatively small slice of my overall asset allocation which follows a more diversified low-cost index approach.  The use of margin debt/options/concentration doesn't represent my true risk tolerance.

More Thoughts on Civeo Corporation

I gave an investment pitch at a CFA Society of Chicago roundtable today with a "Value investing in a not-so value world" topic theme, my idea was Civeo Corporation, below is the deck I used, been a great winner for me so far via a pre-spin call option that expired today.  I presented a pretty bullish view for the purposes of the pitch, but I think it has decent room to the upside as they pursue a REIT conversion.

Disclosure: I own shares of CVEO, sold my shares of OIS

Cadus Corporation: Flip this House with Icahn

Cadus Corporation (OTC:KDUS) might be familiar to a few value investors who enjoy having their patience tested.  Cadus is a former drug development company that sold essentially all their assets in 1999 to OSI Pharmaceuticals (which itself was purchased by Astellas Pharma in 2010).  Ever since Cadus has been more or less a shell company, with cash and some net operating loss carry forwards (zero revenues, no full time employees only a part time CEO earning $25,000 per year).

Carl Icahn has been a major shareholder of the company since the mid-1990s, and has resisted calls from investors to liquidate the company citing the $19,341,000 of NOLs.  It may seem tiny to a multi-billionaire, but Icahn is probably the type where it bothers him leaving any amount of money on the table.  In February, he finally got moving and Cadus announced "the company is currently seeking opportunities to profit from purchasing land and residential homes for construction or renovation and resale in the state of Florida."  He assigned his wife's son in law as the new CEO and as of 5/14/14, they have purchased 9 homes in Florida for $20.9 million, clearly targeting the upper end of the housing market.

Cadus Corporation's strategy sounds similar to David Einhorn's strategy with BioFuel Energy, however with BioFuel they're buying a larger operating company and have significantly more NOLs to monetize.  With Cadus, the house flipping venture appears short term in nature and maybe a simpler tactic to monetize the NOLs, and liquidate the company after the homes are sold?  Cadus should also be a less stomach churning ride as the retail day traders have likely long forgotten about Cadus.

To further fund the house flipping operation, the company went forward with a rights offering at $1.53 a share, one right for each share outstanding.  Icahn backstopped the rights offering and now owns 67.8% (40% prior) of the company after the rights offering, meaning almost all of the original shareholder base other than Icahn declined participating (I would expect a similar result in BIOF's upcoming rights offering).  The pro forma book value looks something like this:

3/31/14 Book Value = $22,314,215
Rights Offering Proceeds = $19,803,934
Proforma Book Value = $42,118,149
Shares Outstanding (after the rights offering) = 26,288,080
Book Value/Share = $1.60

The thesis is pretty simple with Cadus Corporation, it trades roughly at Icahn's recent cost basis and a liquid/current book value.  If the luxury flipping operation works out well, Cadus should be able to use up the net operating losses in the next year or two.  Due the short term nature of house flipping, I could see the company being liquidated once the tax asset is monetized.  It's not going to be a multi-bagger, but could provide an attractive return with minimal downside.

Disclosure: No Position

Civeo: a Spinoff and a REIT Conversion

Oil States International (OIS) is a oil services company that is spinning off its accommodation business, Civeo Corporation, later this month (it goes "when issued" Monday, and trades "regular way" on 6/2) after some nudging from activist investors last spring.  Civeo provides accommodation services for the resources industry in remote locations, think "man camps" that kind of look like portable prison complexes.  As apart of Oil States, Civeo is taxed as a C-Corp, but shortly after the spinoff Civeo's board intends to evaluate converting to a REIT structure, eliminating corporate level taxes, providing an immediate increase in the business's valuation.  This isn't a new idea, but despite JANA partners and Greenlight Capital being major shareholders, there's still a significant disconnect in the combined company's current valuation.

The company has laid out the typical reasons for the spinoff: management focus, optimize each unit's capital structure, cleaner for investors to value, acquisition currency, and aligning incentives.  Both businesses are attractive, it's not a classic spinoff where one of the businesses is orphaned and dumped in order to make the parent's results more appealing. However, the real value is the REIT conversion, REITs are valued more richly than C-Corps due to their tax advantaged status.  The pre-spin OIS trades for roughly 7x EBITDA, lodging/multi-family REITs trade in the 15-20x range, as long as the OIS stub remains priced at 7x EBITDA, a lot of value is going to be created through the spinoff and REIT conversion of Civeo. 

Civeo Corporation
Civeo is a pretty unique lodging company, they provide medium term (contracts are around 3 years) accommodations services to remote resource mining operations, a valuable service since infrastructure and labor supply is lacking in these far off locations.  Some of their lodges/villages can be quite large, for instance their Wapasu Creek Lodge has 5100 rooms, making it the second largest lodging property in North America behind the MGM Grand in Las Vegas.

Civeo Investor Presentation

Their operations are primarily located in the Canada oil sands region in Alberta, and around major metallurgical coal mines in Australia (as a result of the late 2010 acquisition of the MAC).  Being a US based company, this exposes Civeo to considerable currency risk, in particular Australia worries me being so closely tied to the Chinese economy.  Another unique feature of Civeo's business is the permanence of their real estate and how the market might value it?  They focus on providing accommodations to long lived resource assets, in the 30-50 year time frame, but their lodges (at least in Canada) are on leased land, and presumably depreciation expense is more real as a result.

Civeo Investor Presentation

Civeo sports a nice growth profile as seen above.  They "land bank" in growth areas like the west coast of British Columbia near potential LNG projects - their current lank bank pipeline could add another 15,000 rooms to their asset base over time.

One reason for the current discount might be due to a lack of pure comparables, do you value Civeo as a hotel REIT, multi-family/apartment REIT?  I blended the two below and threw in Extended Stay, which is not a REIT but is similar in that it tries to create a medium term apartment feel in a hotel.

Data via Bloomberg - Net Debt Includes Preferreds

As you can see, this peer group average is valued at approximately 17.5x EBITDA, I would place a little discount on Civeo as a result of its dependence on the cyclical resource industry as well as the more temporary nature (temporary in the 30 years sense) of its asset base.  Even putting a 15x EBITDA multiple on Civeo, backing out the $775 million in anticipated debt (and not accounting for any cash on hand) I come up with a $5.6 billion valuation, which is slightly more than the entire market cap of pre-spin OIS.  Even if you disagree with the comps, multiple, or discount the 2013 EBITDA for some anticipated slowdowns in Australia and corporate overhead, you're coming close to getting the remaining OIS for free.

Oil States International: Post-Spin
Post Spinoff, the Oil States stub will become a more focused energy services company with a TTM EBITDA of $435 million on $1.7 billion in revenue.  I haven't spent as much time on the remaining pieces of Oil States, but assuming it remains valued at a little over 7x EBITDA (which looks reasonable given peers trade for 9-10x EBITDA) the stub is worth roughly $3 billion.  Below is another list of comparables to give you an idea for where oil services companies are trading currently.

Data via Bloomberg

$5.6 billion for Civeo and $3 billion for Oil States gives you a pre-spin value of $160 per share.  I'm sure some of my numbers are a little optimistic, using EBITDA multiples obviously has its issues, and it will take some time for the REIT conversion to take place and for investors to fully value each component, but there's upside to be had here.

Risks
A few questions/risks that run through my mind:

• Will traditional oil service company investors dump Civeo after the spin?   Seems unlikely given that's what the investor base has been pushing for, but any blip due to selling pressure would be temporary.
• What about OIS, will that get dumped in favor of Civeo?  This appears more likely than Civeo being sold indiscriminately, however it's already cheap and would be a bite sized acquisition target for larger players in the industry.
• Australia - Civeo is heavily exposed to the country's met coal market and thus the Chinese growth story which we've seen is slowing a bit and potentially in a massive housing bubble.
• REIT conversion doesn't occur, it appears that the IRS is softening up its stance on these non-traditional REITs (like Iron Mountain), but with Civeo structures not being 100% permanent, I could see it being viewed with a skeptical eye.

My Strategy
Most value investors are aware of the spinoff strategy of buying the SpinCo after the initial wave of selling by unnatural holders or ones that don't want the orphan/bad business.  But in this instance, I think that Civeo could be the more appealing company for new investors to come in post-spin due to the planned value unlocking strategy to convert to a REIT.  So instead of waiting for the spin, I bought June expiration calls on OIS early last week, that way I have leveraged upside to the initial reaction to the spinoff which I expect to be positive, and the secondarily I plan to exercise the option, immediately sell OIS (unless it slumps) and hold CVEO until it converts to a REIT for that second leg up in valuation.

Disclosure: I own OIS calls

News Corp Buys Torstar's Harlequin

Last Friday, News Corp announced the purchase of Canadian media company Torstar's book business Harlequin, best known as a romance novel focused publisher, for C$455 million (or roughly 8x 2013 EBITDA of C$56 million).  I think its an interesting deal for both sides, more of an incremental move at News Corp and a transformational one at Torstar.

News Corp
News Corp was spun off of Twenty-First Century Fox last year (it was the spinoff but kept the name of the original parent) and unlike other recent spinoffs, the parent didn't saddle it with debt but instead let it go with $2.5 billion in excess cash.  Originally News Corp created a share repurchase plan and discussed initiating a dividend, but it seems like plans have changed as neither have been utilized and instead News Corp has made a couple small digital purchases in Storyful and a UK Luxury Shopping site.  Now comes a larger one in Harlequin, which is expected to be accretive to earnings and improve News Corp's free cash flow immediately.

Harlequin has a strong brand and a loyal repeat customer base but has experienced trouble making the transition from print to digital under Torstar, maybe under News Corp this trend will improve?  Romance novels initially seem like a great fit to be purchased and read digitally.  Books like 50 Shades of Gray are incredibly popular, yet no one likes to be seen reading a copy on the train, it's easier and more stigma free to read it on your morning commute on a Kindle.  Hopefully News Corp can implement some best practices learned from HarperCollins' move to digital at Harlequin, strip out some fixed costs, and cross sell HarperCollins books through Harlequin's much larger international distribution channel.  It seems like News Corp paid full price, but as a strategic buyer there are some efficiencies to be gained anyway. 

I still think News Corp is an interesting spinoff as I outlined in this earlier post, they have a collection of book publishing and Australian assets that together with their cash position roughly equal the market cap of the entire company.  The majority of their revenue actually comes from the remaining newspaper assets, which have strong valuable brands, but will take time to transition from print to digital.  In the meantime, Murdoch has hinted at even more deals in the works, he's probably not done yet for the year.

Torstar
From Torstar's angle, it was interesting to listen to their investor call on Friday, analysts were congratulating the company on getting a full valuation for Harlequin, sending the stock price up over 20% on the news.  The deal is more transformational for Torstar than it is for News Corp, Torstar will use the proceeds to pay down their debt and will be left with approximately C$260 million in net cash.  Initially it sounds like Torstar will be investing the proceeds into the business or making an acquisition versus returning it to shareholders.  Torstar's remaining businesses include the Toronto Star, 115 weekly community newspapers, and several joint venture holdings in other media assets.  Maybe they could roll-up additional community newspapers in a similar fashion to New Media's strategy?  It also sports a large dividend; on the surface it still looks pretty cheap.

Disclosure: I own shares of NWSA