Wednesday, February 24, 2021

Technip Energies: FTI Spinoff, Forced Selling, Asset-Lite Business

Technip Energies (THNPY, ADR in the U.S.) is a recent spinoff of TechnipFMC (FTI). Technip Energies is an engineering firm that specializes in large downstream energy infrastructure project management, think multi-billion dollar LNG facilities in remote areas, floating LNG megaships and refinery buildouts. This is far from my area of expertise (if I really have any), I've had a few missteps in energy related spins before, but I think it presents an interesting special situation opportunity because:

  • Forced selling by both index funds (FTI was dropped from the S&P 500 index earlier in February ahead of the spinoff) and U.S. domestic oriented managers that can't hold the Paris listed/headquartered Technip Energies.  One data point around forced selling, the shares closed today at €11.26 in Paris, but $12.01 in the U.S. ADR.
  • Complicated percentage of completion accounting that makes the business difficult to analyze that may lead to some valuation errors, or obscure the attractive economics of the business.
  • Technip Energies is a surprisingly asset-lite "people business" despite the cyclicality of mega projects, their backlog (€13B) for the next several years is in place, they're guiding to mid-single revenue digit growth over the medium term and thus have no immediate concerns about growth trailing off, yet it trades for a ~15+% FCFE yield with what's essentially a zero net debt balance sheet.
Pre-spin TechnipFMC was the result of a merger between U.S. based FMC Technologies (original FTI) and French based Technip in 2017, primarily done to formally combine the two's subsea business that they had previously tied together in joint venture. That subsea business is now the parent, TechnipFMC, which retains the name and FTI symbol, along with the dual listing between the U.S. and Paris. The spinoff, Technip Energies, is almost entirely a legacy Technip business and will be headquartered and primarily traded in Paris. Originally, the spin was only going to trade overseas, but in the end the company decided to also include a sponsored ADR that would be distributed to U.S. holders of FTI. But the ADR shares will trade over-the-counter and generally won't be eligible for U.S. based indices. I've covered some merger-spin combination in the past, they tend to be interesting, might be worthwhile to frame this in a similar way even though the spin was 4 years after, but strategically its similar.

Following the spinoff, TechnipFMC retained 49.9% of the ownership of Technip Energies with the intention to monetize that stake over the next 18 months to reduce debt and shore up the parent's balance sheet. While there will be some short term overhang, it also highlights that the parent didn't want to saddle the spin with debt as is typical lately in order to pay a dividend back to the parent -- FTI wants the spin to trade well to maximize the eventual sale proceeds.

To give some scale to the types of projects Technip Energies works on, here's their flagship Yamal LNG, one of the largest construction projects ever in the Artic. It was built to transport LNG from a remote Siberian peninsula, which didn't previously have road or sea access, to China.

Another is the Shell Prelude, a mega floating LNG facility that is longer than the Freedom Tower is tall, WSJ had an article about it last summer highlighting some of the difficulties of operating something the size of a mini-floating city during a pandemic.

With multi-year projects of this size comes some complicated accounting, Technip Energies operates with a large (~$3B) negative net working capital position.  Their clients pay them partially upfront but mostly along the way as milestones are met, but each periodic milestone payment is always ahead of work to be completed.  As a result, the company has a large "net contract liability" line item on the balance sheet that makes it difficult to analyze the company, one could take a view that as long as the company is growing that the NCL should be semi-permanent and give the company credit for much of the cash on the balance sheet.  I'm guessing some data sites and screeners will take this approach when coming up with an enterprise value for Technip Energies.
But for simplicity and conservatism, I'm going to say the balance sheet is basically in a zero net debt position, now if they stopped accepting new business tomorrow and put the business in run off that would be a bit too aggressive, but at the same time it is probably too conservative of a stance given their backlog and projected growth.

To put a valuation around the company, I took a free cash flow to the equity (FCFE) approach to neutralize the cash vs NCL:

15+% FCFE yield for a near zero net debt company with a strong backlog seems too high, I haven't spent a ton of time on comparables, but I think for an asset lite business like this it should be more around 10% FCFE yield, which works out to a $18+ stock price (for the ADR in USD).

Risks/Other Thoughts:
  • Building mega projects is an inherently difficult business, the work is often performed in remote areas, takes many years to complete and your clients tend to be politically exposed state run entities.
  • Some of their contracts are fixed price, which means Technip Energies takes a significant amount of risk in the projects coming in under budget and on time.
  • Client concentration is also high as you'd expect with projects of this size, 5 clients make up 73% of their backlog.
  • With TechnipFMC retaining a significant ownership position in Technip Energies, there could be a share overhang, so we might be only be partially through two of the three forced selling events.  First was the S&P 500 deletion pre-spin, then the ADR selling off from spin dynamics and U.S. mandate deletion, third will be when TechnipFMC fully exits their stake.  TechnipFMC has pre-sold €200MM worth of Technip Energy shares to BPI based on an initial VWAP, an investor in the business already.
Disclosure: I own shares of THNPY

Thursday, February 18, 2021

Acres Commercial Realty: Yet Another Name Change, fka XAN, fka RSO

Acres Commercial Realty (ACR) is the new name for Exantas Capital (XAN) which was previously the new name for Resource Capital (RSO), which I wrote up back in 2016. The situation is somewhat similar to back then, while not a home run, there's a fairly clear path to a 20-30% near term return. Acres is similar to other commercial mortgage REITs, they provide transitional CRE loans so that borrowers can reposition a property (the risk is somewhere between a stabilized loan and a construction loan), traditional banks have largely been pushed out of this market.

Back in 2016, C-III Capital took over RSO and rebranded it Exantas, C-III cleaned up much of the messier non-CRE assets that were in RSO back then and for a while the company was a clean transitional CRE lender that used the securitization market via CRE CLOs to finance their loans on a non mark-to-market basis. Later, C-III then expanded into CMBS (transitional loans are typically shorter term, CMBS usually has stabilized loans underneath and adds some duration to the portfolio) which they financed through daily mark-to-market lending facilities, unfortunately the CMBS market saw a steep market value drop in March/April 2020 as liquidity dried up. Like many other mREITs, Exantas faced margin calls and was forced to liquidate much of that portfolio at a significant loss. While not the intended strategy, after the CMBS portfolio was largely liquidated, the company is back to a straight forward transitional CRE lender.

Oaktree and Mass Mutual came to the company's aid in July, provided rescue financing via 12% 7 year senior notes that also came with common stock warrants for a penny. At the same time C-III exited stage left and sold the management contract to ACRES Capital (Oaktree owns a stake in ACRES) who took over as the external manager. The ACRES team is mostly former Arbor Realty talent, Arbor primarily focuses on multi-family lending, which I anticipate being the primary focus going forward for ACR, the portfolio is already roughly 50+% multi-family so it shouldn't be a significant transition for the portfolio.

Earlier this week, the company completed the rebranding process to Acres Commercial Realty and simultaneously executed on a 3-for-1 reverse split. Oddly, the rebranding, corresponding reverse-split and ticker change to ACR, appears to have triggered a bit of a selloff in the company's shares for no apparent reason other than maybe market participants didn't follow the change from XAN to ACR. The new ticker doesn't show up in some of the more popular free data sites, while it sounds odd, the shares have dropped from above $13 to below $11 (~16%) in the couple days when the rest of commercial mREITs have been essentially flat.

The capital structure is very levered, most of the debt is CRE CLO financing, the first two CLOs have an attractive weighted average interest rate of about 1.50%, the one they did last September is at 3.28% when issuance was just restarting in the securitization market. Spreads have improved since then, whenever they do their next deal, I expect it to come in significantly.  The company did pause their preferred dividend for a couple quarters, but are now current again.
How the business model works on the debt side, Acres will originate new CRE loans utilizing the secured financing facility (5.75% interest rate, roughly what they earn on their assets) and once they build up a large enough portfolio, they'll obtain term financing via the CRE CLO market at significantly better terms. Now that Mass Mutual (financing lender) is also a shareholder via the warrants, makes sense that the new origination channel will open and available to Acres to continue new loan production and grow the business again. Back of the envelope, I have the earnings power at about ~$1.50/year to the common, and since the company has stopped paying the common dividend, book value should have built since 9/30.

Additionally, the company put in place a $20MM share repurchase program (roughly 15% of the market cap) that will be put to use quickly:
On November 2, 2020, the board of directors (the “Board”) authorized and approved the continued use of the Company’s existing share repurchase program in order to repurchase up to $20 million of the currently outstanding shares of the Company’s common stock over the next two quarters. Under the share repurchase program, the Company intends to repurchase shares through open market purchases, privately-negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934 (the “Exchange Act”).

Putting it together, book value has likely come up since 9/30 via earnings power and share repurchases, debt markets should be wide open to them as the new issuance CRE CLO market is surprisingly strong, especially to multi-family heavy portfolios.  I'm viewing this as more of a few month swing trade as the market "finds" ACR and their story, to potentially a bit longer if I want to stick around for a dividend reinstatement.  I'd put a target price at around $14-14.50, roughly 80-85% of where book value is likely to settle out.

Disclosure: I own shares of ACR

Tuesday, February 9, 2021

Aptevo Therapeutics: Positive Trial Results, Tang Capital Offer, Proxy Fight

This write-up is incomplete, it is a strange situation I don't fully understand but figured it was worth sharing in case any readers have a better idea of what's going on here, please comment.

Aptevo Therapeutics (APVO) is an early clinical stage biotechnology company (~$165MM market cap) that was originally a spinoff of Emergent Biosolutions (EBS) in 2016, which is how it came on my watchlist.  Aptevo was spun with a few commercial assets that were designed to provide a source of funding to pursue their primary platform, called ADAPTIR, I won't pretend to know much about it, but Aptevo has since mostly monetized any legacy assets and focused on developing cancer treatments utilizing their ADAPTIR technology.

An interesting series of events happened in a two week timeframe back in November for Aptevo:

  • On 11/3/20, Aptevo announced positive news on their primary asset's (APVO436) ongoing phase 1 clinical trial, a patient went into complete remission.
  • On the same day, 11/3/20, Tang Capital Partners started from zero and began buying stock indiscrimately at prices from $9.65 to $23.87, not stopping until they had purchased 42.5% the company in the span of 4 trading days.
  • On 11/8/20, Aptevo adopted a poison pill plan (too late!).
  • On 11/9/20, Aptevo announced a second complete remission in the same APVO436 phase 1 trial.
  • Then on 11/18/20, Tang Capital Partners offers $50/share for the remainder of the company they hadn't bought up the previous week, wild stuff.  Aptevo acknowledged the offer but has been mostly silent since then.
  • In December, they did update their shelf registration that includes an at-the-money issuance program, the stock took that news negatively as a sign management might pursue a go-it-alone strategy, or it could be negotiating tactics.
Tang Capital and their founder Kevin Tang are life-science focused investors, Kevin Tang is the CEO of Odonate Therapeutics (ODT) and chairman of La Jolla Pharamceuticals (LJPC), and those are only a couple of his current roles, he's had a long history of investing in, building, and running biotech companies both publicly and privately.  Clearly he has some expertise in the field and thought enough of Aptevo's positive clinical news to rush in and swoop it up (again, on the same day results were announced).

Today (2/9/21), news came out that Tang Capital is going to run a proxy contest to add Kevin Tang and one of his lieutenants to the board of directors and get the company to run a sales process.  

TCP is seeking to: (i) nominate, and hereby nominates, each of Kevin Tang and Thomas Wei (together, the “Nominees”) as directors for election at the 2021 annual meeting of stockholders of Aptevo, and at any other meeting of stockholders held in lieu thereof, and at any adjournments, postponements, reschedulings or continuations thereof (the “Annual Meeting”); and (ii) put forward the following advisory proposal for stockholder approval at the Annual Meeting (the “Sale Process Proposal”):

 

RESOLVED, that Stockholders of Aptevo Therapeutics Inc. (“Aptevo”) request that, in light of the pending offer to acquire the outstanding stock of Aptevo for $50 per share, the Aptevo Board of Directors immediately commence a process to sell Aptevo to the highest bidder, consistent with its fiduciary duty to maximize stockholder value.

Management owns about 5% of the company, they did re-strike their options earlier in 2020 and $50 would put all of those in the money.  Clearly, Tang thinks it is worth more than $50, I doubt he could get out of the position without crushing the stock and thus his investment, pot committed at this point and isn't going away.  There's a lot of execution and financing risk if management tries to go it alone, but I can see the view that if you've spent the last 4+ years getting to this point, you want to see it through on your own terms.  But then again, you're a public company and have a fiduciary duty to your shareholders.  This one is worth following, it's highly speculative with considerable downside, but I started a small position in it recently.

**2/10/20 Edit
I asked for some feedback and got it (thank you!), couple things I missed in the write-up as I thought they weren't material but potentially are very material to the APVO story:
  • Aptevo has a 7-year 2.5% royalty on the Pfizer's sales of Ruxience (in the US, Europe and Japan), a biosimilar drug of Roche's cancer drug Rituxan (top 10 selling drug of all time), sales just begun in Q2 2020, and have the potential to be quite significant.  Some light Googling and some expect peak sales of Ruxience to hit $1B by 2026 (towards the end of Aptevo's royalty agreement), depending how you think of the ramp to that point (or if that's realistic at all) the NPV of that royalty stream could be substantial.
  • Aptevo also has a 15-year royalty on the Medexus Pharmaceuticals' sales of IXINITY, a hemophilia treatment, in the United States and Canada.  The company received $30MM upfront and estimates the total proceeds (inclusive of the $30MM) will be $100MM.  Again, depending how you run a scenario analysis on the NPV of those milestones/royalty fee streams, could be quite significant to a company the size of Aptevo.
  • Aptevo has 436,844 remaining warrants with a strike price of $18.20, which if exercised would raise the ~$8MM in cash, and put the share count at ~4.8 million shares assuming the company hasn't raised additional capital through their ATM.  Tang's ownership percentage would then be approximately 37%.
Disclosure: I own shares of APVO

Friday, January 22, 2021

CIM Commercial Trust: Proxy Fight, Possible Liquidation or Sale

CIM Commercial Trust (CMCT) is another small illiquid idea (~$240MM market cap), CMCT owns about ten office properties in LA, Oakland and Austin, plus the Sheraton Grand Hotel in Sacramento.  When thinking about asset types and locations where covid has been the most impactful -- office, CBD hotel, Bay Area migration, LA lockdown -- CMCT checks a lot of those problem boxes.  CMCT is an externally managed REIT, the manager is CIM Group, a fairly large and well respected real estate firm based out of Los Angeles.  The shares trade at a discount to the company's own estimated NAV (which is very stale, pre-covid), two different activists have put forward a slate of new directors  (here and here) with the intention to liquidate the portfolio.  I believe there's a decent chance management caves here and either commences a liquidation on their own or kicks off a strategic alternatives process aimed at selling the company to one of the other west coast focused office REITs.  The upside is a bit unclear to me (open to hearing from people with a stronger view), so possibly this is more of a watchlist idea, but I opened up a starter position at just under $14/share.  It popped unexpectedly today, apologies that this is not as timely or actionable, it could give it all back, but just for context purposes my cost basis is a bit lower than where it is trading today.

CMCT has a strange origin story for a public REIT, it began life in 2005 as a private equity real estate fund diversified across office, multi-family and hotel.  In 2014, as the fund's maturity was coming up, it was reverse merged into a small mREIT ("PMC Commercial Trust") that made SBA loans (CMCT oddly still makes SBA loans in this legacy segment), with the PE fund owning well over 90% of the proforma entity, but only the non-PE investor shares traded publicly creating this odd stub.  Cynically, CIM took a limited life fee stream and turned it into a permanent one at the detriment of their investors as the shares have failed to trade close to NAV since the reverse merger.  In the meantime, CIM has sold the majority of assets within CMCT in a few different slugs and then returned capital to investors either through a buyback or a big special dividend that was issued in 2019.  Notably, those asset sales were done near their published NAVs at the time.  So here we are now, a subscale externally managed REIT with long suffering shareholders that has limited options to raise capital to grow, sort of stuck in no man's land heading into a post-covid world.

Here are the real estate assets today:

Again, the portfolio is heavy on Oakland and LA.  In Oakland, they own the Ordway Building (1 Kaiser Plaza) which is primarily leased by Kaiser (30% of CMCT's overall rent roll).  Kaiser previously announced they would build a new headquarters in Oakland and consolidate their real estate foot print (presumably exiting CMCT's asset) but recently they cancelled those plans in light of the pandemic, so potentially Kaiser could extend their lease.  If not, market rents pre-pandemic were a decent bit higher than in place rents, we'll see how things shake out in the Bay Area, but Oakland could cool off significantly as San Francisco office becomes cheaper and reduces the spill over into the more affordable Oakland market.  Additionally, they do own a parking lot next door, which they've been marketing as a build-to-suit, but presumably new office development is off the table for several years, my guess is it remains a surface lot for the foreseeable future.

The other chunky asset of concern is the Sheraton Grand Hotel in downtown Sacramento.  CIM acquired the hotel in 2009, it sits next to the convention center in Sacramento which is finishing up a renovation and expansion project, the convention center is scheduled to open in February.  Pre-covid, CMCT was planning to invest $26MM to renovate the hotel, but those plans have been put on hold.  CMCT also owns another parking lot across the street that they suggest is an additional development site for either a hotel or multi-family tower.  Located in a state capital and positioned next to the convention center, I can see a path where this hotel fully recovers.  Downtown Sacramento has seen a considerable amount of development recently and there are a number of hotels that are in the pipeline, one is even considering breaking ground soon, signaling demand or at least the expectation of a recovery in the market.  The hotel is still cash flow negative, in October (last data point) it only averaged a 29% occupancy rate, and isn't expected to cross the break even line during the first half of 2021.

In LA they own several clusters of assets, LA is CIM Group's backyard.  I don't have much to add here, the one asset that is only 21% occupied was previously earmarked for a significant repositioning, but that's been put on hold as well.  The below slide management puts out also shows all of the properties CIM has exited over the years, clearly you can see that they're one of the major players in the LA market providing some comfort around this piece of the portfolio.

The other assets include an office complex in Austin that was just leased up and a small loft style office property in San Francisco.  And as mentioned earlier, they oddly still operate the SBA lender business which is a legacy from the reverse merger.  Making SBA 7(a) loans is a fairly good business, a portion of the loan is guaranteed by the government, SBA loan originators are able to sell that guaranteed portion into the secondary market and since it is guaranteed by the U.S. government, originators are able to sell those portions at a premium.  They're then left with servicing rights and the unguaranteed portion of the loan, which most lenders retain.  The one red flag with CMCT's SBA business, the portfolio is basically a pure player lender to franchisees of economy and midscale franchised hotels (think brands under the WH or CHH flags).  They also have PPP loans they've extended to their borrowers that will likely be fully forgiven and paid by the SBA to CMCT.  I tend to think the economy hotels make it through covid, but its worth flagging that there is risk in this asset. 

So those are the assets, the capital structure is a bit odd here, it's heavy on preferred shares, which about half of which are continuously offered through their RIA channel and are not publicly traded.  I took the 2019 proforma NOI from the Lionbridge letter and backed into what cap rate the market is putting on their assets, approximately 6.7% which feels high to me.

CIM Group does put out an annual NAV estimate, the current one is stale from pre-covid, year-end 2019.  The NAV is a little disingenuous as it also uses the old capital structure, the company has issued additional preferred stock since YE 2019.

We'll probably find out in the next month or two what the new NAV estimate is, it will certainly be lower, my back of the envelope guess is somewhere in the $20-22 range, which would be a 6.0-6.2% cap rate on 2019 NOI.

Will CIM Group cave to activist pressure? 

CIM Group was co-founded by Richard Ressler (Chairman of CMCT, also Chairman and former CEO of JCOM), Avi Shemesh and Shaul Kuba in 1994.  Today they manage just under $30B in assets, about $1B of which is CMCT (at their stale valuation) and they also have a significant non-publicly traded REIT business after their purchase of Cole Capital in 2018.  I bring that up because they recently merged a few of their private REITs, potentially in preparation to list them publicly, might be stretch but that vehicle is much larger than CMCT and they wouldn't want to damage their reputation and limit that REIT's growth in future (assuming CIM agrees that CMCT failed in becoming a growth platform).

The management agreement at CMCT is a bit non-standard for an external REIT, it was rolled over from the original PE fund and wasn't revised in the merger:

  • The management fee is tiered with breaks as CMCT gets larger, but instead of getting bigger, it has only gotten smaller as a public entity, and more problematically the fee is based off of the asset value in the NAV calculation.  The stock has never traded anywhere near NAV and clearly NAV is subjective and manipulatable in their favor.  Additionally they have typical expense reimbursement provisions, read through the activist letters for more detail. 
  • It is a perpetual term contract, "and shall remain in full force and effect until the Partnership is dissolved, this Agreement is required to be (or is automatically) terminated pursuant to the terms of the Partnership Agreement or the Partnership and the Adviser otherwise mutually agree" -- I'm guessing this is the angle of the activists, take over the board and then "dissolve" the partnership entity through a liquidation. But not entirely sure a proxy win for the activists is needed here.
  • One benefit of rolling over the original management contract, it doesn't appear to have a termination fee which most externally managed REITs include, making it more attractive for activists to get in here and attempt to remove the manager.
CMCT is a Maryland corporation which does make it difficult to unseat an external manager, CIM insiders own roughly 20% of the company, so it's an uphill battle.  But again, this is a small piece of CIM, why ruin your reputation over a relatively small management fee stream?  And most importantly, CIM has relented to shareholder pressure before, here Lionbridge describes the events leading up to previous asset sales:

What transpired over the next few years bore little resemblance to CIM’s originally stated growth objectives for CMCT. In 2017, CMCT sold over $1 billion in assets and repurchased a similar amount of CMCT stock owned by the private fund. In its public communications, CMCT depicted these corporate actions as the result of a regular evaluation of its business and prudent management. Based on our firsthand discussions with CIM Urban REIT investors, however, we believe these sales were the result of extreme pressure from its fund investors, who were voicing displeasure for the public vehicle. In other words, only when it was clear that the REIT strategy had flopped, and under intense pressure from its pension-fund clients, did CMCT begin selling property and returning capital to investors.

 

Rather than rightfully completing the sale of its portfolio once and for all and returning the remaining value to its investors in cash dividends, CIM dug in its heels. In 2018, the company announced a "Program to Unlock Embedded Value in Our Portfolio and Improve Trading Liquidity in our Common Stock.” At the time, CMCT was trading at a nearly 40% discount to NAV. This program contemplated another $1 billion in asset sales, or roughly half of the remaining portfolio at the time. The net proceeds were distributed to shareholders, but again, instead of completing a cash liquidation, the private comingled fund was dissolved via a distribution of CMCT shares to its partners. The result was a more structurally flawed company with even less scale. Upon the distribution of CMCT shares, the partners would own over 95% of this deeply flawed and obscure REIT’s shares.

In its public messaging CMCT portrays its asset-sale programs as discretionary capital allocation moves made in response to strong markets and emblematic of CIM’s willingness to return capital to shareholders. Again, based on firsthand accounts from CIM’s partners, we believe that assertion is misleading. We understand the asset sales and return of capital were being demanded by the partners, according to some accounts, under threat of litigation and were not what CIM Group was otherwise inclined to do.

Contrary to what CIM representatives portrayed to prospective investors, what awaited the market after executing the plan to “unlock value” and “increase liquidity” was an ownership base comprising almost entirely legacy fund investors whose moods we understand generally ranged from frustrated to incensed at CIM’s refusal to completely liquidate the company for cash. In the aftermath of the distribution, the shares were soon trading at a nearly 50% discount to published NAV, wider than when the “Program to Unlock Embedded Value” was announced. They would remain in that vicinity for months before they further collapsed in the COVID-related market sell-off.

CIM Group has caved twice to CMCT investors, starkly clear this isn't a growth vehicle for them, my thesis is they'll do the right thing and either liquidate or sell the company, keep their public reputation in place for where there is actual growth (like their private net lease REIT) and brush this entity under the rug.

Another interesting way to play this idea is the Series L preferred shares (CMCTP), I tried for a couple weeks to buy shares but didn't have any luck, it is very illiquid but strangely the class has a liquidation preference of $28.37 versus the usual $25, and its redeemable next year at shareholders option, the company has the option to play stock or cash, but either way it seems like a pretty attractive high teens, low twenties IRR if you're able to get shares at $22-$23.

Disclosure: I own shares of CMCT

Thursday, December 31, 2020

Year End 2020 Portfolio Review

What a traumatic and unpredictable year, certainly it has been tragic for those directly impacted by the virus or who have suffered the death of a loved one.  From a pure financial standpoint, I am in a lucky position where I'm able to work from home and didn't need to tap into savings or my brokerage account to make it through the year.  Being in that fortunate position, and also not managing outside capital, allowed me to hold through difficult times and not capitulate.  However, especially after November and December there are now signs of excess everywhere and I'm having a hard time squaring overheated speculation in certain areas with the never ending list of bargains I'm finding.  Confusing times in the market.
I finished the year up 24.34%, which is well shy of some others investors performance this year but still above the S&P's 18.40% -- fully acknowledging that the large cap index is not a good benchmark for my portfolio, on the surface I take more risk, but it's more of an opportunity cost bogey and widely quoted.  My lifetime-to-date IRR of this portfolio is 24.52%.  Positive attribution winners this year included Green Brick Partners (GBRK), Colony Capital (CLNY), Five Star Senior Living (FVE) and Franchise Group (FRG); negative attribution losers were MMA Capital Holdings (MMAC), Liberty Latin America (LILA/K) and some undisclosed special situations (MCK/CHNG splitoff, MGM tender) that went haywire in the spring meltdown.

Thoughts on a few Current Positions
  • While not a high conviction idea, I still do like Accel Entertainment (ACEL), the largest distributed gaming provider in Illinois.  The thought here is that slot players are going to go hyper local post-covid, why drive an hour or two to a depressing rundown regional casino when you can drive five minutes to a depressing rundown strip mall?  These VGT locations are essentially mini-casinos first and a bar or restaurant second, the bar/restaurant piece is often regulatory arbitrage to allow for the VGTs and not the other way around.  Regional casinos make the vast majority of their money from slot machines, ACEL is the slot machine revenue without the capex and overhead of actually running a casino.  Currently there are no VGTs in the city of Chicago, but with covid destroying the budget even further, wide spread tax increases seemingly difficult to push through in the current economy, legalizing VGTs within the city limits could be on the table providing an easy growth opportunity for ACEL.
  • Despite a good run in 2020, Five Star Senior Living (FVE) is still a cheap stock, with an enterprise value of just $150MM ($96MM of cash, $7MM of debt, and I'm capitalizing an RMR termination payment of 2.875x annual fees) and another $96MM of owned real estate on the balance sheet, against $30-35MM of EBITDA, trading under 4.5x EBITDA for a company that is now mostly an asset-lite management company.  Tucked away inside of FVE is a high growth rehabilitation concept, Ageility, that is growing quickly and only requires $20-30k of upfront start up costs per new location, it could be quick to scale.  What happens to all the cash?  Management clearly has their hands full operating the business this year, but once covid passes, what will be the capital allocation plan?  It hasn't been well articulated at this point.
  • My obligatory bullish comments on Howard Hughes Corporation (HHC) -- Their diversified model should help them versus pure play REITs, in the coming years I picture HHC being more focused on residential land development than on office/multi-family new construction they were pre-covid, their big land banks are in Las Vegas and Houston, maybe not as hot as Austin and Miami but they're both low cost-of-living and no state income tax markets that should have the wind at their backs.  While not in the same markets, Green Brick Partners (GBRK) should continue to benefit from similar migration trends to Texas as well as their shift in focus to entry level homes which are benefiting from incredibly low mortgage rates.  Rounding out a real estate discussion, "new" BBX Capital (BBXIA) should still have some upside despite the obvious problems, their assets are primarily cash, a note to a timeshare operator (good reopening/stimulus trade) and Florida real estate which should have continued tailwinds.  It's trading at just 35% of book value, even if the right number is 50% of book value, that represents an additional 42% upside.
  • MMA Capital Holdings (MMAC) has been a frustrating hold since they went to an external structure, I won't pretend that I've spent more than a few minutes on Hannon Armstrong Sustainable Infrastructure Capital (HASI), it appears to be a better and more diversified business, but it trades at over 4.75x book value and MMAC trades at 0.65x.  Just reading through the HASI 10-K and investor presentations you get all the good ESG vibes that MMAC should be putting out, but still aren't, maybe with the recent CEO we'll see a change, with all the money flowing into ESG products, MMAC has to take full advantage.  Even from a skeptical external manager point of view, you'd assume Hunt wants a piece of what could be a decade long theme.
  • Colony Capital (CLNY) was a significant winner for me this year, thank you to those that encouraged me to take a closer look at the common after my post on the preferred stock near the bottom of the crisis.  I doubt I'll have much to add on CLNY going forward, the business is a bit above my head, but willing to give Ganzi some room and will continue to hold.  I found this write-up well done and helpful in modeling the path forward from here.  Even if you're not sold on CLNY, I think it is worth of monitoring because of the number of transactions that revolve around it (hopefully CLNC), there will opportunities that arise in the next few years.
Previously Unmentioned Positions
  • Back in the spring, I puked out of my position in Perspecta (PRSP), a 2018 spinoff of DXC that provides IT services to the government, but since then activist fund JANA Partners has taken a liking to it after PRSP passed its 2 year safe harbor post-spin making it able to be acquired without jeopardizing the tax free spinoff.  In November, Bloomberg reported that PRSP had hired advisors to pursue a sale.  The original thesis was that PRSP could be a replay of CRSA (also a DXC government services spinoff) which was sold for 12x EBITDA to General Dynamics, that thesis might still hold, 12x PRSP's ~$600MM EBITDA would be approximately $30 per share. 
  • ECA Marcellus Trust I (ECTM) is a 2010 vintage oil and gas trust that were a popular structure a decade ago, an E&P company would sell producing wells to the trust and the trust in turn sold shares to retail investors promising high dividend payments.  Unsurprisingly, these didn't go quite as promised, ECTM is now a tiny nano-cap that is pushing closer to tripping a clause in its trust indenture that would force a liquidation of the trust, returning any proceeds to unit holders.  ECTM shut off the dividend and if the royalty payments fall below $1.5MM for the trailing twelve months the trust will liquidate, royalty payments were $1.12MM through 9/30 putting it very close to tripping for the year.  Greylock (successor to the original sponsor ECA) projects the royalty to exceed the threshold this upcoming quarter (however that was before natural gas prices started to fall on fears of a warm winter), even if it does, it appears this trust will trip it sometime next year forcing the liquidation.  The trust has 17,605,000 units outstanding, trading at a price of $0.17, for a total market cap of just ~$3MM against a book value of $17MM.  Most of that book value is the estimated fair value of the royalty interests which can be pretty squishy, Greylock has the right of first refusal buying the royalty interests back and there's a bit of uncertainty around if ECTM is entitled to get 100% of that payment or 50% (I read it as the 50% clause applies only on the formal trust termination date of 3/31/30 but I could be wrong).  Either way, pretty attractive upside that should be non-correlated with much of the market, but again, only a small PA type trade.
  • I did jump into the SPAC arb trade with Pershing Square Tontine Holdings (PSTH) thanks to a great post by Andrew Walker.  Instead of selling puts, I did a buy-write trade, just fits my eye a little better.  I see the downside as pretty minimal, Bill Ackman is an incredible marketer (I'm generally a fan of him despite his flaws) and if a deal is announced in the next few months that would close before 6/18/21, I have a hard time imaging it would trade significantly below the trust value after it de-SPACs.  Ackman will get on TV, etc., and he'll also be investing a significant sum alongside PSTH in a pre-committed PIPE at $20 further providing support to the transaction value.  Selling pre-deal SPAC call options might be a theme for me next year.
Closed Positions
  • On 10/19, Front Yard Residential (RESI) announced that it would be acquired by a consortium of private equity (Ares and Pretium) for $13.50 per share, I sold that day, and then several weeks later on 11/23, the offer was bumped up to $16.25 after a better offer came to light.  This could be the start of similar deals where post-covid the entity will be too subscale (MCC and CLNC are two potential examples) and there is plenty of private equity money out there willing to buy cheap real assets.
  • I've mostly reduced my exposure to hospitality plays, Extended Stay America (STAY) has weathered the storm nicely as their rooms feature kitchens (limiting interaction between guests) and acts as temporary residences rather than true leisure travel.  It also drummed up some rumors of PE interest, I sold to put money to work in other places, but it could be worth monitoring as it still is the only remaining major hotel chain that is both the brand manager and the owner of its hotels (plus the weird paired share structure), eventually that will change.  Similar idea with Hilton Grand Vacations (HGV), it probably still gets sold at some point to Apollo (who will pair it with DRII before coming back to the public markets), but I sold to put money to work elsewhere, HGV might be interesting as a re-opening trade.  I could see stimulus checks going towards downpayments on timeshares, people will want to "live a little", prioritize vacations again, plus timeshares are similar to extended stay, often feature a kitchen and more space that might be desireable in a post-covid environment.  Lastly, I have been selling calls over and over on Wyndham Hotels & Resorts (WH), the implied volatility (not that I really know what that means) seems to be too high to me and so I've been rolling covered calls until the day when the shares get called away from me.  WH is almost a pure franchising play on economy and midscale hotels, which have held up better than the upscale business or destination focused hotels, but its trading at a fairly full 12x 2019 EBITDA and who knows when it'll get back to 2019 EBITDA levels?  I like the business, but feels like its been bid up as a reopening play alongside MAR/HLT when it shouldn't necessarily as its business model is significantly different enough.  These three all skew away from the traditional business traveler which will likely be the last to return in full, so all three could be attractive depending on your view of the reopening trade.
  • Another one where there is probably a little more upside but I've needed cash for other ideas is Gaming & Leisure Properties (GLPI), their primary tenant is Penn National Gaming (PENN), PENN's stock as 20x since the bottom and presumably has unlimited access to capital right now thanks to Barstool Sports and the online sports gambling theme.  PENN starts to pay cash rent again here next month which should allow GLPI to reinstate a cash dividend (dividends have been a combination of cash and stock this year) and should fully recover to the mid-to-high $40s. 
  • I finally let go of Liberty Latin America (LILA/K) this month (at least temporarily), I did fully participate in the recent rights offering and the stock responded well after that, but had a sizeable tax loss that just became too valuable for me this year.
  • I sold about 2/3rds of my Avenue Therapeutics (ATXI) position after getting long term capital gains treatment, unfortunately, I should have sold it all as I ended up taking a loss on the remaining 1/3rd when ATXI failed to secured FDA approval for IV tramadol.  Their merger partner has moved to terminate the deal while ATXI is trying to fix their FDA submission, I'm far out of my comfort zone in trying to handicap the situation but could be an interesting idea for others more inclined.
  • The Marchex (MCHX) tender offer was bumped up and I exited, haven't followed it much since then but did have several people reach out to me saying their call analytics software is best-in-class so there might be something there to those interested in small cap software businesses.
  • Maybe it was a bit of "quarantine brain", but I did a lot of small merger arb or other quirky special situations throughout the year that I didn't get to writing about or didn't have anything more to add to the discussion -- more than I normally would -- these included CETV, SKYS, BREW, DLMV, SPAC warrant exchange offers for BIOX and ATCX.  One positive to the SPAC mania this year is its likely to result in a lot of interesting special situation opportunities in the coming years.  Screw ups included the MCK/CHNG exchange offer where I was unhedged and loss a fair amount of money and to a lesser extent miscues with the MGM and AMCX tender offers.
  • Two old CVRs came up empty, INNL and GNVC, BMYRT appears to be the same way, I still want to like these but it is important to be selective, think through the structure of each CVR and the counterparty.  On the positive side I did receive interim distributions from IDSA and MRLB -- although curiously MRLB hasn't paid its final milestone payment despite the sales threshold being met several months ago, if you know the story there, please reach out.
Performance Attribution

Current Portfolio
My leverage is a bit higher than I'm comfortable with right now, but given personal circumstances, didn't want to realize gains in 2020 versus 2021, so I might be trimming early in 2021 (anecdotally I'm not the only one) some winners to make room for new ideas.  As always, thank you for reading and especially to those that I've interacted with either via the comment section or via email/DM, I'm not always quick to respond but I do appreciate the networking and the sharing of ideas has made me a better investor.  Happy New Year and stay safe, there's light at the end of the tunnel.

Disclosure: Table above is my blog/hobby portfolio, I don't manage outside money, its a taxable account and only a portion of my overall assets.  The use of margin debt, options, concentration doesn't fully represent my risk tolerance.

Sunday, December 13, 2020

Colony Credit Real Estate: CLNY Moving Quickly, CLNC Sale Next?

Colony Credit Real Estate (CLNC) is a commercial mortgage REIT that is trading at 52% of undepreciated book value (their owned real estate is triple-net), Colony Capital (CLNY) owns 37% of the shares and is the external manager of CLNC.  CLNY is in the midst of a transition to a PE manager focused on digital infrastructures assets (they've hinted that they'll likely convert to a c-corp next year) and is quickly selling off their legacy traditional REIT assets, in recent months announcing the sale of their hospitality portfolio (a bit of a surprise versus handing over the keys) and more recently their remaining industrial assets.  CLNY CEO Marc Ganzi is everywhere, blitzing the virtual conference circuit, multiple TV appearances and selling assets left and right, the CLNY stock price has responded by roughly doubling in the last 5-6 months.  

CLNY has two large assets remaining (lots of smaller ones too), their healthcare real estate portfolio and CLNC, prior to covid they announced intentions to pursue an internalization transaction with CLNC where CLNY would presumably have gotten additional shares in CLNC as compensation for their management contract.  Post-covid, that internalization concept no longer makes sense as the bid-ask spread is too wide since CLNC trades at such a significant discount of book value, it makes it difficult for both sides to come to an agreement, CLNY would have to take a discount or CLNC shareholders would face dilution for an internalization transaction to work at current prices.

What do I think might happen?  Somewhat similar theme to MCC, most commercial REITs are externally managed and thus incentivized to grow/acquire --  I think we could see Ganzi push a sale of CLNC and CLNY's external management agreement to another commercial mREIT.  This would create a win-win for all sides, CLNY would get full immediate value for their external management contract, the buyer would acquire CLNC at a discount which benefits both its shareholders and adds AUM to the buyer's external manager, and CLNC shareholders would get a premium to current price and relieve the overhang of what might happen to CLNY's non-strategic 37% ownership position.  There is some transaction on the horizon, just a matter of the structure, here is Ganzi on the Q3 CLNY earnings call (courtesy of tikr.com):

Jade Rahmani (KBW)

Okay. Well, I applaud the swift actions the management team had taken. Definitely refreshing and very good to see the progress. I wanted to ask you about a particular -- as Tom Barrack might call it a Rubik's Cube, which is CLNC. There's an overhang in the mortgage REIT space because people are looking at commercial real estate as a long cycle to recover and potential impairments, loan losses on the credit front. So that's one thing that they have to address. Secondly, there's the liquidity that go into managing that. And finally, there is some access investment capacity. But when you look at stocks like CLNC and there's many others TRTX, LADR, to name a couple trading at 40% to 50% of book value. It means that investors are also potentially assuming an eventual dilutive capital raise.

So CLNY owns 37% of CLNC. And to me, that bodes for an opportunity, you can have CLNC buyback some of those shares at a premium to where it's trading, yet it still would be wildly accretive to its book value, wildly accretive to its earnings. It would reduce the overhang of CLNY's 37% stake because people do wonder when those shares will be liquidated, and yet it would provide CLNY with fresh capital to accelerate the digital transformation. How do you think about that as a potential option for both CLNY and CLNC to explore?

Marc Ganzi

Well, Jade, it's almost like you bugged our investment committee. So look, seriously, first and foremost, I want to applaud Mike Mazzei, Andy Witt, David Palamé. For those of you that had the chance to hear that earnings presentation, it's also another great story of transformation and execution.

When we brought Mike Mazzei on board to run that business unit, we couldn't have been more clear about what the objectives were: first and foremost, to make sure that we shored up our loans that had any issues with them, hit repo lines on 2 loans, gravitating to liquidity, and Mike's done an amazing job stabilizing that portfolio, returning cash to the balance sheet. And now that business is poised, as you heard yesterday, to play offense and be selective. And they'll play offense inside of their sandbox. And I don't get too involved in what Mike and his team does. I think they're doing a great job of executing and as one of their largest shareholders, we couldn't be happier with the progress that's happening at CLNC.

When you look at its peer group, CLNC got ahead of its issues quickly. Mike addressed those issues. He stabilized the story, he rotated the cash and now we have an enviable position where we can play offense, and we'll continue to recover book value.

You saw the shares perform well after market last night. They performed well today. We have a lot of confidence around that management team's capability. And in the meantime, we keep our options open, Jade. No option is off the table for CLNC. We've made that clear 2 quarters ago. We made it clear a quarter ago. I'll make it clear today. As we rotate to digital, if there's a good opportunity to harvest, the hard work that's been done at CLNC, we have an open ear, and we'll listen to whatever proposal comes across the table.

Seems pretty clear to me that a transaction will happen soon, given the pace of divestitures at CLNY, I would bet on Ganzi surfacing value here.  I doubt that CLNC would buy back CLNY's shares as suggested by the analyst question as it doesn't divest the external management contract, an outright sale of both CLNC and the management contract seems more likely, swift and bold, more in the Ganzi deal mold.

But let's take a look a CLNC a bit closer, I think its reasonably attractive as a standalone entity.  CLNC was created out of the threeway merger of old CLNY/NSAM/NRF, it was previously a non-traded product that was brought public in early 2018 and has since had a rough existence.  As expected with a non-traded REIT, their portfolio resembled an asset gatherer mentality without much of a cohesive strategy.  Here's what the portfolio looks like today, predictably they have a legacy segment ("LNS" = legacy non-strategic) where they house all the iffy stuff like their retail exposure.

The portfolio is a little bit of a grab bag, but back in March, Colony brought Michael Mazzei in to be the CEO of CLNC, Mazzei is an alumni of Ladder Capital (LDR, disclosure: long) where he served as the president until June 2017.  Ladder has a reputation has being a conservative credit shop, I personally like their style, so when Mazzei joined CLNC it was worth monitoring.

I've been surprised along with others, but commercial real estate loans have generally held up better than expected during the pandemic, whether the reason is modifications, interest reserve accounts, or the equity injecting additional cash into the deal -- their CLO for example hasn't experienced any credit events in the portfolio -- with a vaccine on the way, I tend to think all parties involved will continue to work together to salvage value and get to the other side.  Now is the time to get long some of these asset plays with a catalyst, the market exuberance hasn't quite made its way down to publicly traded private credit vehicles with actual real assets, but I think it eventually will.

CLNC has confidence in the future, I like when management at least acknowledges what the market is thinking, this is an external vehicle, so their options aren't ideal, but they've already hinted they'll reinstate their dividend in Q1 2021 and are making new loans today (tikr.com), you don't do that if you're on the ropes:

We also recognize that our current share price is a deep discount to our book value. This discount is also greater than that of our peer group. The current market valuation effectively implies that there are approximately $1.2 billion of future potential losses. We feel the best way to address this disconnect is by shifting the focus and momentum of the CLNC team beyond the challenges of COVID-19 and toward playing offense.

In our effort to close this gap, we are committed to continuing to protect the balance sheet while redeploying capital into new investments, building earnings and reinstituting a quarterly dividend.

In summary, while not fully out of the woods, we have accomplished many of our goals during this challenging time. We are now focused on executing our business plan to grow earnings. We have already begun to originate new loans while continuing to remain vigilant on asset, liability and cash management. The continued risks of COVID-19 can, by no means, be dismissed. However, through the efforts of the CLNC team and the support of our counterparties, CLNC is now in a position to lean forward.

CLNC does have a mix of financing, a CLO, repurchase agreements, they should have decent amount of flexibility to handle any problem loans.  Leaving out a lot here, but at 50-55% of book value, I think the setup is more important than the actual assets -- I trust Ganzi to make something positive happen here both for CLNY and CLNC.

Disclosure: I own shares of CLNC and CLNY

Wednesday, December 2, 2020

Medley Capital: Internalizing Management, Sale Seems Likely

Apologies for the recent string of relatively small and/or illiquid ideas, here is another one from the trash bin: Medley Capital (MCC) is an orphaned BDC that will likely be sold in the next several months.  The story begins in August 2018, when MCC's external manager, Medley Management (MDLY), orchestrated a three way merger that would combine the manager with its two BDCs, publicly traded MCC and non-traded Sierra Income.  That deal met a lot of resistance from shareholders as it appeared to be a non-arms length way to bailout the overleveraged MDLY at the expense of the BDC shareholders while ensuring underperforming management continued on top.  The deal was in limbo until May of this year, almost a full 2 years after the merger announcement, when the deal was finally put out of its misery and terminated.  I'm skipping a lot of drama in those two years including a proxy fight with the team from NexPoint, but following the termination, MCC continues to retained advisers to pursue strategic alternatives and recently announced that MDLY's management agreement would be allowed to expire at year-end and that MCC will internalize management.

After a 1-for-20 reverse split earlier this year, MCC is trading for ~$26.50 ($71MM market cap) with a 6/30 NAV of $54.83 (MCC's fiscal year end is 9/30, the 10-K should be coming out shortly), meaning MCC is trading at roughly a 50% discount to NAV.  For reference, despite the pandemic, the average BDC trades for 86% of NAV today.

For the uninitiated, BDC is an acronym for business development companies, which typical function as non-bank lenders to leveraged middle market (sub $50MM in EBITDA) companies, often providing financing for private equity buyouts or M&A transactions.  Following the financial crisis, banks can no longer provide these loans on reasonable terms, so non-bank lenders like BDCs of CLOs have filled much of the void.  These loans are all below investment grade and the leverage ratios of the underlying companies is typically 5-7x EBITDA, they can be a bit scummy and certainly shouldn't be pitched as safe dividend payers to retail investors.  There are some 45+ publicly traded BDCs (like REITs, there are also non-traded ones like Sierra Income that are sold through the investment advisor channel), most of them are externally managed, often by household names (at least to anyone reading this) like Ares, KKR, Oaktree, Apollo, BlackRock and others that can essentially use the BDC as a lender for their own PE activity.  If that wasn't enough, they charge hedge fund style fees to the BDC.  These management fee streams are highly valuable as a BDC is technically a closed end fund and the capital inside it is essentially permanent.  So the average BDC trades for 86% of NAV, roughly 10 of the 45 trade above NAV which allows the BDC to issue additional equity, anyone below NAV is generally restricted from issuing shares but they can still grow assets through M&A which has been fairly active in the bottom of the sector.

Given this dynamic of external managers wanting to grow fees and now that MDLY will be out of the way (MCC no longer has to serve two masters in a transaction), the orphaned BDC should make for an easy M&A target, especially considering the wide discount to NAV.  The buyer and MCC can essentially split the discount somehow and both come away happy.  Following the sale of their broadly syndicated loan (larger borrowers, more liquid loans) JV to Golub and paying off one of their two baby bonds, MCC is clearly too subscale (maybe the 40th largest BDC of the 45 by assets) to be internally managed and if the plan was a true go-it-alone strategy, they likely would have refinanced the baby bond versus pay it with cash on the balance sheet.  The new CEO is an activist in MCC, David Lorber of FrontFour Capital, he's also headed up the Special Committee, from the internalization press release they've hired a credit person on what seems like a temporary basis to oversee the remaining portfolio, all sort of signals to me that this is once again for sale.

Of course, everyone has seen the deal, it was shopped previously and the conflicted board (MDLY management on the MCC board) turned down other offers during the go-shop period in order to continue to push the MDLY-MCC-Sierra deal that would have preserved MDLY's management team.  However, now that MDLY is largely out of the way, debt markets are flush with capital (low rates is great for private debt, everyone will be reaching for yield), we're looking at a potential reopening and economic recovery, I'm guessing at least one of those suitors will come back and make a deal for MCC.

Other Thoughts:

  • I haven't discussed the portfolio, obviously given the turmoil this company has been through in the last two years as you'd expect, the portfolio is a bit of an unclear mess of assets.  It is more heavy on equities than most peer BDCs, including 764,040 shares of AVTR which is up ~66% since 6/30 or $8MM in NAV ($3ish per share).  On the downside, the JV they did sell to Golub is about -$7MM in the other direction.  The S&P/LSTA Leveraged Loan Index is now trading about 95 cents on the dollar, up significantly from the lows in March and April, and for reference, on 6/30 it was trading at 89.  Even the junkiest of loans, rated CCC, are today trading at 86.  We'll see in a few days where the 9/30 NAV is struck, but I don't think it should be materially below where it was on 6/30, but I'm not a credit analyst and only spent a little time thumbing through their holdings.
  • This situation reminds me a little bit of RESI, a broken deal, external management being pushed aside and no reasonable path to becoming an internally managed company for the long term.  That one ended very successfully with a quick deal that was then revised upwards after a competing offer came to light (I unfortunately was out by the time of the revised deal).
  • BDCs are no longer included in most indices, MCC doesn't pay a dividend, there really isn't a natural investor base for this and I think that partially explains how its languished here and really doesn't have a future outside of a deal.

Disclosure: I own shares of MCC