Wednesday, June 22, 2022

Transcontinental Realty: VAA JV Properties Sold, What's Next?

Over the weekend, news came out that Transcontinental Realty Investors (TCI) and their partner, Macquarie, sold the assets inside their Victory Abode Apartments joint venture for a total of $2.04B (which was the original thesis from my December 2021 post for some background).  On an annualized Q1 2022 NOI basis the sale was done at a 3.85% cap rate, on a forward basis it is probably a bit above 4% as rents are resetting considerably higher in this sunbelt portfolio.  Given the current economic backdrop, that price seems like a great exit for TCI as I was nervous shareholders would be disappointed with no sale or one around the recent $1.4B appraised value (as disclosed on p13 of their recent 10-Q).  The sale is a bit complicated in that 53 properties were sold in total with 7 of those properties being sold back to TCI at the same valuation as the rest of the portfolio.  After paying off mortgage debt and transaction fees, TCI expects to net $320MM in cash from the sale after $100MM they've earmarked for taxes.

The sale is expected to close within 75 days (~early September), post deal closing TCI will screen extremely cheap on a price to book basis as their equity VAA joint venture is being carried on the books for $50.6MM while they're netting $320MM in cash plus the value of the 7 holdback properties, that delta in my estimation almost doubles the book from $45/share to $86/share.  Shares trade for around $43, even after the sale announcement, about 50% of proforma book value.

The sale press release gives limited details, but using the Q1 10-Q and some swag math, we can back into the value of the 7 holdback properties.

A $2.04B topline price tag, minus the $851MM of mortgage debt, nets $582+MM in value to TCI.  Then backing out the remaining earnout owed to Macquarie, some transactional costs and the company's estimate of taxes, the plug to get to $320MM is about $125MM in value for the holdback properties.  I'm probably off there, so as always, correct me if I made any major mistakes.

Then Pillar, the external manager owned by the controlling shareholders, is due an incentive fee for the capital gains related to the VAA sale, the math is challenging and difficult to model out, but they're due 10% of any capital gains above a 8% annualized hurdle rate.  TCI estimates their tax rate at 21%, if the company's estimate of $100MM in taxes is accurate, let's just guess the incentive fee is roughly $35MM for our purposes.

With some simple math, adding the net cash to TCI, estimated value of the holdback properties, subtracting out the incentive fee and the previous carrying value of the JV partnership.  I get the below proforma book value.

Once Q3 earnings come out and book value is reported (November time frame if it closes in Q3), maybe some quantitative strategies take notice?

Of course, book value tends to understate the value of real estate companies due to depreciation and historical cost factors.  Below I've taken most of TCI's balance sheet and pulled it apart, I'm missing a couple things in their restricted cash and their other assets, there's limit disclosure around those two line items.  I've put market multiples on the multifamily and commercial segments, grossed up their land at their Windmill Farms development to approximately equal what the going rate for their acreage has been recently.  I get a little under $100/share in NAV, which is probably on the conservative side.

One potential source of hidden value is in their convertible loans, here they lend money to developers with the option to convert the loan to 100% equity ownership in the properties.  The terms aren't disclosed but 6 of the 9 development loans in that bucket are on stabilized assets.

But the big question remains, what will TCI do with the proceeds from the asset sale?  In the press release, the company says:
the Company intends to use of most of the cash flow it will receive from the aforesaid in subsection 3 above to make new investments and to expand its multifamily residential property portfolio.
That doesn't sound too promising for the prospect of minority shareholders being bought out and likely why it didn't pop on the JV sale news.  But the controlling shareholders own 85% of TCI (mostly via ARL), leaving ~1.3 million shares in the float, if insiders offered shareholders $65 that would be an $85MM check, well within reserving "most of the cash for new investments" and would also transfer $45+MM of value to insiders if my NAV is believable.  They've never had this much liquidity before, the patriarch died three years ago, Pillar Asset Management has a new CEO that has inherited this crazy structure, maybe we see something happen once the deal closes.

Other thoughts/items:
  • Yes, this is externally managed, there's a 0.75% management fee on gross assets plus a 10% fee on net income and capital gains.  Not super shareholder friendly, but they're really only grifting on the 15% of minority shareholders.  I don't see a lot of benefit to them staying public even with the management fee structure, they haven't attempted to grow (they don't even issue shares to themselves, share count has remained steady over the years), there's public company costs that they're bearing (on three different levels, ARL, TCI, IOR), it would seem to make the most sense to take advantage of the big discount in the market by tendering for the remaining float.
  • The corporate structure here is really confusing, almost all of TCI's assets are in the Southern Properties Capital entity that was created to issue bonds in Tel Aviv.  The commercial properties, the remaining and holdback multi-family properties, all should provide plenty of collateral to back the outstanding Israeli bonds giving them liquidity to do a tender offer.
  • ARL and TCI are both entering the Russell 2000 on Friday.  ARL traded strangely for a while, trading well above parity with TCI, I switched from ARL to TCI, but it is worth monitoring both of them in the future.  I'm guessing most of the index buying has taken place ahead of the reconstitution but given the extremely low float (what a dumb index that would include either of these at their full market cap!) we could see some strange price action.
  • One lazy error in my back of the envelope model -- one of the properties in the wholly owned multi-family segment was included in the asset sale, so there's likely a tiny bit of double counting, but shouldn't be too material.  There's limited disclosure to parse apart, so I just ignored it. 

Disclosure: I own shares of TCI

Sunday, June 12, 2022

Franchise Group: In Exclusive Acquisition Talks w/Kohls

Franchise Group (FRG) is one of my largest positions, naturally I feel obligated to post something on the headline grabbing news that FRG is the apparent winner of the auction for struggling retailer Kohl's (KSS).  Kohl's would be a transformative acquisition, FRG is currently a $2.7B enterprise value company and press reports have them paying $8B for KSS ($60/share).  FRG is currently guiding to $450MM in 2022 EBITDA, TIKR has the consensus KSS estimate at $2.1B.  The combination of FRG being smaller than the target, little known outside of certain value/event-driven circles and fears of credit markets tightening seem to have the market doubting this deal gets done (KSS last traded for $45.75).  But I have faith in CEO Brian Kahn, FRG entered my portfolio as a special situation when it was then called Liberty Tax, which went about a complicated merger and tender offer transaction that looked novel and interesting from an outsider perspective.  Here is FRG's most recent investor presentation for what the company looks like today, a lot has changed, including FRG selling the original Liberty Tax to a SPAC (sponsored by NexPoint).  My thesis in the last two years has mostly revolved around "in Kahn we trust", given the news leaks around credit providers being lined up, it appears this deal is getting done.  I've added some KSS as a small speculative merger arbitrage position alongside FRG.

Taking a few steps back, in April, news broke from Reuters that FRG was joining the bidding for struggling retailer Kohl's (KSS), I was a bit surprised but not entirely, Kahn is a creative deal maker and likely looks at many acquisition opportunities that don't fit Franchise Group's stated strategy of "owning and operating franchised and franchisable businesses".  My guess is the "franchise" part is more aspirational than truth, it is a generic name and strategy, they just look for attractive deals.  Kohl's certainly doesn't seem to fit the franchise mold, hard to imagine someone operating a department store as a franchise, but the deal does resemble other recent FRG acquisitions as the non-core assets could be used to finance the transaction.

Last November, FRG entered into a transaction to buy southeastern furniture retailer W.S. Babcock for $580MM.  Subsequently, FRG went on to sell Babcock's credit accounts receivables to B Riley (RILY) for $400MM, the retail real estate for $94MM, and the distribution centers and corporate headquarters to Oak Street Real Estate Capital for $173.5MM.  More than paying for the acquisition with asset sales and still expecting to receive $60MM in proforma LTM EBITDA.  A similar transaction seems to be in store for Kohl's, the department store chain owns their corporate headquarters, almost all of their distribution and e-fulfillment centers, and own 410 of their retail stores outright and another 238 of them owned but on ground leases.

Reports have FRG re-teaming up with Oak Street Real Estate Capital (part of Blue Owl's platform) to provide $6B in financing based on the corporate headquarters and distribution facilities real estate (might also include the retail real estate, so my 6% cap number below might be too low), and $2B (fuzzy, Seeking Alpha number) from Apollo in non-recourse Kohl's level term loan financing, with FRG kicking in the additional $1B via an upsized term loan.  Apollo isn't the ideal lender, but since they're a direct lender and aren't relying on syndicating the loan immediately like a large regulated bank, the financing seems more secure in the current uncertain environment.  It is an interesting structure, FRG is using no equity, financing it all with debt and will fully own a levered equity stub KSS.

Putting together a quick back of the envelope proforma, I come up with the below:

As always, probably a few mistakes above, feel free to point them out, and obviously, this is all excluding the capitalized leases which is real leverage even if it is non-recourse, but even if you did an EBITDAR valuation, the proforma company would be extremely cheap.  But I think it shows the creativity of Kahn and FRG, they're creating a diversified series of levered bets via non-recourse sale leaseback financing.

Other thoughts:

  • While not a "bet the company" deal, it is pretty close and certainly risky.  The market doesn't like highly leveraged companies, FRG will likely trade cheaply for a while as they bring down the debt and eventually further diversify away from Kohl's with future deals.  Kohl's is certainly a weak business, it is in the middle ground of not really having an identity, I can't think of anything you must buy at Kohl's that you couldn't get elsewhere. There's a lot of debt here, things could go horribly wrong.
  • There is some political pressure to reject the deal, particularly in Kohl's home state of Wisconsin, likely if FRG acquires KSS, long term this is a slow motion liquidation.  FRG often partners with B Riley, the two are intertwined some, B Riley has a retail liquidation business and often invests in these distressed retailers.  Selling to FRG probably cements Kohl's as a declining business and that might face political backlash.
  • FRG is heavily into home furnishings (previously mentioned Babcock, they also own American Freight which sells clearance appliances and Buddy's, a rent-to-own retailer), based on the recent Target inventory debacle, people aren't buying home furnishings anymore now that covid is mostly in the rear view mirror.  Cynically, FRG might be doing this deal to distract from issues at the core business.  However, Brian Kahn has sounded sober through the pandemic regarding inventory, supply chain, going forward expectations, he hasn't sounded surprised by the slowdown and thus far hasn't had to drastically change guidance.
  • Macellum Capital Management has been engaging in an activist campaign against Kohl's, they lost their proxy fight recently, but have been putting significant pressure on the company to sell themselves.  Kohl's management believed they were worth $70+, but with the recent downturn and disappointing Q1 earnings, bids have come in lower, so it might be an opportunistic time for FRG to swoop in and be the white knight.  FRG also runs a decentralized management structure, so it could be seen as a preferred buyer for management as they could keep their jobs.
  • FRG did recently put a $500MM buyback in place (after it was reported they were a KSS bidder), things could get pretty wild if they use the KSS cash flows to buyback shares versus paydown debt given their Debt/EBITDA ratio would likely remain within there target range immediately upon closing of the transaction.
  • Brian Kahn has never been shy about buying shares in the open market (did a lot during that initial Liberty Tax/Buddy's transaction, signed big boy letters with anyone that would sell him shares) and his private equity firm, Vintage Capital, owns 25+% of the company.

Disclosure: I own shares of FRG and KSS

Friday, May 13, 2022

Radius Global Infrastructure: Tower Ground Leases, Rumored Sale

Now onto something that is a little more in my historical wheelhouse.

Radius Global Infrastructure (RADI) is a holding company that owns 94% of the operating company APWireless (but I'll just refer to the company as Radius/RADI going forward).  Radius is a wireless tower ground lease company (the legal structure can vary by country, but in each case works similar to a ground lease) that purchases rent streams mostly from mom and pops, individuals or smaller investors who own the underlying real estate.  Historically, before tower REITs really took off, the wireless carriers would build their own towers and lease the land/rooftop from individuals or building owners.  Today, tower companies mostly develop and own the land under their new structures, but there's a large fragmented global market of leases for Radius to rollup.

Radius checks a few other boxes for me:

  • RADI is not a REIT and doesn't pay a dividend, although the business model would lend itself well to both, thus limiting its investor pool today.  This would be a great YieldCo (see SAFE).
  • RADI doesn't really develop new towers, but they have a global originations team that scours the market to create new leases, as a result their SG&A looks high for their current asset base (it doesn't screen particularly well), but their SG&A could arguably be separated and thought of as growth capex (HHC or INDT are semi-similar, but RADI's distinction is probably cleaner).  Their origination platform would likely be valuable to someone with access to lots of capital, for example, an alternative manager like DigitalBridge (DBRG).
  • Bloomberg recently reported that Radius was exploring strategic options including a sale.  RADI has some financial leverage and given the stability of their lease streams could trade privately for a low cap rate juicing any returns to equity holders.
A bit more about the business, stealing slides from their latest supplemental:

Radius has all the major tower companies and wireless companies as tenants, wireless infrastructure is an essential service that is only increasing in importance.  As a ground lessor, Radius is senior to the tower companies which are great businesses and have historically traded at high multiples.

In the current environment, everyone is concerned about inflation, Radius has inflation indexed escalators in 78% of their portfolio against a largely fixed rate debt capital structure, further increasing the attractiveness of their lease streams.

For a back of envelope valuation, I'm simply going to take the annualized in-place rents minus some minimal operating expenses to create an NOI for the as-is portfolio.  This portfolio should have minimal expenses other than a lockbox to cash the rent checks as there is no maintenance capex (these are structured as triple net leases).  Note the RADI share price below is my cost basis, things are moving around so much this week, don't know what the price will be when I hit publish.

The other challenging thing for RADI is all the dilutive securities.  There's also an incentive fee that is rebranded as the Series A Founder Preferred Stock dividend, I've left that out for now but may try to workout how much it would dilute any takeover offer, although I think there's enough room for error here either way.  As usual, I've probably made a few mistakes, please feel free to correct me in the comments.  But above is roughly the math if the acquirer buys Radius and fires everyone, sits back and collects the inflation-linked levered cash flows.

The piece I struggle valuing is the origination platform, but I have a feeling someone like DBRG (just as an example, any private equity manager really) would be very interested in it as they could deploy a ton of capital over time and generate pretty reliable returns.  RADI has guided to originating $400MM of new leases in 2022 at an average cap rate of 6.5% inclusive of origination SG&A and other acquisition costs.  Even using the current market implied cap rate of 5.1% above, the origination platform would create ~$110MM in additional value this year by putting the 5.1% public market valuation on the lease streams they originated for 6.5%.  RADI's management thinks they have a long runway for origination growth as they've just scratched the surface (low-mid single digit penetration) of this fragmented market.  Any value prescribed to the origination platform would be above and beyond my simple math in the Excel screenshot.

Interestingly, during the Q1 DBRG conference call, DBRG CEO Marc Ganzi said the below with regards to the digital infrastructure M&A environment (transcript from bamsec):

We do see public multiples retreating in some of these different data center businesses or fiber businesses or ground lease businesses. There's been a pretty sizable contraction and the window is beginning to open where we see opportunity. And I think by being once again by being ultimately a good steward of the balance sheet and being prudent in how we deployed that balance sheet last year, we've taken our shots where we have good ball control, and we've taken our shots that are candidly going to be accretive

And there's reason to take Ganzi's comments quite literally as DigitalBridge made a splashy deal this week in one of the three categories he called out by purchasing data center provider Switch (SWCH) for $11B.

I've bought some RADI common this week and also supplemented my position with some Aug $15 call options.  Similar to other ideas over the years, I like call options here, there's no reason to really think that RADI's business is deteriorating alongside the overall market, their leases are inflation linked and structurally very senior in an infrastructure like underlying asset.  There's financial leverage, low cap rates and an origination platform that could be valuable to someone, all of which could lead to a big takeout premium if they strike a deal.

Disclosure: I own shares of RADI (plus DBRG, HHC, INDT) and call options on RADI

Friday, May 6, 2022

Argo Group International: New Activist Pressure, Pursuing a Sale

This will be a brief post and not the most exciting idea given the current chaotic market backdrop, but I wanted to throw something out there as it has been a while since hitting publish. I've mostly just been sitting tight, waiting for events to play out and adding to a few current positions during this downturn.  I also don't have much experience with insurance companies so be easy on me in the comment section.  

Argo Group International (ARGO) is a specialty insurer (~$1.5B market cap) that first popped up on my radar screen in 2019 when it faced a proxy contest from Voce Capital, their largest shareholder (9-10%), which eventually added three representatives to the board.  Voce put out an entertaining deck that outlined the now ex-CEO's lavish lifestyle (corporate penthouses, art collection, sailing sponsorships, private jets, etc.) that was essentially being expensed through Argo.  

In the ~2 years since Voce refreshed the board and the ex-CEO resigned, Argo has gone about shedding unprofitable or volatile business lines to highlight the strong U.S. focused specialty insurance business. 

The crown jewel is their excess and surplus business line that focuses on risks that standard insurance markets are unwilling or unable to underwrite.  This the non-commoditized, less regulated corner of the insurance market and thus should be more profitable.  The transformation goal has been to uncover and highlight this business: 

However, the perceived slow speed of the transition and a surprise reserve adjustment in February brought forward another activist pushing for board representation in Capital Returns Management, an insurance focused hedge fund.  Capital Returns has also insisted the company put itself up for a sale and the board agreed last week to run a strategic alternatives process which includes exploring a sale of the company.  While, Capital Returns argues the board doesn't have skin in the game (in aggregate they own ~1% of the company), there are three Voce representatives on the board and they've moved the business down Voce's suggested path.  My guess is Voce is in agreement that now is a good time to pursue a sale and the board is unlikely to resist a reasonable offer.  In short, this may go from semi-hostile to friendly, the verbiage from the recent earnings call seems to imply that as well:

Thomas A. Bradley Argo Group International Holdings, Ltd. – Chairman of the Board & Acting CEO

Thank you, Greg, and thank you to everybody for joining us today. Before I jump into our results for the quarter, I'd like to take a moment to discuss our announcement last week. Over the last year, Argo has instituted a number of substantive strategic initiatives, actions that we believe have positioned the company for a clear and consistent long-term path to stable growth and profitability. The Board of Directors and management team, however, do not believe these initiatives are adequately reflected in the company's current market valuation.

After much thoughtful and deliberate discussion and analysis, our Board with the assistance of our advisers has initiated an exploration of potential strategic alternatives. In this review process, our objective is simple: to maximize the value of the company's strategy and its considerable long-term prospects for the benefit of all shareholders. To that end, the Board will consider a wide range of options for the company, including, among other things, a potential sale, merger or other strategic transaction.

What would be a reasonable valuation in a sale?  Again, I've only looked seriously at 1-2 insurance companies here in the last decade.  But below is a list of U.S. based peers that I took from Capital Returns' proxy, and the data is from TIKR.
This is admittedly rudimentary, but for a business that's proforma combined ratio should be in the low 90s, a 1.5x book valuation seems reasonable for a strategic buyer?  Kinsale Capital (KNSL) is a pure play excess and surplus insurer which trades for a high valuation, there's a KNSL short thesis on VIC worth reading, giving a little bit of comfort that other players will be interested in ARGO and that it should trade at a reasonable premium to book.

The sale process could take some time, maybe we hear something in 5-7 months, so again, there are likely more immediate/actionable opportunities in the current market dislocation, but keep this one on the watchlist.

Disclosure: I own shares of ARGO

Friday, March 11, 2022

LMP Automotive: Car Dealer Rollup Gone Bad, Pursuing a Sale

Full warning, similar to Armstrong Flooring (AFI), this could be a terrible idea, it has significant red flags and is highly speculative.

LMP Automotive (LMPX) is a micro-cap (~$45MM market cap) that came public in late 2019 with a car subscription model where users could rent a car month-to-month, positioning itself as splitting the difference between a short-term car rental and a traditional car lease.  LMPX then put an online dealer/mobile app business model spin around it to market the stock.  In 2020, LMPX became a bit of a meme stock, briefly trading up alongside other e-commerce car dealers like Carvana, but then crashed as they were unable to source cars economically to run their subscription model.  Instead, the company pivoted to be a traditional car dealership rollup business and went on a debt fueled acquisition spree in 2021.  LMPX finished the year with 15 new car dealerships and 4 used car dealerships across 4 states.  On 2/16/22, the company said they were unable to secure new financing for their previously announced but not yet closed acquisitions (7 of them!) and quickly pivoted to pursuing a sale:

Sam Tawfik, LMP’s Chief Executive Officer, stated, “The Company intends to terminate all of its pending acquisitions in accordance with the terms of their respective acquisition agreements, primarily due to the inability to secure financial commitments and close within the timeframes set forth in such agreements.”

“The Board of Directors believes that LMP’s current stock price does not reflect the Company’s fair value. Given the record M&A activity in our sector and multiples being paid for these transactions, LMP’s Board of Directors has directed management to immediately pursue strategic alternatives, including a potential sale of the Company.”

The stock closed at $5.25/share on 2/16, it now trades for ~$4.25/share.

Putting aside terminal value questions (auto OEMs bypassing dealers, electric cars needing less maintenance), car dealerships are fairly high cash flowing business and were big covid beneficiaries. There is a lack of supply (nationwide, dealership inventory is ~1/3rd of normal, going to take a while to normalize) that has raised prices and reduced the need for car salespeople (dealerships have been slow to rehire those laid off during the pandemic) as more people browse online and the low inventory has all but eliminated haggling.  Car owners are also holding onto to their cars longer creating more high margin service revenue.  Some of these covid changes may be lasting, many dealers talk about inventory being permanently lower as dealers become more of a distribution center and less of a place where people walk the lot to find the car they want, they've already decided on the specs online before going to the dealer.  

There are thousands of dealerships across the country, they're reasonably liquid assets that change hands regularly (similar to why I like REIT special situations, the assets are fungible and there's a large pool of buyers).  Here, there are 7 large publicly traded dealership groups (KMX, LAD, PAG, AN, ABG, GPI and SAH, but only ~10% of all dealerships) and many other large private ones.  The windfall profits of the last few years has prompted the larger public players to do a lot of M&A, rolling up this fragmented market.  While large dealership groups are thriving, many smaller dealerships are struggling to source inventory and are at risk of failure, in order to press their scale advantages, the big are getting bigger.  Awkward long way of saying, I don't think LMPX will have trouble finding buyers for their dealership assets, but it is more a question of price.

Given the rapid rollup nature of LMPX, nailing down the valuation causes a bit of brain damage to work through the financials, here's what CEO Sam Tawfik said in the Q3 earnings call:

Our third quarter annualized run rates excluding the acquisition we closed this quarter, which we expect to be immediately accretive to income this quarter are $565 million in revenue, and $47.6 million in adjusted EBITDA.

The acquisition referenced above is the White Plains Chrysler Dodge Jeep Ram Dealership that closed in October, purchased for $19.2MM that was estimated to generate $2.6MM in 2022 EBITDA.

Then in the company's annual letter on their website, Tawfik provides:

We completed the acquisition of our contracted White Plains, New York Chrysler Dodge Jeep Ram in the early fourth quarter using approximately $5 million in cash from the company’s balance sheet, 55,000 shares of common stock and $1.3 million in cash from our existing credit facility. This acquisition will be immediately accretive to earnings in the fourth quarter of this year. As a result of this year’s acquisition activity, the company currently owns 15 new vehicle franchises, operates 4 pre-owned stores across 12 rooftops in 4 states which generate over $600 million in annualized revenue.


 We intend to pay down our existing term debt by approximately $11 million in the fourth quarter of 2021, resulting in a balance of approximately $85 million, of which the company allocates $53 million to its real-estate holdings and $32 million to its dealership blue sky purchase debt. Essentially at the current pace of cashflow generation, if we choose, the company can extinguish its current blue sky debt in less than a year.

Adding it up together:

The car business does have some seasonality to it, Q1 is usually lower than the other quarters, so annualizing Q3 EBITDA isn't a perfect run rate.  I attempted to normalize that and LMPX's focus on tier 2 dealerships (domestic and economy imports brands) which fetch a lower valuation than luxury in the 4x EBITDA multiple.  Obviously, I'm not a automotive sector expert, feel free to correct or push back, but seems like there could be something here despite all the risks below.  I bought a smallish position this week.

Risks/Red Flags:

  • Obviously, top of the list, LMPX went on a crazy acquisition spree in 2021 and couldn't raise capital to complete them (credit conditions have tightened slightly this year, but still pretty open).  Most of these deals included a combination of debt and stock, struck when the stock was $15-$17, by the time it came to close these transactions the air was being let out of the growth balloon, the stock was $7 and the window to raise capital closed on LMPX.  Buying dealerships at 7x EBITDA while the stock trades well below that doesn't make much sense.  It could be nastier than that simple explanation under the hood, but the Q3 numbers look fairly decent, this is a mess but was at least cash flow positive during the last reported quarter.
  • Tawfik owns approximately 35% of the company, he appears to be the sole decision maker and doesn't seem to have a strong board around him.  There are a number of related party transactions, none appear overly egregious but in total they don't look great, plus in October, Tawfik bought a company plane for himself only a few short months before it all fell apart.  His biography includes founding Telco Group which was sold to Leucadia back in 2007 for $160MM and also founded PT-1 Communications which was sold to Star Communications in 1998 or $590MM.  Presumably he's not totally incompetent but might have just gotten caught up in the market hysteria last year.
  • Tawfik has been selling a small amount of shares regularly as part of a 10b5-1 plan, I'm not an expert on these insider selling plans, not sure if they can be cancelled halfway through, but it is not a great look if you think the stock is materially undervalued.
  • LMPX reports EBITDA per share versus enterprise value, that's always a red flag for me as it is intentionally comparing apples to oranges.
  • Their current term loan matures in March 2023, so they've got a little time to get this process done and less of a forced sale than AFI.

Disclosure: I own shares of LMPX

Thursday, February 17, 2022

Regional Health Properties: Revised Pref Exchange Offer

Last June, Regional Health Properties (struggling skilled nursing real estate company) proposed an exchange offer where the company's Series A preferred stock holders (RHE-A) would receive 0.5 shares of common stock (RHE) for each share of preferred stock.  At the time of my post, RHE was trading at $12/share, today it trades sub-$5 as all speculative trading sardines have generally come down substantially over the past several months.  Last Friday after hours, with no corresponding press release this time, Regional Health snuck in a new exchange proposal whereby Series A preferred stock holders could exchange their shares for new Series B preferred stock.  The Series A preferred stock trades for $4.50/share.

The proposed Series B preferred stock has some interesting terms that I haven't seen before:

  • First to nudge Series A holders to exchange, if the proposal passes (need 2/3rds) then anyone who rejects the exchange or is just too lazy to exchange gets pretty severely penalized.  The Series B becomes senior to the Series A, the liquidation value of Series A goes from $25 to $5 and all the accumulated but unpaid dividends get erased.
  • The headline dividend rate is 12.5%, but it will not be payable or start accruing until the fourth anniversary of the issuance/exchange date.
  • The liquidation preference starts at $10 and increases back up to $25 at the fourth anniversary.  If all Series A holders exchange, the liquidation preference will initially drop to $28.1MM, there's $55MM of debt ahead of the preferred stock, last June I estimated the value of their owned real estate at $87MM (9.5% cap rate), so that might cover the preferred stock at a $10 liquidation preference.
  • Instead of the typical 6 quarters of missed dividends penalty to nominate a preferred stock board member, since the Series B won't be paying a dividend for the first four years, the Series B terms call for a "cumulative redemption" where Regional Health has to repurchase or redeem a certain amount of preferred each calendar year.  It starts with 400,000 shares in 2022, then 900,000 shares by year end 2023 (again, cumulative, so an additional 500k shares in 2023), then 1,400,000 shares by year end 2024, and then finally 1,900,000 shares by year end 2025.  If they fail to do so, then the preferred shares will have director nomination rights.
  • Additionally, if Regional Health doesn't redeem or repurchase 1,000,000 with 18 months, Series B holders get common shares in a pro-rata fashion to make up the difference.  Interestingly for both this penalty and the cumulative redemption penalty, the threshold is a specific Series B share amount, so if only 2/3rds of the shares are exchanged, each of these milestones becomes a greater percentage of the Series B.
  • They then throw in a little game theory to encourage Series B holders to participate in early repurchases or redemptions, once there are less than 200,000 Series B preferred shares outstanding, the liquidation preference drops back down to $5 (for reference, there are 2,811,535 Series A preferred shares currently outstanding).
  • Like the last exchange offer, this offer requires both the preferred (2/3rds) and common shareholders (majority) to approve.  The common vote might be hard to obtain, they didn't get many shareholders to vote in the last annual shareholder meeting, these shares are likely mostly in retail hands.
Regional Health's plan following this exchange is to grow their way out of this mess, issue new stock, attempt to take advantage of the distress following covid (similar to SNDA, but without the creditable board/support) in the senior housing sector and redeem the preferred over time along the way.  My initial thoughts are this is a pretty attractive deal for the Series A owners, certainly better than the initial offer.  In my typical fashion, just penciling out what the returns might look like if Regional Health actually kept to that redemption schedule.
Now this is far too simplistic, but assuming that everyone exchanges (unlikely given that this hasn't paid a dividend in many years and is probably sitting in the forgotten corners of retail brokerage accounts), and Regional Health keeps that redemption schedule at the liquidation value (I had to average the liquidation value table since they don't line up perfectly) pro-rata for all shareholders which they probably won't and instead try to repurchase shares or tender at a discount, then they orphan it again afterwards and its worthless (which it wouldn't be).  The cash flows won't look like this, it is just a sketch out of the redemption schedule, but I get a 30+% IRR if all works out.  The biggest assumption is management can actually get out from under this, raise equity, gain creditability, etc. and that's pretty unclear, but it is a situation that deserves a second look.

Disclosure: I own shares of RHE-A

Wednesday, February 16, 2022

Bally's Corp: Standard General Go-Private Offer

Bally's Corporation (BALY) is the old Twin River Worldwide Holdings (old ticker, TRWH) that began with two casinos in Rhode Island, then really starting in 2019 through an aggressive series of complicated acquisitions created a sprawling omni-channel gaming company that appears well positioned to benefit from the long term growth in iCasino and online sports betting.  The architect of this transformation is Soo Kim of Standard General, he is the Chairman of the Board and his investment firm owns more than 20% of the shares.  On 1/25/22, Standard General submitted a non-binding offer to buy Bally's for $38 per share (shares trade for $35-$36).  

The offer appears very opportunistic as the economy is reopening, the pieces of Bally's serial acquisitions are starting to come together but before their true earnings power are fully apparent, all while the market has sold off gaming stocks.  Likely Kim is simply highlighting the shares are cheap, he's best positioned to understand the value of the company, and nothing further comes to fruition on the management buyout front.  However, now that the acquisition strategy is maturing and the need for a public currency might not be as important, he could actually want to take it private and negotiate a higher price with the board.  But at current prices, I agree shares are cheap and would be happy to own the stock absent a deal.

Here's a slide from their investor presentation showing the pace of acquisitions, almost all of the regional casinos were acquired in 2019-2020, many the result of forced divestures when larger gaming peers consolidated.  This allowed Bally's to pick properties up on the cheap and build a nationwide footprint in which to standup a mobile gaming presence.  I generally prefer the regional casinos to destination ones as they're more stable and proved that throughout covid.  Bally's Corp bought the "Bally's" brand name from Caesars (CZR), they're in the process of rebranding all of their regional casinos to the Bally's brand, the old CZR's owned Bally's in Las Vegas (the original MGM Grand) is being rebranded to a Horseshoe property (and Bally's Corp is buying the Tropicana Las Vegas from GLPI).

The two non-physical casinos deals really worth calling out are:
  • On 11/19/20, Bally's entered into an agreement with Sinclair Broadcast Group (SGPI) to rebrand their regional sports networks (the 21 they acquired from FOXA in the DIS deal) from Fox to Bally's, in exchange Sinclair got stock and warrants in Bally's, Bally's also must commit a certain percentage of marketing spend on Sinclair's networks.  The cord cutting trend is well known, RSN valuations are down  (Sinclair's RSN's debt trade at distressed levels), sports is generally the reason cited for cord cutting because their content is so expensive.  But from Bally's angle, this deal puts their brand right in the face of the most engaged sports fans, even if RSNs are losing subscribers, they're unlikely to be losing the ones that Bally's is targeting.  While Caesars, MGM or Draft Kings are spending big on the NFL at the national level, Bally's has instead targeted the more engaged local fan, one that might have a more frequent/year-round betting cadence than just the NFL season.
  • On 4/13/21, Bally's announced a combination with Gamesys Group (GYS in London) for cash and stock, the deal closed on 10/1/21.  Gamesys is a UK based online gaming company (casino strategy versus sports betting, mostly UK and Asian markets) that does both bingo and iCasino games, the idea is to pair the successful Gamesys iCasino offering (where legal in the U.S.) with the Bally's sports betting/Sinclair offering to create an integrated experience.  Generally you need a physical presence in a state to get an online license, so in order for Gamesys to fully access the U.S. market they needed to partner with someone like Bally's who thanks to their acquisition spree, have a presence in most of the desirable gaming jurisdictions.  To fund the rollout of iCasino and online sports betting in the U.S., both the existing Gamesys international business and the U.S. regional casino business are highly cash generative.  Bally's expects to spend 20% of FCF for the next several years on the rollout, but they're taking a more measured pace than other competitors when it comes to promotions, etc.
Interestingly, the CEO of Gamesys became the CEO of Bally's, signaling an emphasis on bringing the successful Gamesys model to the United States.  Also, the management of Gamesys elected to take stock in the merger instead of cash, at current prices that appears to be a mistake as the value of those shares is roughly half what the cash offer was a few months ago, but shows their confidence in being able to replicate their success here.

Valuing Bally's is a little tricky, it was a covid beneficiary but hard to tell how much (margins will come in as service levels are restored to pre-covid levels), the capital structure is messy due to their acquisitions and the net leases on some of their physical casinos, and we've yet to see the inflection point in their omni-channel strategy.  All reasons why Soo Kim is probably best positioned to value the company versus outside investors.  Here's Kim explaining his offer on CNBC.

Below are all the contingent equity securities that have been issued in conjunction with various acquisitions over the last two years (note the Gamesys acquisition shares are in the share count today, the others generally aren't in reported numbers):
Here are their Q3 2021 numbers annualized (Bally's hasn't reported Q4 numbers yet or provided 2022 guidance):
And to show possibly more normalized numbers, here are what the Bally's regional casinos did in 2019:
If we back out the corporate expense on the above for an apples to apples with the Q3 numbers, we get $317MM versus the $359MM (post rent) done in Q3, for simplicity, let's just say normalized is somewhere in between there, an average would be $343MM.  Add Gamesys (pretty consistent grower over time) and subtract the corporate expense gets us $633 of EBITDA against a $5.9B EV (using 68 million shares, $3.445B of debt excluding capitalized leases) for an 9.4x EBITDA multiple (or a 14% levered FCF yield using management's estimate) that gives no value to the mobile app opportunity in the U.S. (currently loss making).  Again, there are a lot of moving parts, I could be wrong, please double check, but I think that's a pretty reasonable price to pay for a company that is potentially in play and/or at an inflection point in their business model.

Disclosure: I own shares of BALY