Wednesday, September 22, 2021

Consensus Cloud Solutions: Quick Thoughts on Garbage Barge Spin

Just to get this out of the way early, I don't own J2 Global (JCOM) and this spinoff is pretty dicey, but I find the setup pretty fascinating from several angles, more from a case study perspective and want to throw this out there in case others want to share their thoughts as well.  

Consensus Cloud Solutions (CCSI) will be spun off from J2 Global in the coming weeks, Consensus is JCOM's legacy eFax business.  It is a high-margin subscription business, one of those that people often forget they even have especially if their employer is paying for it, that allows you to receive faxes in your email.  Surprisingly, many industries, particularly health care and financials are still heavy users of fax as it's viewed as a secure communication method.  Even if you only get a fax occasionally, you still want to have that capability to receive them and end up keeping your subscription until your last client stops faxing, even then you might keep it just in case.  But unlike Jackson (okay, some may disagree with that), eFax is a melting ice cube, faxes are converting everyday to other communication methods and I can't imagine many use cases converting from something else (snail mail?) to fax.

Over the past decade or so, JCOM has been using the cash flows from eFax to diversify their business by buying a bunch of legacy internet media companies, the parent after the spin will be renamed Ziff Davis (and trade as ZD) which is the old holding company name of PC Magazine.  In one more attempt to extract value from the eFax business, JCOM is effectively selling the company via a spinoff.  Their tax basis is too low to just sell it outright for cash, so instead they're going to encumber Consensus with $800MM in debt, which is about 4x EBITDA.  Probably not too different than what they'd be able to sell the business for entirely and possibly more than they'd get after tax.  Additionally, they're retaining just under 20% of the CCSI shares to divest over time, so it's really economically and strategically a sale from the parent's perspective.  That's going to leave a levered stub equity in a declining business, the textbook "garbage barge" spinoff.

What makes Consensus different than many other garbage barge spinoffs is while it is a declining business, the business itself has some attractive qualities to it.  It's reasonably sticky (as said earlier, you want to keep your subscription just in case), it is high margin (50+% EBITDA margins) and fairly asset-lite, despite the debt, they're projecting $100MM of free cash flow to the equity on $200MM in EBITDA.

A few quick thoughts on the investor presentation which you can find here.


They're doing what most declining businesses are doing and split themselves up into two segments, one that is the slow-or-declining business (SoHo, which is their small and home office segment) and corporate which is where they're focusing on the healthcare vertical and is showing growth.  Now the big question that always been around JCOM, how much of the growth is organic versus M&A, many of the bear writeups in the past have made that argument.  And its hard to tell, they do a good job obscuring their financials, in the Form 10, the proforma financials only show the proforma numbers for 2021 and 2020 and everything prior is obscured by JCOM's segment reporting (only the eFax business is being spun, JCOM is retaining the rest of their cloud segment). 

But if this is really a mid-single digits grower on an organic basis with 50+% EBITDA margins, CCSI would trade multiples of where this is likely to trade.  It seems reasonable that the revenue growth guidance includes M&A, but hard to tell how much, and thus hard to trust that FCF number, how much of it is really capex via M&A?

Again, showing growth even in the legacy segment, one question could be how much was this business a covid beneficiary?  I could see them gaining some marginal subscriptions from people moving from the office to home and instead of buying a fax machine, employers signed everyone up for eFax.  Maybe that's a permanent shift as with each passing day it seems like a full return to office is off the table.

Management is saying this is a $100MM free cash flow business, mirrors their LTM proforma net income which makes sense for a business like this with limited capex.  I've only seen one sell side report thus far, but they're comparing this business to other declining businesses, oddly in cable networks, but pegging this at 5x EBITDA.  At 5x, the EV would be approximately $1B, with $770MM of net debt, the equity stub would be $230MM with $100MM of earnings/free cash flow, obviously on a very levered basis, on an unlevered basis CCSI would only be a ~15% UFCF yield.

They plan to de-lever, the proforma income statement seems to suggest the bonds will have a 6.5% coupon (second thought, this will probably have a term loan above the bonds, so the bonds will have a higher coupon which makes sense), maybe that could be interesting to some fixed income investors.  Could be a great short if management misses guidance early and the market questions the sustainability of their business, but could also work tremendously well if they can steady the business for a few years, de-lever and harvest the cash flows into something with a longer term growth profile.  But with the debt, they'll really need to thread the needle, I'll probably stay away and just watch as a spectator.  Curious if others have more complete thoughts.

Disclosure: No position

Jackson Financial: Spin/Demerger, Technical Selling

Jackson Financial (JXN) is the largest variable annuity provider in the U.S. and was recently spun (or "demerged" in ex-US terms, good Google alert term btw) from Prudential PLC (different than Prudential Financial) which is a London listed insurance company that primarily operates in high growth areas of Asia and Africa.  Jackson is only listed in the U.S. and much smaller than its parent, as a result it is likely experiencing (or has already in the when-issued market) some forced selling by both geographically filtered and market cap filtered investment mandates or indices.  Directly from the Form 10:

Index funds that hold Prudential ordinary shares likely will be required to sell their shares of Class A common stock received in the Demerger to the extent we are not included in the relevant index. In addition, a significant percentage of Prudential Shareholders are not residents in the United States. Many of these shareholders may sell their shares immediately following the Demerger. The sale of significant amounts of our Class A common stock for the above or other reasons, or the perception that such sales will occur, may cause the price of our Class A common stock to decline.

In a variable annuity, the client deposits funds into a separately managed account in mutual funds that Jackson's asset management arm selects to be on its platform, then Jackson guarantees some minimal performance for a fee.  Jackson takes those guarantee fees and purchases hedges to protect against a sustained market downturn that would turn these insurance contracts upside down.  The hedges are marked-to-market in GAAP accounting while the corresponding liabilities are not, so a combination of opaque accounting with long dated market/longevity risk leads these variable annuity insurers being valued like death.  Jackson is insuring against the market collapsing, which seems like a difficult risk to forecast, especially in this environment when arguably the market is overvalued.  To see this in action, look towards Brighthouse Financial (BHF) which was spun from MetLife a few years back, BHF trades for 2.4x LTM adjusted earnings and 37% of adjusted book value (basically ex-AOCI), torturing value investors like David Einhorn for years.

Jackson just reported Q2 earnings last Friday, LTM adjusted earnings come in at roughly $2.4B or $25/share and adjusted book value at $91.38/share, versus the current trading price of $26/share which is 1x LTM adjusted earnings and 28% of adjusted book value.  So it's absolutely cheap and somewhat relatively cheap, but does have a lot of black box type risk to it, hard to fully grasp all the market risk they're taking and believe in their hedging strategies.  But just the math of something that's not a melting ice cube, trading at 1x adjusted earnings (feel free to pick at the adjustments), not a lot has to go right for that to work out reasonably well.

Other ways to look at the valuation:

  • Last summer, Jackson offloaded their fixed annuity risk to Athene (ATH, soon to be acquired by APO) and concurrently, Athene took an equity stake in Jackson.  Athene invested $500MM for an 11.1% economic stake in the business, which equates to a ~$45/share price, or 70+% above where it is trading today.  Apollo via Athene might have slightly overpaid, need to probably consider it in context of the reinsurance transaction as well, but unlikely they severely overpaid, especially when markets were still a bit dicey last summer.  I don't think ATH/APO would purchase the entire company as its now a pure play on variable versus fixed annuities (much different profile in my opinion for APO and investing the float), but a good valuation point nonetheless.
  • In the Form 10 and throughout their investor presentations, Jackson makes it clear that they will be a significant returner of capital to shareholders.  In year one, they expect to distribute $325MM to $425MM out in shareholder yield during the first twelve months.  At the midpoint of $375MM, that's 15% return of cash, either in the form of dividends or share repurchases.  Again, seems more of a black box than a melting ice cube, but over time that 15% return of capital should at least mirror the shareholders ultimate return without any re-rating of the rock bottom multiple.
  • Their statutory capital is about $4.4B, maybe a more conservative way to look at the book value, that would be $46.50/share or roughly trading at 56% of this more conservative number.  This is also an important number in context of the above bullet as they've guided to distributing 40-60% of the annual growth in statutory capital out to shareholders over time.
Other miscellaneous thoughts:
  • Another way I've thought about the cadence here, London based funds are selling and soon this will be have to be picked up by U.S. based funds and indices, so there could be a time period here where the stock is orphaned and as a result trading at an artificially depressed multiple.
  • Prudential PLC held back 19.7% of the JXN shares, they're going to monetize that over the next year, so maybe similar to the situation over at Technip Energies (THNPY), it could provide a small overhang until their divestiture is completed.
  • PPM is their internal asset manager, they mostly invest the corporate balance sheet in fixed income securities, they do manage some external capital for Prudential PLC related entities which may be at risk (they've had some of their funds withdrawn already) now that the companies are separate.
  • We all know about the long term demographic trends in this country, baby boomers are retiring and might look to annuities to offload that market and longevity risk.  They've even made some regulatory headway getting these products in 401(k)s, now I wouldn't recommend anyone actually buy them.  To that point, this is more a product that is sold rather than bought, maybe similar to a timeshare in that sense, and possibly the market is punishing this business similarly/unfairly.

Disclosure: I own shares of JXN

Thursday, September 9, 2021

Atlas Financial: Senior Bonds Should Reject RSA, Reopening Play

At a certain point, I should probably turn this blog over to a few of my smarter readers, Atlas Financial Holdings (AFHIF) has been mentioned a few times in the comment section by ADL.  Be warned, Atlas has a lot of hair on it, thinly traded and the common stock is a nano-cap (sub $10MM).

Atlas is in the early innings of a business transition, previously they were an insurance company to the niche light commercial auto market (think taxis, limos, shuttle buses, etc.), that wasn't a great segment prior to covid and then really got crushed during the pandemic with rides down 90+%.  Anyone that has tried to get a ride-share or taxi lately knows, there's a massive driver shortage and fares have spiked significantly, eventually this will normalize and drivers will return.  The insurance subsidiaries of Atlas are now in receivership/liquidation, the remaining business and the go-forward strategy is a managing general agent ("MGA") model (d/b/a Anchor Group Management) where Atlas originates and services insurance policies for a fee but the risk is borne by third-party insurance company partners.  In addition, they've developed a mobile app targeted at ride-share drivers that offers micro-duration policies (essentially an hour-to-hour type thing) that would have sounded very SPACable earlier this year, but at the moment is more of a call option and not super material to the business as far as I can tell.

If they can return to writing the same volume as they did in 2018 (~$285MM, approximately 15% market share) under the MGA model (management put this goal out there in their recent investor call), this could be a multiple bagger (they take a 20% commission and guided to 20-30% pre-tax margins), but the path between here and there is highly uncertain and probably not realistic.  To put that goal in context, they currently have only 5% of that in-force, writing a bit more than on a run rate basis as new business is inflecting with the reopening.  To make it even hairier, the company has a quickly approaching $25MM debt maturity in April 2022, that security is a baby bond ($25 par, exchange traded) under the symbol AFHBL.  

The company missed the July payment on these bonds (although you would have no way of knowing unless you owned the bonds) and then last week the company announced it had come to a proposed restructuring support agreement ("RSA") with 48% of the noteholders to exchange the current bonds for a new security with similar terms (same headline 6.625% coupon, but the company has the option to PIK at 7.25% for the first two years) but pushing the maturity out 5 years in an amend and extend.  Troubling, alongside the restructuring of the bonds, Atlas is receiving rescue financing from "certain supporting noteholders" in the form of a 12% $2MM convertible term loan with an additional $1MM delayed draw.   As a "setup fee" the supporting noteholders are also getting a free 2,750,000 shares (and up to 5 million shares if the delayed draw is fully drawn), which is close to $1.4MM at current prices, quite the setup fee for a $2MM loan!  The loan has a conversion price of $0.35, which is in the money at today's $0.50 share price, so if fully drawn and converted, this rescue financing could end up with over 13.5 million shares compared to the current share count of just over 12 million shares.  The convertible loan is also senior secured and senior to the proposed restructured bonds, effectively these "certain supporting noteholders" are extracting value from the rest of the noteholders.  In a normal bankruptcy proceeding, all noteholders would be treated equally and would likely receive a pro-rata combination of new bonds and equity.

The bonds (AFHBL) did trade up on this news to $11-$11.50ish (par value is $25) creating a yield-to-maturity in the mid-to-high 20% range if the proposal is approved.  But I think there is an opportunity for a better, fairer deal for AFHBL noteholders, if you own the bonds feel free to reach out to my email and I can put you in touch with a group that is pushing for a better deal.  I plan on rejecting the RSA.  Either way, seems like an interesting quirky way to play a reopening or normalization of the post-pandemic economy.

Other thoughts:

  • Atlas has its corporate headquarters for sale (953 American Lane, Schaumburg IL) for $13MM, they do have a $6.5MM mortgage on the property that is held by the estate of one of their former insurance companies that are now in receivership.  So there should be some equity in the property, providing meaningful liquidity to a company of this size, potentially negating the whole need for the egregious convertible loan if they could get it sold quickly.
  • Atlas is heavily tied to two insurance providers, so this isn't quite the "originate to distribute" model it sounds like but more of an outsourcing model with two customers, so the customer concentration risk here is quite high.  National Interstate Insurance Company is the partner for shuttle buses and Buckle Corporation is the partner for the taxi and limo business.
  • It appears that Uber and Lyft are being more rationale in their pricing post pandemic, both are public now and no longer have near free cost of capital to sustain negative gross margins, maybe some market share stabilizes or inches back for taxis and limo services where Atlas's business historically focused.
  • The same CEO that drove this into the ground is still the CEO, which gives me some pause on the likelihood that they'll be successful executing the turnaround.
  • This likely isn't a takeout candidate, in the 10-K, they mention that as part of the insurance company liquidations, Atlas agreed that if they choose to sell the MGA operations, the insurance company estates would receive 49% of the proceeds.

Disclosure: I own AFHBL

Tuesday, August 17, 2021

PFSweb: Another Asset Sale, Cheap RemainCo Situation

PFSweb (PFSW, ~$280MM market cap) is reader suggestion to the recent theme of companies that have sold a major business segment leaving the proforma stub business looking cheap, and here again, the company is continuing to pursue strategic alternatives, which will likely lead to a sale of the remaining segment.  

PFSweb has an interesting history, they started out as "Priority Fulfillment Services" but changed their name to "PFSweb" (as any e-commerce adjacent company did at the time) and IPO'd in December 1999, popping over 160% on their opening day, as you can imagine, it has been an ugly ride since the IPO.  Ostensibly the company helps enable mostly old line retailers with their ecommerce strategy and fulfillment operations.  This has historically been done in two business segments, LiveArea is their e-commerce consultancy/advisory business and the PFS business is some combination of a third-party logistics ("3PL"; warehousing, fulfillment, returns) and a business processing outsourcing ("BPO", call centers, etc) operation.  

Somewhat unexpectedly, PFSweb sold their LiveArea business to a subsidiary of the Japanese conglomerate Dentsu International for $250MM in cash (roughly a 20x EBITDA multiple on LiveArea's 2020 segment EBITDA), the deal is expected to close this quarter and net PFSweb between $185-200MM in proceeds after taxes and fees.  Included in the press release is a line regarding the remaining PFS segment:

"With the divestiture of LiveArea underway, PFSweb has also engaged Raymond James to lead the exploration of a full range of strategic alternatives for its remaining business segment, PFS, to maximize shareholder value."

And from the investor presentation:

That all sounds like a sale to me, the remaining PFS business is in the hot 3PL space, I personally have a hard time distinguishing between what is really 3PL and what is just a BPO, how much of it is a commodity business, etc., it has almost become a buzzword like SaaS or cloud in the technology space.  But the industry has been a significant covid beneficiary with branded manufacturers and retailers scrambling to become more omnichannel and improve their ecommerce capabilities.   

Look no further than the recent XPO Logistics spinoff, GXO Logistics, it was XPO's 3PL/warehouse outsourcing business that has taken off since the spin (~+35% in a month) and now trades at something like 15x 2021 EBITDA (I spent 5-10 hours on GXO, couldn't wrap my arms around it).  They're not an apples-to-apples comparison, GXO has something like 100x the warehouse/logistics space that PFS currently operates (about 1.6 million square feet spread across Vegas, Dallas, Memphis, Toronto, the UK and Belgium), but more just to illustrate the opportunity and growth investors are pricing into the industry.  This is a pretty fragmented industry, PFS is subscale (bloated SG&A expenses), seems like there would be any number of buyers that could fold it pretty quickly into their operations.

Here's the current proforma situation (PFSW is late on the 10-Q, noting they want more time to adjust the financials for the sale of LiveArea, so I could be off on this):

One question I had is how the company is presenting the remaining PFS segment, in the investor slide above they guide to 8-10% "standalone" adjusted EBITDA margins, yet in their quarterly segment reporting PFS did ~$26MM in LTM EBITDA.  I asked their outsourced IR, got sort of an unhelpful non-answer, but I'm assuming that standalone includes a portion (but it wouldn't be all) of their previous corporate overhead that was a bloated $20MM in 2020.  So on a segment basis (what a strategic acquirer might be looking at) the proforma PFS is trading for only 4.2x EBITDA.  For my back of the envelope valuation, I've assumed that some of that corporate overhead (going with a round 50%) really should be distributed to the segments.  They've hinted at moving some SG&A to the segments on earnings calls and mentioned in a recent 10-Q that an increase in property tax (sounds like an operating expense) bumped SG&A up.  The top row of each scenario is the EBITDA multiple assigned to the PFS segment.

As of the 10-K, PFSweb did have $56.5MM of NOLs, but based on the LiveArea sale, hard to know if there is any tax shield remaining for a sale of PFS, I'm backing into about a 23% assumed tax rate on LiveArea and applying it to PFS in the "Fully Taxed" scenario.  But of course there are ways to avoid the double taxation and simply sell all of the remaining PSFweb in a cash or stock transaction.  We also don't know what PFSweb plans to do with the LiveArea proceeds other than paydown their debt, similar to LAUR, I tried to map out what a tender offer might look like if they went down that path and used 1/3 of their proforma cash position to repurchase shares.  Just a guess and playing around with numbers.  But either way, assuming the LiveArea deal closes (make your own determination if that's a good assumption), then the remaining 3PL business is extremely cheap to acquirer, maybe just sort of moderately cheap as a subscale standalone, but should have downside reasonably protected given the industry tailwinds.

Other miscellaneous thoughts:

  • The industrial/logistics REITs are trading for high multiples and experiencing a lot of M&A (i.e. Zell fighting off others for MNR, Blackstone buying WPT), growth in 3PLs is a large part of that (PSFW is guiding to 5-10% topline growth over tough 2020 comps at the PFS segment with expanding EBIDTA margins), this is a different angle at a similar theme (I continue to own and like INDT as well).
  • Transcosmos owns 17.5% of PSFW, they're a Japanese call center/BPO business, they made a strategic investment several years ago, but unclear how much influence they have, just semi noteworthy as PSFW's largest investor.
  • PSFW has a little bit of noise in their financial reporting, they will pass along certain third-party expenses (like last mile delivery) to their clients but book it as revenue with an offsetting expense, so it might screen as lower gross margin than the business is in reality.  In addition, they have one client (Ricoh) where they will briefly take ownership of the inventory they're managing so that causes some fluctuation in working capital.
  • PSFW does have options available, I don't own any but they could be interesting, with LAUR the company already has a significant buyback ongoing with the prospect of a tender offer to support the price and limit the downside, here we don't know PSFW capital allocation plans outside of debt repayment.  Feels pretty similar otherwise.

Disclosure: I own shares of PFSW

Monday, August 2, 2021

Laureate Education: Asset Sales, Informal Liquidation, RemainCo Cheap

After my RVI post, a reader pointed me to Laureate, a setup that rhymes with RVI -- a large asset sale that is obscuring value in the RemainCo which will also likely be sold.

Laureate Education (LAUR) is a global for-profit education company that went private in 2007 (KKR in an LBO), was re-IPOed in 2017, and at the time of the IPO owned or operated over 70 universities across 25 countries, about half the business was in Latin America.  The IPO had a lukewarm reception and the company pivoted to selling their assets, usually at multiples that well exceed where public markets were valuing Laureate.  Today, the company has a pending sale for their U.S. for-profit school (Walden University), once that deal closes with Adtalem Global Education (ATGE, fka DeVry) in Q3, the company will have a net cash position of $1.66B and down to just five universities in two countries (Peru and Mexico) that management is guiding to $280MM in 2022 EBITDA against a $2.9B market cap ($1.25B EV adjusted for the Walden closing).

Laureate is not done selling assets, while Peru and Mexico are presented as continuing operations in their filings, they make it clear that they're still entertaining offers for both segments (transcripts courtesy of TIKR).

From Q4 2020 Earnings Call:

"...the decision to focus on a regional operating model in Mexico and Peru does not preclude further engagement with potential buyers for these businesses as we are committed to pursue the best strategy to optimize shareholder value."

From Q3 2020 Earnings Call:

"However, we will continue to explore strategic transactions for our remaining operations in both Mexico and Peru, and we'll pursue opportunities that can generate superior value for our stakeholders, net of friction costs versus retaining those operations as a publicly traded company."

The strategy of focusing on Mexico and Peru seems unintentional and more just the pace and sequence of asset sales.  It is unlikely that a smallish U.S. headquartered company providing higher education in Mexico and Peru will be valued properly or have much need to be public.  Management agrees, they've been consistent and clear in their belief that the stock price doesn't reflect the intrinsic value of the company, and their plans to return capital to shareholders to close this gap.  A few more snippets from recent earnings calls:

From Q1 2021 Earnings Call (5/6/21, stock was trading at $13.70):

"In addition, I am pleased to report that our Board has approved an expansion of our stock repurchase plan by an additional $200 million, bringing the total authorization to $500 million. Since beginning the plan in November, we have repurchased approximately $250 million worth of stock. We continue to believe that returning capital to shareholders through stock buyback is very accretive use of capital for investors given the significant discount of our stock price versus the intrinsic value of the individual institutions in our portfolio."

From Q3 2020 Earnings Call: 

"Let me now close out my prepared remarks by providing some guidance on the use of our excess liquidity. Our capital allocation strategy remains unchanged: first, support our business operations; second, repay our debt only if needed; finally, return excess capital to shareholders in the most tax-efficient manner possible.

...the most tax-efficient manner to return capital to shareholders is in the form of open market purchases, so share buyback, like the program we've just announced, as well as other means, such as a tender offer. So at this point in time, we are not thinking of distributing cash or excess cash to shareholders in the form of dividends. Obviously, that may change. But our priority is really to do it in the most tax-efficient manner."

The company has been a significant buyer of their own shares and that has likely continued as their share repurchase authorization was increased alongside their first quarter earnings release (we'll see how much on Thursday when LAUR reports Q2 earnings) and will presumably be increased again or in the form of a tender following the closing of the Walden transaction.

In my usual back of the envelope way, here's the simple EV for LAUR following the sale of Walden (due your own due diligence if assuming Walden will close is a good assumption):

The 2022 EBITDA guidance includes corporate overhead, in 2020, the individual segments did $113MM in EBITDA for Mexico and $189.5MM for Peru respectively, any strategic buyer could likely cut the corporate overhead, so the EBITDA multiple is somewhere in the 4-4.5x range for proforma ongoing operations.  Their Brazilian segment was recently sold for close to 10x EBITDA.

And what might a tender offer look like?  I'm really just guessing here, but let's say they use roughly half of their net cash to do a Dutch tender and it gets done at $17/share, what might that do to the stock after an ultimate exit of the Peru and Mexico operations?  Below is a range of possibilities.

Looking at that scenario analysis, its probably best to think of the tender as a special dividend than shrewd capital allocation, although in the higher multiple scenarios it would begin to make a difference.

The big risk might be in the Peru segment, mostly for political reasons.  Laureate took a sizable ($418MM) write-down on their Chile segment in 2020 and sold it for a very cheap multiple (sub-2x EBITDA), in their words from their Q3 2020 earnings call, due to "the risks and uncertainties that the market perceives around operating higher education institutions in Chile given the current political and regulatory environment as well as the possibility of a new Chilean constitution that could come into effect as early as 2022."  Last month, Peru elected a new President, Pedro Castillo, that ran a similar far left campaign that investors fear will upend the economy with plans for a new constitution.  But maybe that's already priced in?  It could mean that a sale isn't imminent, instead the company waits for covid to fully get in the rear view mirror and more political certainty before selling the remaining businesses.  In the "Peru is only worth 2x" scenario, then the current market price is valuing Mexico at 8x, which is probably about right, hard to see a lot of downside here.

Other thoughts:

  • The proforma net cash number of $1.66B does include taxes paid on the Walden sale, its unclear to me what the tax basis is on the Peru and Mexico segments or what local taxes might be due, they do have some NOLs, Laureate seems at least tax sensitive and could do a stock-for-stock deal or sell the remaining company outright which would eliminate the corporate level taxes versus doing a piecemeal liquidation and then distributing the proceeds to shareholders after.
  • Laureate took a write-down on the value of the Laureate network brand name in the first quarter, which hints that it won't be used much longer and confirms that a two country RemainCo is not the end state for the strategic alternatives process.  They also exercised the right to terminate their corporate headquarters' lease early, it now only goes through 6/30/22.
  • Management's incentive package is tied to an undisclosed "Total Value Factor" which includes both total valuation and more interestingly speed as inputs, meaning there's alignment, less risk of management kicking the can to keep their jobs.
  • Vaccine rates in Mexico and Peru are well behind developed markets, there's significant foreign currency risk (although lessened a bit now that their USD debt is gone), and September is a big enrollment period for them, if the delta variant impacts enrollment, that could throw a wrench in their guidance.
  • Prior to covid, they did get a bid for all of their Latin American operations for $3.3-$3.6B in cash but the buyer backed away because of the pandemic.  The company has sold about $1B of operations in the region since, if they were able to get this price again, that would be about a 8-9x multiple on EBITDA for Peru and Mexico.
Maybe an interesting way to play this is via options?  Others investors have explained how to think about event-driven options strategies better than I can, but here it seems like an interesting setup, similar to ones I've had success with in the past.  The recent past volatility won't look like the near future where we potentially have several catalysts that could move the stock price significantly higher: 1) Walden deal closing; 2) continued share repurchases or a large tender offer; 3) sale of the remaining company.  I supplemented my common shares with some call options, specifically the December $15 strike price, these could be too short term, but ATGE expects the deal to close this quarter and that should give LAUR enough time to announce a capital return and/or another sale.

Disclosure: I own shares of LAUR and some Dec $15 calls

Wednesday, July 21, 2021

Retail Value Inc: PR Portfolio Sale, Liquidation De-Risked

Retail Value Inc (RVI) is a retail strip center REIT that was a 2018 spin of SITE Centers (SITC, fka DDR) and has always been on my watchlist.  There were a few of these "good REIT/bad REIT" spins during that era, this is the "bad REIT" as it contained the Puerto Rican assets (along with some of their lower quality continental U.S. properties) that were largely offline due to Hurricane Marie.  From the beginning, RVI was designed to liquidate the portfolio and return capital to shareholders, over the last several years they have made slow progress on this goal by selling the continental U.S. properties piecemeal.  The question in my mind was always what value to put on the Puerto Rico portfolio?  That question has been answered which substantially de-risks the situation, last week, the company announced a bulk portfolio sale of their Puerto Rican assets for $550MM, which post-closing would leave 8 continental U.S. properties and a pile of cash.  By triangulating a few numbers, I have the remaining portfolio trading at approximately a 13% cap rate, which even for secondary/tertiary markets, seems too cheap.

Here's my back of the envelope math, feel free to point out mistakes:

Now there could be some frictional costs that I'm completely omitting, but I'm also not including any ongoing cash flow from the remaining properties, make your own assumptions there.  But here are some of my assumptions:

  • Much of the restricted cash is Hurricane Marie insurance proceeds and reserves for their CMBS financing, the insurance proceeds were to be used to rehab the properties from hurricane damage, in their Q1 10-Q they mention only needing $6MM of restricted cash to complete restoration work.  Additionally, the PR asset sale 8-K mentions that the deal doesn't include restricted cash and the CMBS will be paid off following the closing, I'm assuming the restricted cash becomes unrestricted at that point, but double check my work.
  • In the PR asset sale 8-K, the company mentions their current CMBS mortgage balance is $214.5MM, in order to get there and based on the asset sales that have closed in Q2, it appears they've spent another $20MM in cash towards the CMBS above the asset sales.
  • RVI is externally managed by SITC, the external management agreement is pretty reasonable towards RVI, there's no termination fee or incentive fee, but there is a little incentive fee built into the preferred stock that SITC is holding.  You'll see the preferred stock on the balance sheet at $190MM, but if the total disposition proceeds are above $2B, its $200MM.  I have the current total disposition at around $1.66B, and with the additional sale of the 8 remaining properties, they'll likely cross over that threshold.
  • RVI provides NOI guidance in their quarterly supplemental, it excludes assets sold to-date, they estimate $35-40MM in NOI for the continental U.S. properties.

Doing a very basic scenario analysis for what the remaining properties are worth yields anything from $26.50-$33.90/share in my estimates, versus a $25/share price today.  

Just to smell check these estimates, based on the delta between the 2021 NOI guidance given in the Q4 and Q1 supplemental, the three continental U.S. properties RVI has sold this year for a combined value of $34.4MM generate about $3MM in NOI for a 8.7% cap rate.  The Puerto Rico portfolio is being sold at an approximate 9% cap rate.  Another way to look at it, on a square foot basis, RVI will have 3.779 million square feet remaining, in 2020 they sold properties for $107/sqft, applying a similar number to the remaining portfolio would yield a value equivalent to a 9.3% cap rate.  So somewhere in that 9% range seems reasonable now that we're recovering from covid.

In summary, assuming the PR deal closes (maybe that's the biggest risk, we are in hurricane season), RVI will have no debt, approximately half their market cap in cash and only 8 properties left to sell.  I could see this taking a similar path to the MIC liquidation discussed recently, where they have back-to-back portfolio sales (although they'll probably wait until after the PR deal closes, supposed to be by end of Q3) to clean up the liquidation quickly.  Similar to MIC, not a home run, but with the situation largely de-risked, a potential ~20% upside seems pretty attractive.

Disclosure:  I own shares of RVI

Friday, July 16, 2021

CorePoint Lodging: Strategic Alternatives, Another Hotel REIT for Sale

CorePoint Lodging (CPLG) is an old friend of the blog that I've tried hard to forget, it is a hotel REIT that was spun from LaQuinta (LQ) in 2018 simultaneously with Wyndham's (WH) acquisition of the LQ franchise/management business.  It is a unique public lodging REIT in that it targets the economy and midscale select service segment (essentially all LaQuinta branded), most public REITs own upscale and luxury hotels.  Looking back at the spin, it was a garbage barge spin and performed like the moniker suggests.  

Hotel REITs are a tough asset class because as a common shareholder, you have a lot of mouths to feed ahead of you.  REITs can't be operating businesses so hotel REITs need management companies to run the hotels themselves which runs 5% of revenues, then you have the franchise fee which is another 5% of revenues, if you rely heavily on online travel agencies, that's another big hair cut. On top of that, you have a lot of fix costs and a heavy asset base with real depreciation, interest expense, etc., these aren't good businesses for public markets generally.  For those reasons, hotel REITs tend to avoid the economy and midscale segments because the average room rates are low and don't provide enough scale to justify all the overhead costs involved.  These hotels tend to be run by local mom and pop type operators who don't have the corporate costs and can avoid the management fee by operating the hotel themselves.  

CorePoint executives clearly understand this even if they don't say it explicitly and have been selling off their older, economy level hotels to individual operators at multiples that are way above where the common stock traded.  Which is sort of the opposite of what you'd expect, but if the buyer is purchasing the hotel unencumbered by the management fee, gets an SBA loan, and they get a tax depreciation shield, it starts to make some sense.  This week, CorePoint essentially put the rest of the company up for sale by announcing they are pursuing strategic alternatives.

Going back to the logic I used recently with Condor Hospitality (CDOR), another hotel REIT that is in the process of selling themselves, I came up with a very rough back of the envelope calculation for what CorePoint is currently valued at off of 2019 Hotel EBITDA (again, I understand the faults of that math, but it's what other comparable transactions are quoting as a valuation metric).  With Condor it was relatively simple because their hotel portfolio has remained constant since 2019, but CorePoint has sold a significant portion of their hotels in the last 18 months.
In CorePoint's 2019 10-K they gave us a "Comparable Hotel" EBITDA number which adjusted for those hotels that were sold or non-operational (CorePoint had some hotels hard hit by hurricanes a few years back) of $158MM.  From there, I attempt to back into what the comparable-"Comparable Hotel" 2019 EBITDA would be adjusted for all the asset sales that have taken place or are pending.  For the Q2 and pending sales, I'm using a 15x EBITDA multiple, I didn't see it directly in their filings but management mentioned 15x on their last earnings call.  From there I get about a $118MM "2019 Hotel EBITDA" number for the remaining hotels, please check my work if you're interested in the situation.  On an EV of about $1.1B, that's a 10.75% cap rate or 9.3x 2019 Hotel EBITDA, well below where the company has been selling its less attractive non-core assets and where other hotels have transacted recently.

Similar to the extended stay segment, economy and midscale hotels held up better through the pandemic and have recovered faster than urban or group oriented hotels.  Alongside their strategic alternatives announcement, CorePoint updated us on the performance of their hotels in the second quarter:
It's not an apples-to-apples comparison since CPLG has sold off a number of lower RevPAR hotels since 2019, but here's a snip from the Q2 2019 earnings release, so business is either back to 2019 levels or at least near it.
Blackstone owns 30% of CorePoint, a legacy of taking LaQuinta private in 2006 and public again in 2014.  Blackstone is obviously a big real estate investor and recently partnered with Starwood in a club deal to buy out Extended Stay America (STAY), maybe they'd do something similar here as CorePoint's hotels serve a similar segment (but clearly without the franchise business like STAY) and select-service hotels could over time look more like extended stay models with less than daily cleaning, etc., driving higher margins.

I'm a little gun-shy on putting a target price on CPLG, the stock price has run significantly and I still have mental scars from my last go around, but to a private buyer who can detach the management contract, it could be worth a decent amount more than where it is trading today at $13.75.  A 9% 2019 Hotel EBITDA (my number could be flawed) cap rate would be around $18 and would still be a lower valuation than where they've been selling their lower quality assets during a pandemic, maybe that's too high, but shouldn't be too far out of reasonableness.

Disclosure: I own shares of CPLG (and CDOR)