Year End 2013 Portfolio Review

One of my main goals of this blog is to keep myself accountable for my investing decisions because I am a loose believer in the Efficient Market Theory and think most people should invest in low-cost index funds.  All of my retirement accounts and a good chunk of my taxable account are invested in low-cost Vanguard funds (I'm sort of a Boglehead in that sense), but I do believe there are some opportunities for the smallish investor to exploit the market if you have the right temperament and the time/energy to devote to the process.

Strategy Overview
Below is a quick visual of the broad investment themes where I concentrate my time and believe where investors can generate above market returns, the more themes an particular investment hits the better.

I work in the banking/financial services industry, so my background knowledge and circle of competence skews towards investments in asset based businesses.  My goal over the long term (10+ years, multiple market cycles) is to generate an IRR of 20%, which will be difficult, but if I'm going to spend the time and effort, I want to make sure its worth my while over an index fund, otherwise I could be using this time on other income generating activities.

Year End Results and Current Portfolio

I started my active taxable account at the beginning of 2011 (but have been investing since 2004), below are my result from my first three years, a time period where I've admittedly had the wind at my back with only a few short and shallow corrections.  A couple clarifying points, my returns are an annual IRR for each particular year which produces slightly different results based on when I added cash to the portfolio (I haven't made any withdrawals), the 2013 returns are "pure" as I didn't make any additions to the account during the year.  The S&P 500 returns are not based on IRR, so its not quite an apples to apples comparison, and additionally one could argue the S&P 500 is not a proper benchmark given my lean towards small cap value stocks.

At this point, I'm pleased with my overall results, but also realize that I could be just lucky given the short time frame.

I also thought it might be beneficial to post my portfolio on a quarterly basis, so readers can relate and Monday Morning Quarterback my decisions, plus it will force me to only invest in high conviction ideas.  The below is my taxable brokerage account which follows the ideas that I post on this blog, as a full disclosure it's only a smallish portion of my net worth so the appearance of concentration or margin debt is not particularly significant for me, at this point its more of a hobby account.

As of 12/31/13

As I learn and gain experience, I will probably gradually transition some of my retirement accounts and other taxable accounts to a similar strategy, and at that point I'd probably also diversify further to 20-30 positions.  So take the above performance figures and holdings with a little grain of salt.

Year End Quick Thoughts on a few Portfolio Positions

Asta Funding

Asta is quickly turning into my lowest conviction holding and could be on the chopping block if I find a significantly better opportunity, I've started to lose faith in management.  On the latest conference call,  Robby Tennenbaum of Alta Fundamental summed it up perfectly with the following question (via Seeking Alpha)

This question is for Gary. So it looks like the personal injury business is growing nicely, and I'm sure there's good potential in the disability benefits business. But with your stock around $8.50 and a book value in excess of $13, and that's excluding the value of the zero basis portfolio, it's kind of hard to imagine how anything could have a better return on invested capital than buying back your stock. I mean, said differently, the market appears to be valuing all of your noncash assets at about $17 million. So I was hoping you could shed some light on how you think about the trade-off between maintaining the high cash balance for potential investments, especially in this challenging pricing environment, versus buying back your stock.

CEO Gary Stern then punts the question (which he has in the previous couple of conference calls as well) by talking about the private market transaction they did with an activist shareholder (PMCM) in June 2012 - they've also allowed their share repurchase program to expire last March.  First, management purchased shares back from PMCM at $9.40 a share, a premium to the then market price.  Why didn't management do a tender offer so that all shareholders could have benefited?  Probably because they wanted to reduce the activist stake and reduce the pressure on themselves.  Second, Robby Tennenbaum is exactly right, there's almost no investment that Asta could make that would be more accretive to shareholders than to buyback shares.  I just have a hard time selling at these prices, and when I invest in a deep value stock like this, I go in with an intended holding period of 3 years which should give management or the market enough time to realize a firm's intrinsic value.

American International Group

One of my larger positions has been in AIG, and it has contributed significantly to my portfolio's success this year.  I believe that large financials in the US are one of the few places to find significant value.  AIG still trades at a meaningful discount to book value, despite it's great turnaround in both operational metrics and capital allocation.  The company remains overcapitalized and will have significant opportunities to return cash to shareholders, hopefully in the form of share repurchases if its market price remains below book value.  Increasing interest rates should also benefit AIG as their low yield fixed income holdings roll over generating a higher ROE and EPS.

Early in 2014, I plan augmented my position (with fresh cash) in the AIG common stock with the TARP warrants that were issued in 2011 with a strike price of $45 and a maturity date of 1/19/2021.  I probably should have bought the warrants initially, but despite the run up in 2013, they still represent a great risk/reward profile and one of the few opportunities to earn a high IRR for 7+ years (also potentially valuable tax deferral).  The warrants come with a few anti-dilution adjustments to protect holders from dividend payments (above $0.16875 per quarter, the current dividend is $0.10 per quarter), stock dividends, rights offerings, and above market tender offers.  With the ILFC sale approaching a resolution, AIG remains one of my highest conviction holdings and should be setup for another good year in 2014.

2013 was a great year for the markets, I'm pleased to have out-performed over the broad market, and eked out a small gain over many diversified mid/small cap value funds.  Thank you for reading during the past 12 months and Happy New Year.

Howard Hughes Corporation: Ward Village

I'm here in Honolulu on vacation, so I took the short walk over to Ward Village to get a first hand account of one of Howard Hughes Corporation's primer strategic development assets.  Howard Hughes is planning to turn Ward Village into a vertical master planned community with 22 residential towers (4,000 units) and 1.5 million square feet of prime retail space.  Back in March, I put about a $2 billion value on the redevelopment asset (discounting it back to today), but given its long time horizon that's a very rough number that's subject to a lot of change.  What follows are just some random thoughts and pictures I took as I walked around the property today.

Below is the map of Ward Village, just south of the map is the Pacific Ocean, I can attest that any condo towers that are built in the area will have fantastic views of the ocean to the south, and great city views to the north.

For me, seeing the current state of Ward Village was a mixed bag, its a great location, but its current form is rather scattered and somewhat disappointing.  With it being 4 days until Christmas, I'm happy to report that all the parking lots were completely full with cars circling for spaces,  but most of the current Ward Village is Class C quality at best.  The below sign pretty much wraps up the current state of Ward Center and most of the entire property, quaint, but sort of stuck in time and clearly targeted at the lower-middle class shopper.

Ward Center

Ward Center feels like a small town indoor mall, not something you'd expect to see in downtown Honolulu.  The stores are mostly small local operations, one of the anchor tenants is Famous Footwear, and the hallways are tiny.  Again, it was fairly crowded, but likely due to the holiday season, I don't see why someone would go to Ward Center over Ala Moana mall just across the street.

Ward Warehouse

Ward Warehouse is pretty similar to Ward Center, but its an outdoor mall, but the same small town feel with local retail stores, but not really targeting the tourist market.  It seems odd to have both Ward Center and Ward Warehouse next to each other, they're different, but the same, definitely an opportunity to redevelop the area.  Neither are particularly valuable in their current form.

Ward Gateway Center

Across the street from Ward Warehouse is a pretty typical strip mall, nothing particularly interesting about it, looks dated, but still useful too.  I'd imagine this area is towards the back end of the redevelopment project, but there's a lot of unused space, it looks more like a strip mall in a suburb than something you'd expect to see in an urban center.

The IBM Building

The IBM Building, which is going to double as the sales office for Ward Village is the only sign of construction I see currently (and on a Saturday).  Slightly disappointed that it didn't appear the sales office was open yet as I was hoping to get a few brochures or more information.

On the plus side, The Ward Village Shops are nice and brand new with Nordstrom Rack and TJ Maxx as anchor tenants that distinguish the area from the Ala Moana mall next door.  The Ward Entertainment Center with the movie theater looks in reasonable shape as well, and will probably serve as a nice central point of the new planned community with only minor renovations needed.

Overall, I guess I didn't find anything groundbreaking walking around the property for an hour or two, but I did get a sense that the transformation isn't going to happen overnight, this is a long term asset that's going to take many years to fully play out.  22 towers will take a long time to build and sell without overwhelming the market, patience will be key.

I was fairly lucky and purchased Howard Hughes in the mid $30s when it dived in October 2011 (the last real market correction we had), so I'm sitting on a lot of gains.  Howard Hughes has a lot of great themes at play, its really a company that probably shouldn't be public, management doesn't issue guidance and the quarterly earnings results mean very little.  Also there's an owner/operator theme at work, David Weinreb bought in significantly when he took the CEO job, and Bill Ackman is the Chairman of the Board and has stated very publicly that he may never sell Howard Hughes and calls it one of the undiscovered gems.  While its hard to say that Howard Hughes Corporation is currently materially undervalued, I'm reasonably confident that the capital allocation decisions will be made with shareholder interests in mind, always important, but particularly so for a real estate development company with a long runway and many projects to choose between.  I'm planning on holding for the long term, let my gain hopefully compound, and defer the tax man.

Happy Holidays from Hawaii.

Disclosure: I own shares of HHC

Taking Some Profits in Gramercy

One benefit of writing down your investment thesis is it helps keep you rational, especially with your selling discipline, which I find much more difficult than buying.  Gramercy Property Trust (GPT) has been my largest and highest conviction position for almost two years and my investment thesis has mostly played out as anticipated.  I'm grateful to the Board of Directors for bringing in such a talented and transparent management team in Gordon Dugan and Benjamin Harris who breathed some much needed fresh air into a commercial mortgage REIT that was near death several times following the financial crisis.

While I believe in their business plan, the recent jump in the stock price is pricing in the future equity/asset growth over the current asset base, so today I decided to sell a little less than half my position at $5.31 to take some profits.

Running the same quick balance sheet valuation that I ran after the 2nd quarter results were announced, I actually come up with a lower per share value after the equity raise.  I think the issue is two fold, Gramercy has been purchasing assets at lower capitalization rates in the past quarter or two, and the equity raise was probably timed a little early (it would be great if they could do one at today's prices).

Going back towards a AFFO forecast valuation, I actually come up with an even lower amount than I did with the balance sheet method as MG&A is too high for the current asset base (nothing new here, management knows this).

+ $45MM in current & pipeline real estate NOI
+ $5.5MM in acquisition capacity real estate NOI
+ $3.5MM in asset management net contribution
- $12.8MM MG&A
- $12.2MM interest expense ($304 million @ 4%)
- $7.2MM preferred dividend
$21.80MM AFFO / 75.24MM shares = $0.29 AFFO/share

You can put your own multiple on AFFO, but at 15 times you get $4.35 per share.  Of course Gramercy won't look like this in 3-6 months as there will be another large equity raise and more acquisitions.  The operational leverage will start to take effect as management has previously mentioned that they could double the asset base while only increasing expenses by 10%.  That math (or buyout speculation) is the only explanation for the recent rise in the stock price that I could come up with, so I came to the conclusion that the prudent thing to do was to reduce my position from an outsized one to a more standard size core position for me (which is still concentrated).

I intend to hold my remaining position for the long-term as I'm reasonably confident in management's ability to add value through accretive asset purchases going forward and take advantage of the operational leverage by keeping the MG&A expenses relatively flat.  It's less of a Benjamin Graham stock now, more of an appealing growth story with significantly less margin of safety.

Disclosure: I own shares of GPT

ReHo Pulls the Sewko Holdings IPO

As a follow up to a previous post this summer, Retail Holdings ("ReHo") stated they were planning a sale of a portion of their equity interest in Singer Asia via a listing of a newly formed holding company Sewko Holdings (which in turn owns 100% of Singer Asia) in Singapore.  Unfortunately, the IPO date has been pushed back to sometime in 2014.  I'm not entirely sure what to make of this announcement as the markets, at least in the US, are at all time highs and it appears like a great time to come public.  I can only assume that they were unable to get a valuation close to the underlying value of the operating subsidiaries as that's been a target value in past annual reports.  ReHo has also done this before when they announced the sale of the Bangladesh subsidiary before terminating that agreement due to market conditions.  Is over promising and under delivering starting to become a pattern?

Checking in on the sum of the parts analysis of ReHo's valuation (cash has been reduced by the $1 per share dividend):

ReHo still seems very cheap at current levels, even if an IPO is a year off.  But why was the IPO delayed?

There was a Seeking Alpha article published a little over a month ago that did a good job of laying out the liquidation thesis, but a few commenters pointed out that an IPO might not close the valuation gap because Sewko would still be a holding company of publicly traded subsidiaries and still deserved a conglomerate discount.  I had the link to the preliminary prospectus, but its now dead, luckily I printed out the corporate structure and ownership as I was struggling with the question of whether Sewko deserves a discount.  The publicly traded subsidiaries are highlighted in yellow.  Hopefully its readable.

Sewko Prelim Prospectus

All of the operating subsidiaries other than Singer Thailand are controlled companies and majority owned.  Throughout the now dead draft prospectus, Sewko gave the impression that they control all of these subsidiaries and that they're essentially operated as one Singer.  I'd also argue that the market is relatively efficient and would price the operating subsidiaries at a discount in their home markets given the ownership structure and the minority shareholder position.  But it's still an issue that potentially prevents ReHo from realizing the full value out of a Sewko IPO.

I've also been corresponding with another ReHo shareholder that has concerns about the company's lack of operating cash flow for the past several years, which is certainly a bit concerning on the surface, but given the complexities of the consolidated accounting rules and different holding company structures I hope there's a good explanation?

Given the failed IPO, I think its wise to be a bit skeptical of the full NAV as a short term price target.  I'm open to any thoughts or comments from other holders on why the IPO might have been pulled, but these were a few thoughts I had today after hearing the bad news.  I'm still holding, but my conviction in the liquidation thesis has been taken down a notch, it might be time to take a closer look under the hood.

Disclosure: I own shares of RHDGF

Ultra Petroleum Diversifies Into Oil

On Monday, Ultra Petroleum announced the acquisition of an oil asset play in the Uinta Basin located in northeast Utah for $650 million.  The initial details and return figures of the acquisition sound great, almost too good to be true.  Ultra hasn't disclosed the buyer, but I'm sure that will come out as the details flow through SEC filings, but why would the other party sell at these levels of returns?  I'm admittedly an oil and gas industry novice, but the quoted returns at 60+% IRRs are great, right?

The acquisition also seems designed as a way for Ultra to ride out the low natural gas environment by focusing their efforts on this oil play that is cash flow positive in year one and has a paid back period of approximately five years.  Using 2014 production estimates, Ultra will now be a 90% natural gas and 10% oil, versus about a 97% and 3% split currently, which slightly impacts my natural gas macro thesis (and might cause some slight investor churn).  The oil acreage does come at a significant cost, Ultra is financing the entire $650 million through a combination of their credit facility and additional senior notes.  This will increase the debt load by 35% for an already leveraged company but given the quick payback nature of the acquisition, may still be a reasonable level, just limits their flexibility in the near term.

New Valuation: EV/EBITDA
2014E EBITDA = $915MM ($755MM previously disclosed estimate using $4 gas prices and $160MM from Uinta acquisition)
Net Debt = $2.49B (2014 $1.84B previous target, plus $650MM acquisition price)
Current Market Cap = $3.07B

EV/EBITDA =  6.07x

It still appears to me that Ultra Petroleum is an undervalued business, but I'm also beginning to fully understand my limitations as an investor and evaluating oil and gas exploration companies might not be in my circle of competence.  The market didn't like the acquisition, the price popped after the initial news but has declined well below the pre-news level since, but I'm going to be patient here and see if management can meet their lofty return goals.

Disclosure: I own shares of UPL

Buying "New" News Corp

(I actually like the logo)

Over the summer, the "Old News Corp" split up the business into two, the parent company was renamed 21st Century Fox and retained the entertainment and media assets, while the spinoff kept the News Corp name and was castoff with the less desirable publishing and newspaper assets.  Media mogul Rupert Murdoch remains the Chairman and CEO of 21st Century Fox, but also became the Executive Chairman of News Corp and, along with his family, controls 39.4% of the voting right Class B shares.  Even though he appears to have less influence over News Corp compared to 21st Century Fox, his reputation and heart is more on the line with the publishing and newspaper business.  At the May 28th investor day in New York (where the below slides come from) he started off the conference by saying "I have been given an extraordinary opportunity most people never get in their lifetime: the chance to do it all over again."  Rupert Murdoch inherited a paper located in Adelaide, Australia and turned into it the combined 21st Century Fox and News Corp in 60 years, an impressive record.

So there are lots of attractive investment themes at play here for the new News Corp: (1) a smaller unwanted spinoff that was designed to showcase the larger parent's more attractive growth businesses, (2) an owner/operator that is financially committed to the business, (3) an out of favor business with a clean balance sheet and attractive non-core assets that provide a margin of safety.

As I'll layout below, the new News Corp features several non-newspaper assets and a cash heavy balance sheet that when accounted for on a sum of the parts basis roughly equal the entire market capitalization of the company, so you get the newspaper businesses for "free" which generate over 70% of the company's revenues.  While the "for free" argument has significant flaws, when that business is the vast majority of News Corp it makes it a much more compelling thesis.

Cable Network Programming (Fox Sports Australia) & Foxtel
Australia is a rabid sports nation and News Corp owns its largest sports cable channel family in Fox Sports Australia, which is comparable to ESPN's dominance in the U.S. but on a smaller scale as Australia only has 23 million people.  The cable channel business is still an attractive one as content providers get the dual income stream of subscription fees and advertising revenue.

Additionally, News Corp along with Telstra Corp, Australia's largest phone company, each own 50% of Foxtel which was formed in 1995 and is an Australian pay television company operating cable, direct broadcast satellite television and IPTV services.  Foxtel is a dominate player in this space with over 2 million subscribers or roughly 30% of Australia's market.

In September 2012, News Corp purchased Consolidated Media Holdings in Australia for roughly $2B, doubling their stake in both Fox Sports (from 50% to 100%) and Foxtel (from 25% to 50%).

Extrapolating this valuation to News Corp's entire stake and you get roughly a $4B valuation for this segment.  It's interesting that this segment was included in the News Corp spinoff and didn't remain with 21st Century Fox with the rest of the TV and entertainment assets.  The company cites synergies with the publishing and media assets, but I would guess its more to provide an attractive asset or two (along with REA Group below) to carry the newspaper and publishing assets until there is a clearer path to monetizing the shift to digital.

Digital Real Estate Services (REA Group)
News Corp owns a 61.6% stake in the largest residential property website in Australia, REA Group (REA.AX), another non-core asset.  REA Group owns and operates Australia's largest residential property website, realestate.com.au, and Australia's largest commercial property site, realcommerical.com.au, which together have approximately 20.6 million desktop visits each month.  Many believe that Australia remains in the midst of a large real estate bubble, the topic has its own detailed Wikipedia entry even though it hasn't popped yet.  A down turn in Australian real estate values would presumably have a negative impact on REA Group's value as its been a pretty high flyer momentum stock, but its growth is nonetheless impressive.

REA Group is publicly traded on the ASX and has a market capitalization of A$5.38B implying News Corp's stake is worth $3.2B.  News Corp consolidates REA Group on its balance sheet, but doesn't have an intention of acquiring the remaining minority shareholders and is content to collect the dividend.  I'm a little skeptical on the synergies between REA Group and News Corp's other Australian assets and would welcome a sale of their stake given the overheated real estate market.

Book Publishing (HarperCollins)
News Corp operates HarperCollins the second largest English language publisher, which publishes over 200 best sellers every year.  In their stable are many of the popular fiction, children's and religious authors.

The book publishing industry is changing rapidly due to e-readers and tablets as more consumers download book content digitally.  Unlike the music industry where digital downloads essentially eliminated the album format and consumers chose to buy individual songs instead, consumers can't really do that with books, you don't buy only the 3rd chapter of a bestseller, you still buy the entire book.  This means the book publishing industry actually benefits from digital revenues as their margins increase as the production costs, return costs, and working capital needs (inventory) are much lower.  Below is a slide from News Corp's initial investor presentation showing the margin differential between hardcover books and digital copies, the difference between the two was surprising to me.

News Corp's book publishing business generated $142MM of EBITDA in fiscal 2013, putting a reasonable 7x multiplier implies a value of $1.0B for the unit.

Cash/Balance Sheet
21st Century Fox was generous to the new News Corp and left it with a strong balance sheet featuring approximately $2.5B in cash and no debt.  News does have an underfunded pension liability, but with interest rates likely to rise over the near to medium term, the liability should be less of an issue as interest/discount rates rise reducing the accounting value of the pension benefits.

Sum of the Parts w/o the News Divisions
So the main thesis, that purchasing shares today essentially gives you the newspaper assets for free, is laid out below.  The values below might be on the high side based on the control premium that News Corp had to pay for CMH and the potential bubble of real estate prices in Australia inflating the market price of REA Group, but I think it still clearly illustrates the remaining newspaper businesses within News Corp are being considerably undervalued.

So without any consideration for the News and Information Services business and the optionality of the Amplify digital education business, the other assets of News Corp values are greater than the current market capitalization ($9.72B) of the entire company.  So with that in mind, below are the assets the market is heavily discounting and could represent significant value if News Corp is able to drive revenue growth through digital platforms.

News and Information Services
The News and Information Services division of News Corp generated over $6.7B in revenue last fiscal year (~75% of the overall company), for $795MM of EBITDA, so despite the challenges facing the industry at large as people continue to move away from print to (mostly free) digital, this segment has tremendous value.  News Corp, and specifically The Wall Street Journal, as been on the forefront of the switch to digital and actually being able to charge for their content.  The real value driver for this business segment will be whether News Corp is able to take that model and apply its other papers in the UK and Australia.

Dow Jones & New York Post: Back in the pre-Great Recession days the old News Corp purchased Dow Jones for $5B in 2007, its probably worth substantially less now but its also worth noting that The Wall Street Journal has also grown its circulation by 8% CAGR during that time (graphic below), when most other newspapers have been struggling.  The Wall Street Journal is the number one daily newspaper in the U.S. by circulation, and has been proactive from the beginning in creating a valuable pay wall online where others have had difficulty making the transition.  WSJ is a strong brand with a focused demographic where many of its subscribers are not price sensitive (for instance, my work reimburses me for my subscription) giving News Corp ample room to raise prices in the future.  Dow Jones also has an institutional business, the model here is to create a Bloomberg like service where customers pay for real time business news, analysis and statistical data.

Additionally, News Corp owns the New York Post, the oldest daily newspaper in the country that's known for its outrageous headlines (particularly towards NY sports teams) and their Page Six celebrity section.  However, the New York Post is said to be a money losing operation, but also a Murdoch favorite so its likely to stick around.

News International (UK):  News Corp is #1 by print sales in the UK with 35% market share, it operates the #1 tabloid in the UK in The Sun, the #1 quality Sunday newspaper in The Sunday Times, and one of the top quality dailies in The Times.  The UK operations reputation was given a significant black eye after the phone hacking scandal at The News of the World in 2011.

Early in 2013, News International gave a glimpse at its strategy when it acquired the rights to online and mobile highlights of English Premier League matches for three years.  It will show them on the websites and mobile apps of its three remaining newspapers.  The Sun recently started charging for digital subscribers 2GBP per week for its content, it will be interesting to see how well this strategy works in the next few quarters.

News Corp Australia: News Corp owns a smattering of newspaper and magazines in Australia, including daily newspapers in each of the major cities (The Daily Telegraph - Sydney, Herald Sun - Melbourne, The Courier Mail - Brisbane, The Advertiser - Adelaide) and the only national newspaper in The Australian.  As of June 30, 2013, its daily, Sunday, weekly and bi-weekly newspapers accounted for more than 59% of the total circulation of newspapers in Australia.  The Australian newspaper assets probably have the furthest to go in the switch to digital, but at least management has a playbook to work off of and the desire to institute the pay wall model.

How much these business are worth is pretty hard to say given the rapid change going on in the industry, their declining revenues, but you don't have guess someone's weight to know they're fat, I believe the market is being unfair and valuing these businesses close to zero.

Core EV/EBITDA (ex-Foxtel, Fox Sports, REA Group)
Another way to look at the valuation would be to strip out the non-core publishing assets (Foxtel, Fox Sports Australia and REA Group) and look at the EV/EBITDA valuation the market is putting on the core newspapers and book publishing businesses.

Despite what News Corp says publicly, the Australian TV and RE assets seem rather non-core and appear to be included in the new News Corp in order to temporarily support the struggling publishing assets.  As a natural contrarian, I'm attracted to these publishing assets, but also appreciate the margin of safety provided by the non-core assets.

Capital Allocation, Previous News Corp Mistakes, and Amplify
Other miscellaneous stuff that should be mentioned when talking about the new News Corp: At the time of the spinoff, the new News Corp authorized a $500B share repurchase plan to support the stock in the event that holders would elect to sell their shares in the publishing business.  As of the 6/30 fiscal year end, News Corp has not repurchased any common stock.  News Corp will likely pursue some acquisitions although its unclear what form they will come in as they would likely face regulatory scrutiny over any newspaper purchases in their current markets.  There is some risk to having this much cash burning a hole in Murdoch & Co's pockets as evidence by the $5B price tag they paid for Dow Jones in 2007, and the even worse $580MM News Corp paid for MySpace before wrecking it and selling it for $35MM in 2011.

Amplify
News Corp is heavily investing in their educational start up that hopes to reshape the way K-12 is taught in America through digital content delivery.  In fiscal 2013, Amplify featured a $163 million EBIT loss.  This investment is a long term one, also one that operates in an industry with a lot of entrenched (union labor) interests that are averse to change.  While it is strange that the education sector has been exempt from technological change, much of the free cash flow of News Corp is going to Amplify, so an investment in News Corp rests somewhat on their ability to create a profitable and useful benefit (unlike most of the for-profit sector) in this segment.  Expect additional losses for the next 2-3 years, although management has indicated that starting with the 2014 school year, we should see some progress on Amplify's adoption level.

Conclusion
In totality, I'm willing to bet on Rupert Murdoch's attempt to recreate the magic in the new News Corp and rebuild his legacy after the UK phone hacking scandal.  The non-core assets that were included in the spinoff provide a nice margin of safety giving management a little time to monetize their undervalued and underutilized newspaper/digital content brands.  I would put the initial fair value at least 50% higher, and potentially more if the market warms to digital content assets like the ones in News Corps portfolio.

Disclosure: I own shares of NWSA (purchased today at a cost basis of $16.76).  NWSA are the non-voting class A shares, NWS are the voting class B shares, otherwise they are economically the same.

Gramercy Will Pay the Preferred Dividend

Exciting day for long time Gramercy shareholders, management must have received a lot of questions regarding their equity raise press release last Friday without many other details, like what the money would be used for?  This morning, Gramercy reissued a press release announcing it had identified a large pipeline of acquisitions and that it will pay the accrued preferred dividend in full this quarter.  They also stated their intention to begin paying a dividend to the common shareholders starting next year (likely Q1?) which will mark its final step in its transformation from a commercial mortgage REIT to a net leased equity REIT.

The large investment pipeline is great news as it will be accretive to Gramercy's NAV as it takes advantage of the spread between private and public market values (although I'd assume its narrowed in recent months).  It also makes sense why management was willing to give the private placement investors the downside protection granted in the CVRs as these acquisitions should increase Gramercy's market value as it gains scale. 

I probably won't be able to listen into the conference call live this afternoon, but I'll update this post if there's anything that strikes me as interesting.  And as I've said before, I'll probably sell most, if not all, of my outsized position once the dust settles a bit and Gramercy is being valued and talked about like a normal equity REIT.

Disclosure: I own shares of GPT

Gramercy & Howard Hughes Both Raise Capital

Despite the government shutdown grabbing all the headlines, good management teams at both Gramercy and Howard Hughes are moving forward with their business plans.  In the past two weeks, both have issued press releases announcing capital raises.

Gramercy Property Trust
With Gramercy, it's a little more puzzling as the capital raise raises quite a few questions itself, below is the press released issued Friday after the close of the market.

As of the end of the second quarter (including pending asset purchases), Gramercy had $96.9 million of acquisition capacity, and during the third quarter, they announced only $20 million in asset purchases which about half appeared to be in the pipeline previously, so I'd estimate they have $85 million remaining without any undisclosed purchases.  Additionally, Gramercy announced this quarter that they closed on the long awaited credit facility, which has $63.8 million in initial borrowing capacity.  Since the acquisition capacity numbers already assumed paying the preferred dividend, plus the credit facility, and now an additional $47.4 million in equity raised, what does Gramercy have in mind for all this dry powder?  My best guess would be a rather large acquisition similar to the Bank of America JV that would give Gramercy scale, spread the MG&A expenses over a larger base, diversify their tenants and finally pay the dividend.

One other interesting feature of the equity raised was the corresponding CVRs the private placement investors received protecting their initial downside.  I think this is a good signal from management that a floor is in place here, hopefully they wouldn't risk additional shareholder capital and make this capital raise even more expensive.

CEO Gordon Dugan has delivered all along, it won't be long before we find out what he's been up to lately, I'm hoping for good news.

Howard Hughes
I haven't mentioned Howard Hughes on the blog since I wrote a few posts about them earlier in the spring.  The story is fully intact, this past week management gave a new investor presentation that's available on their website.  I think it's interesting how they're fully going about monetizing their master planned community assets (a difficult asset to have in a public company) and utilizing that cash to develop and redevelop long term operating assets.  It's really going to be a great case study in long term capital allocation that will probably spur additional spin-offs in the future.  But anyway, Howard Hughes recently raised $750 million through the issuance of senior bonds, they had previously announced a $500 million offering, but that must have been oversubscribed.

The redevelopment of their Ward Village development in Honolulu will be capital intensive, so I'm guessing a lot of this money will be directed there in addition to the Shops at Summerlin and their Woodlands commercial development properties.  The potential of Howard Hughes remains great, just the Ward Village alone is a $7 billion opportunity with 30% profit margins, simply just have to sit back and wait.

Misc
I apologize for the lack of posts lately, just have been standing still with my holdings (which I think is important sometimes, the best move is often no move at all) and waiting for a few situations to develop.  Hopefully I'll have a few more ideas in the coming weeks to share.  I also just finished up The Manual of Ideas by John Mihaljevic, it was a good read and a nice refresher on different value opportunities/themes as well as providing a lot of good tips for sourcing and screening ideas.

Disclosure: I own shares of GPT and HHC

Experimenting with Mutual-Bank Conversions

I've been having trouble lately finding new cheap investment ideas without a lot of hair on them.  So I've spent some time re-reading classic investment books and seeing what I can glean from a 2nd or 3rd reading.  A common investment theme of Peter Lynch, David Einhorn, and Seth Klarman has been investing in mutual bank conversions, something I've looked at in the past, but generally passed on for no particular reason.  But at this point in the business cycle, I'm attracted to the built in value and clean balance sheets of mutual banks that convert to stock corporations.  This isn't a new strategy, but I think for the individual investor, its an easy formula to follow for above average returns with relatively low risk.

Why Mutual Conversions?
Mutual banks are those that are "owned" by their depositors and have no shareholders, they're designed to be low risk institutions that cater to their members by taking deposits and making loans in the community.  They tend to be conservative in their lending and accounting as there is no stock or ownership group to please, and reporting profits could be a sign of risky lending.

When a mutual bank determines it wants to convert to a stock corporation, the depositors have to come up with cash in order to buy shares in a company they already "own".  Unlike a typical IPO, there's no exiting investor group selling their shares to an unsuspecting public, its the bank's directors and the IPO buyers on the same side of the table.

By construction, the post-IPO thrift conversion is undervalued.  By adding the new IPO share proceeds to the existing equity capital held by the bank, the new investors effectively get the company for free as ownership of the post-IPO bank includes both the offering proceeds (minus expenses) and the exisiting capital itself.  What you end up with is a low-risk balance sheet with excess capital available to increasing assets at a significant discount to tangible book value.  In many cases, mediocre banks begin to show profit improvements after the IPO as the animal spirits of the thrift's management takes over.  Newly converted mutual banks tend to outperform due to these reasons, however they are restricted from repurchasing their stock for 1 year post IPO and from being acquired for 3 years post IPO.  After this three year lock up period, many converted thrifts are purchased at premiums to their tangible book value. 

Sunnyside Bancorp
On July 15th, Sunnyside Bancorp (OTC: SNNY) completed their mutual conversion IPO by selling 793,500 shares (adjusted maximum) for $10 a piece.  Sunnyside Bancorp is the holding company for Sunnyside Federal Savings and Loan Association of Irvington, a one branch thrift located in Irvington, NY, a bedroom community about 25 miles north of New York City in Westchester County.  Irvington is a small affluent village on the Hudson River.  It's been named as the "Best Place to Live in Westchester" which is the second wealthiest county in New York, with a median household income of $80,725 and a median home value of $547,000.

Balance Sheet & ROE Potential
Besides being located in an attractive community, Sunnyside's balance sheet shows a conservatively run thrift that's ripe for additional capital to improve profitability.  Sunnyside is primarily funded through customer deposits and has no senior debt.  A vast majority of their loans, 86.4%, are owner occupied residential mortgages which ranked high on Peter Lynch's criteria when investing in small thrift banks.  The view on the safety of residential mortgages has probably changed drastically from the early 1990s (when Peter Lynch was investing in mutual conversions), but Sunnydale's portfolio is rather clean, they have no subprime or Alt-A loans and borrowers almost always need a 20% downpayment.  Historically, Sunnydale hasn't written their mortgages to "conforming" standards since they've held all their mortgages on balance sheet, but going forward they will be putting more emphasis on selling mortgages to the GSEs in order to increase non-interest income, a general theme of their strategy going forward to increase profitability.

Unlike many large banks, Sunnyside's balance sheet is basically free of problem assets, as of the S-1, they had zero delinquent loans.  It looks like that's changed slightly as of the latest quarterly as 1 loan has slipped into delinquent status, but overall Sunnyside's balance sheet is almost a blank canvas.

Although the balance sheet is clean, Sunnyside posted a net loss in 2012, but with the excess capital, what could Sunnyside's income statement look like post-IPO?  Below I attempted to make a pro-forma income statement using Sunnyside's current net interest margin (which hopefully will increase as Sunnyside makes slightly riskier loans), increasing the thrifts non-interest income to represent the new strategy to sell loans to the GSEs and then increasing expenses as appropriate for the increased size and newly public status.

While a 5% ROE is still too low, it should be a fairly conservative proforma estimate.  I would expect Sunnyside to improve on these results as it engages in slightly riskier lending and the stock ownership/options of management increases their incentives to generate a profit where that wasn't a key motivation as a mutual bank.

And despite a potentially low ROE, Sunnyside's value should still be close to tangible book value as an acquirer (after the 3 period is up) can come in and buy the company, strip out the costs, and utilize any excess capital to their advantage, the equity capital is worth more than the bank as an ongoing entity.

SBA Lending
Slight tangent: In December 2012, Sunnyside was approved as an SBA lender and plans to hire an SBA loan officer here shortly.  SBA 7(a) loans are typically for small businesses that cannot get credit at reasonable terms elsewhere, so these are risky loans made to less than credit worthy borrowers.  To encourage small business lending, the SBA will guarantee up to 85% of the loan balance if the loan meets certain criteria which can often lead to a lengthy paper intensive underwriting process.

On the positive side, the guaranteed portion of SBA loans are in high demand (and sell at huge premiums) because they have no default risk due to the U.S. government guarantee, and their interest rates are typically higher than comparable treasuries as they are floating off of prime.  Many banks will sell their SBA loans to regional investment banks who specialize in pooling these loans into securities.  The original lender will keep the unguaranteed portion of the loan, and will continue to service the loan and collect a servicing fee.  By selling the guaranteed portion, a bank like Sunnyside can effectively increase their profit margins on each loan because they maintain the servicer fee on the entire balance, while only keeping the unguaranteed portion on their books (and the credit risk), plus they pocket much of the premium at the initial sale of the guaranteed portion.

Sunnyside currently has little in non-interest income, so the move into SBA lending will likely be a nice source of additional profits for the small thrift.

Management Experience and Incentives
In 2008, Sunnyside brought in Timothy Sullivan as President and CEO, his previous experience is mostly as a commercial lending guy which explains the gradual move toward commercial lending that Sunnyside plans to make.  Being such a small thrift, it's hard to get much information on Mr. Sullivan, but given Sunnyside's lack of delinquent loans and relatively strong balance sheet, it would appear that he's taking a moderate approach to the move into riskier commercial lending.  Directors and senior officers are buying $440,000 of the offering, not a small amount for a bank with only 15 full time employees.  Additionally, there will be an ESOP which will dilute shares, but is a net benefit as it will align their incentives with the outside shareholders and in this case, the performance of each employee can really make a difference.

Risks
Sunnyside is a very small bank and pre-IPO it wasn't particularly overcapitalized like many pre-conversion thrifts.  Post conversion, they're going to need to increase their asset base by 75-100% to generate an acceptable ROE, given tepid loan demand and fierce competition for good loans, Sunnyside might not be able to lend that money out at favorable risk adjusted rates.

Strategy Going Forward
My plan going forward is to dedicate a portion of my portfolio to purchasing new mutual conversions soon after the IPO date if I can buy the newly converted thrift for less than 2/3rds of tangible book value.  I will then look to sell once the thrift reaches tangible book value and recycle that cash back into new mutual conversions.  I'll leave myself a little room to change course if the 3 year acquisition period is around the corner, but my general goal is to be methodical with this strategy long term.

Disclosure: I own shares of SNNY

Tropicana Entertainment Buys Lumiere Place from Pinnacle

Tropicana Entertainment is the majority owned gambling unit of Icahn Enterprises that trades over the counter under the symbol TPCA.  The quick summary thesis is as follows: (1) Tropicana has a large net cash position, (2) Carl Icahn owns 68% of the company and has a strong track record in the gaming industry, (3) A small float and an OTC listing creates an opportunity for individual investors as its equity is ignored and illiquid, (4) the regional casino industry was over built in the 2000s and is generally unloved by investors.

Lumiere Place
On Friday, Tropicana used the majority of their net cash position and available liquidity to purchase the Lumiere Place casino and attached hotels/restaurants in downtown St. Louis from Pinnacle Entertainment for $260 million.  As part of the Pinnacle's purchase of Ameristar (for over 8x EBITDA), Pinnacle came to an agreement with the FTC to sell one of the combined Pinnacle/Ameristar's three casino properties in St. Louis that controlled 60% of the market share which was a concern for regulators.

Opened in the beginning of 2008 at the height of the casino building bubble, Lumiere Place is an upscale casino located across from the Edward Jones Dome and America's Center convention center near the Gateway Arch.  In addition to the 2000 slot machines and 68 table games, the Lumiere Place property includes two hotel properties in the Four Seasons Hotel St. Louis and the HoteLumiere, plus additional restaurant and retail space.  Pinnacle has positioned Lumiere Place as a luxury brand that is less focused on the slot/retail gambler and more focused on table games and non-gambling related revenue which is a departure from Tropicana's current core consumer (I believe should be seen as a positive).

Pinnacle Entertainment's Sept 2012 Investor Presentation

In total, approximately $600 million has been invested in the project since it opened 5 years ago, and its currently on the books for $401 million as of June 30th.  While Lumiere is probably worth far less than $600 million today, Tropicana clearly purchased it for less than replacement cost.  Pinnacle has previously disclosed an annualized EBITDA of $34 million for Lumiere, at a $260 million purchase price, the EV/EBITDA multiple is 7.5x, just below what the average casino operator is trading today of 8-9x.

Liquidity
As of 6/30, Tropicana had $241 million in cash and $170 million in debt, for a net cash position of $71 million.  The $13 million in interest payments on the term loan facility versus the minimal interest income from the cash has been a drag on earnings.  Tropicana has the option to increase their term loan by $75 million and has an used $15 million letter of credit facility giving it plenty of room to make the Lumiere purchase, but not a lot more given their annual capital expenditure needs (which currently roughly match cash flow from operations).  This purchase seems about the perfect size given Tropicana's balance sheet, meaningful but not a stretch.

Pro Forma Valuation
While I continue to think that the EV/EBITDA ratio is best for the gambling industry due to the varying capital structures, the purchase of Lumiere Place should also make Tropicana look cheaper on a more traditional P/E basis as the idle cash and term loan (which have a drag on earnings versus being cancelled out looking at it from an EV/EBITDA basis) will be invested in a productive income generating asset.

But looking at the "new" Tropicana, I come up with the following back of the envelope valuation:

EBITDA
Tropicana's current core = $84 million
Lumiere Place = $34 million
Total = $118 million

Enterprise Value
Market capitalization of the equity = $405 million
Net Debt = $189 million (current cash is $241 million, so take the $170 million in debt and add the additional $19 million)
Total = $593 million

EV/EBITDA = 5.02x

Icahn Enterprises currently values (for the purposes of their non-GAAP NAV) their 68% pre-Lumiere stake at $566 million, or 9x EBITDA.  Using that same 9x EBITDA valuation for the post-Lumiere Tropicana, and the equity should be valued at $873 million versus a market cap of $405 million today, so the market is giving you almost a 55% discount to become a minority shareholder in a company controlled by one of this era's top investors, seems like a good deal to me.

Disclosure: I own shares of TPCA

Asta and BMO Revised the Great Seneca Portfolio

It's been years since Asta Funding has been actively buying distressed consumer debt portfolios, their core business, and while they returned to that market this past quarter with a $3.3 million purchase of $53 million in face value of receivables, I think the much more important transaction is the renegotiation of the Great Seneca portfolio debt with BMO.  In the past I have treated the Great Seneca portfolio as a free option, and assumed it was worthless and the non-recourse debt would be written off as well.

During the quarter, Asta wrote down the value of the Great Seneca portfolio by $10.2 million to $46.3 million which they identify as the net realizable value.  Then below is the explanation for the transaction they completed with BMO:

"On August 7, 2013, in consideration for a $15 million prepayment funded by the Company, BMO has agreed to reduce minimum monthly collection requirements and the interest rate significantly. After BMO receives the next $15 million of net collections from the Great Seneca portfolio, offset by credits of approximately $3 million for payments made to BMO prior to the consummation of the agreement, the Company is entitled to recover, out of future net collections from the Great Seneca portfolio, the $15 million prepayment that it funded. In exchange for possible future debt forgiveness, BMO has the right to receive 30% of future net collections, after the Company has recovered its $15 million prepayment"

Although the 6/30/13 financials show $105 million in cash and securities, Asta paid BMO $15 million this past week as part of the revised agreement and now has $94 million in cash/securities (presumably after $4 million in cash inflows).  In essence Asta is reinvesting in this portfolio, while it might not be counted as a new portfolio purchase, its almost the same thing.

Going forward the first $12 million (net of $3 million in previous payments) will go to BMO, following that Asta will get the next $15 million and recover the prepayment, then the remaining revenue will go 70/30 to Asta/BMO.  So given the Great Seneca's net realizable value is $46.3 million, the first $27 million is allocated to BMO first, then Asta, leaving the remaining $19.3 million to be split 70/30, or $13.5 million to Asta Funding.  Asta's accounting is generally conservative (still making $9.75MM this quarter in zero basis assets), I think the $13.5 million number is likely an appropriate value for the end recovery value of the Great Seneca portfolio and may end up being a bit low.

Asta currently receives about $3 million a quarter on the Great Seneca portfolio, if this continues, BMO will be paid off in one year, and Asta will recover its $15 million prepayment in about 9 quarters.  If the $3 million quarters continue from there its about another 8 quarters (or 4 years from now) before the net realized value would be recovered in the 2nd quarter of 2017.  While it might initially feel generous to assume the $3 million can continue that far into the future, I've been pleasantly surprised the zero basis portfolios have continued to produce consistent cash flow for the past several years, and show little evidence of slowing down.  So assuming a $3 million a quarter run rate, Asta would earn about a 33% IRR on it's initial $15 million investment over the next 4 years, or an NPV of just over $7.1 million using a 20% discount rate.  The prepayment will make the balance sheet look a little weaker in the next few quarters, but I would say this is clearly a smart transaction for Asta.

Based on how I've previously valued Asta Funding, removing out the Great Seneca portfolio and adding in the NPV of the zero basis portfolio, I've made another attempt and included a line for the NPV of Great Seneca given the new arrangement.

As you can see, I roughly value Asta's book value at $16 per share, or 77% higher than it's current price of just over $9.  All the minority shareholders would probably prefer a big stock repurchase plan (which has expired and has not been renewed), but it appears Asta is finally using their excess cash and investing again in the core business which should be a net positive.

Disclosure: I own shares of ASFI

Summary of 2nd Quarter Results

Below is a brief round up of a few names I've mentioned on the blog before and their recent results.

American International Group
AIG had another nice quarter, exceeding expectations and announcing the initiation of a $0.10 dividend and another $1B in share repurchases.  These moves were surprising given the drama surrounding the ILFC sale to a consortium of Chinese buyers, which has seen several deadlines come and go.  They're still working with the consortium to see if a sale can be completed, the deadline has been pushed back to the end of August, but AIG is also preparing for an IPO of ILFC later in the year that would de-consolidate ILFC (meaning they'd sell at least 51%) from AIG's financial statements.

AIG's book value is now $61.25, and its recently trading for just under $49, so the discount to book value has been closing fairly quickly.  While I still view AIG as a long term hold, I would consider selling for around 95% of book value which is still a little while off.  In the meantime hopefully book keeps growing with retained earnings and gets accelerated with AIG repurchasing shares at below book.

Calamos Asset Management
Calamos Asset Management's (CAM, but CLMS is the ticker) market value hasn't moved much since I initially profiled the company a few months ago, but the assets under management have taken a 10% slide to $27.4 billion as of 7/31.  As a result, pre-tax earnings are down over 30% from last year's run rate, proving the operating leverage in the asset management business works both ways.  Their flagship Calamos Growth and Calamos Growth & Income funds are suffering large outflows due to poor recent performance; the Calamos Growth Fund is in the bottom 92% of its peer group over the last five years, according to Morningstar, making it a dreaded one-star fund.  What financial advisor wants to answer the "why am I in a one-star fund" question from a client?

Calamos has been countering their growth fund strategy issues by introducing several new value and alternative strategy funds to diversify their revenue business model.  The alternatives segment is the one strategy where Calamos is seeing net inflows, and I think that it has the most potential as its not a strategy that's easily replaced by an index or passive fund.  Financial advisors are moving assets to index and passive mutual funds, traditional managed A share type funds are at best out of favor and might be in a permanent secular decline.  Alternative mutual funds are an easy sell after the past decade of volatility and given their complexity, one where the management fee is a more justifiable, maybe.

The value in Calamos is still primarily in the odd corporate structure that causes the operating company to be consolidated with CAM, but where CAM only owns 22.1% of the operating company.  This consolidation hides the assets that are attributable just to CAM, which are worth roughly half the market capitalization.  Based on the same assumptions as my original valuation, I put the CAM's current value at roughly $16.39 per share today.

The Calamos family has the right to exchange their ownership for CAM shares based on a fair value approach.  The above is the quarterly reconciliation that Calamos publishes based on the accounting quirk that's the primary reason its undervalued, but it could also be used as the reason for the Calamos family to dilute the CAM shareholders out of that value under the guise of a fair value exchange.  The shares issued line under the no recognition of other assets assumption is almost twice the shares in the full recognition assumption.  That's been hard for me to get comfortable with, so despite the CAM shares being materially undervalued, it's remained on my watch list.

Ultra Petroleum
My natural gas pick, Ultra Petroleum, had another good/boring quarter as they continue to keep capital expenditures within cash flow and just tread water until natural gas prices fully recover to a more normalized level.

One interesting takeaway from the conference call was when CEO Michael Watford said the following about how they value their assets:

"So a quick reminder of how we view our assets. At $4 gas, we restore all the value and volume to our proved reserves. That puts us at 5 trillion cubic feet of proved reserves and PV-10 value of $5.25 billion, which is approximately our enterprise value today. Looking forward a bit to $4.50 gas and ignoring the 5-year limit on PUDs, Ultra would have 9.2 trillion cubic feet equivalents of proven light reserves, with a PV-10 value of $8.1 billion. This translates into a $20 per share increase in stock price."

$4.50 gas might be farther away than it sounds as prices have moved back down to under $3.50 in the past few weeks.  On my favorite slide in their presentations, Ultra doesn't forecast $4.50 prices until 2016, but its a comment that I wanted to keep highlighted for future reference.  The other management comment I liked was the possibility of a share buyback or dividend in the future with their free cash flow, versus all the talk of an acquisition last quarter.  Given the high returns of their Pinedale asset, I don't see why they'd be looking to dilute those returns unless it was an acquisition for acquisition's sake.

I picked up some shares in the $16-17 range earlier in the year, and recently sold an equal amount of higher cost basis shares to reduce my position size to a just above average weighting.  I wanted to take some risk off the table and with Ultra's share price increasing with natural gas prices decreasing, seemed like a good opportunity.

Disclosure: I own shares of AIG, UPL, no position in CLMS

Gramercy's Business Plan is Moving Along

Gramercy's quarter again looked mostly as expected, and as management stressed on the call there's a noticeable lag in what the financials look like and the future state of the business.  Gramercy made significant progress towards investing their available cash in net leased assets, completing 11 discrete transactions for $111.2 million (mostly towards the end of the quarter).  During the question and answer session of the conference call, management indicated that this level of activity would be a good base case run rate for Gramercy through the end of the year.  I found this comment particularly interesting based on their capacity analysis slide below showing $96.9 million in remaining capacity.

So this leads me to believe that most of Gramercy's available cash and borrowing capacity will be exhausted by the end of the 3rd quarter or early 4th quarter, setting up for the dividend to be caught up on the preferred by year end as that would likely need to occur before any major capital raise.

As for the what the common is worth, I'm going to take a slightly different approach than my previous quarterly recaps (here and here) and instead take a balance sheet look at the valuation based on a slide that Gramercy provided in their presentation.  The one thing I noticed initially, is the plug "Intangibles" line item on the asset side is negative, meaning the market is valuing Gramercy above its current NAV.

Given Gramercy's acquisition pace and their capacity analysis slide, I made a few adjustments below to back into a new NAV based on full cash/capacity utilization before a capital raise.  I took the $96.9 million in net equity capacity and assumed Gramercy would make new acquisitions at a 9% cap rate (average of the 2nd quarter), and then those assets would be revalued by the market at a 7% cap rate ("widest arbitrage in our experience") to come up with $124.59 million in additional real estate owned (on top of the $10.6 million in the pipeline).  Making those asset purchases zeroes out both the cash and CDO advances and asset sales line items, but keeps the KBS Promote and CDO Bonds line items.  In Gramercy's slide they leave out the value of the asset management contracts, but these clearly have value.  Given that they're generating $4 million in after tax contribution annually, and have about a 3 year lifecycle, I discounted that back a bit to a round $10 million to come up with a total asset value of $631.8 million.

On the liabilities side, I removed the preferred dividend as its paid in the capacity analysis calculation and then added the pipeline and current portfolio borrowing capacity numbers given in Gramercy's guidance, making the total debt $237.9 million, or roughly 40% of the real estate value, inline with management's comments today.

Removing the preferred par value, and the common is worth $305.8 million, or $5.14 per share, which is pretty much the same as I've come up with before, and is only ~15% above what it's trading at now.  But I think the dividend is finally on the horizon, and then Gramercy can start raising capital and further exploiting the private/public net lease arbitrage.  Gramercy remains my largest position, although I might be tempted to sell a bit if it trades above $5.20 again without paying the dividend.  

Disclosure: I own shares of GPT

UCP Inc - Worthwhile on its Own?

This will be the last post on the PICO/UCP story for a while, but I haven't had much time to dig into new situations and there just seem to be fewer interesting investing ideas with the markets drifting higher and remaining relatively calm.  As I've covered recently, UCP is the home builder/land developer unit of PICO Holdings that recently completed its initial public offering.  While I consider the transaction a positive for PICO, given PICO's complexity and management compensation structure, UCP might be the better investment for the near term as its a purer play on the continued housing recovery.

To summarize, UCP Inc (the publicly traded entity) owns 42.3% of the operating company UCP LLC, while PICO owns the other 57.7% and will remain the controlling shareholder.  UCP is primarily a California home builder and land developer with some additional exposure to the Puget Sound Area in Washington state.  Below is a snapshot of the current owned and controlled lots in UCP's inventory:

Since UCP essentially didn't get started until after PICO bought it in 2008, UCP has no legacy or problem assets on its balance sheet, the majority of their lots were purchased opportunistically in the 2008-2011 period and are carried on the balance sheet at historical cost.

What have real estate prices done in the areas where UCP operates?

Fresno: http://www.zillow.com/local-info/CA-Fresno-home-value/r_18203/

Monterey: http://www.zillow.com/local-info/CA-Monterey-County-home-value/r_2444/

Santa Clara: http://www.zillow.com/local-info/CA-Santa-Clara-County-home-value/r_3136/

Seattle: http://www.zillow.com/local-info/WA-Seattle-home-value/r_16037/

While Zillow isn't the perfect data source, their estimates all show year over year price increases in UCP's markets of anywhere between 12-22%.  So if anything, the real estate on the balance sheet is likely understated, but for the sake of being conservative I won't make any adjustments.

Below is the pro forma balance sheet after the offering:

Based on the current market price of $14.23, UCP has a market capitalization of $261 million, and a price-to-book ratio of about 1.2x.  Other home builders trade for a multiple of book value, but a good recent comparable seems to be TRI Point Homes (TPH) as its almost exclusively based in California, was formed by a private equity investor during the crisis and as a result of its January IPO, has plenty of cash.   TPH trades for 1.6x book value, a 33% premium to UCP, maybe some of that is justified by more desirable community locations, but given the similarities, I think its a good comparable.  UCP also compares favorably on the home building margins and it has the optionality of being a developer and selling their lots to other builders.

So why is UCP cheap?  Besides its small size and geographic concentration, there was very little hype leading up to the offering, little coverage since,  and it hit the market as home builders have been tumbling with the rise in mortgage interest rates (the home builder index is only up marginally on the year, but was up significantly in 2012).  It just seems to be overlooked here, UCP debuted at $15, the low end of its range, and has traded lower ever since.  Some of that discount is probably a result of the organizational structure, as PICO will continue to hold 57% of the economic interest and control the board, making an acquisition or other transaction unlikely.  Additionally on the negative side management is getting a nice raise, and doesn't own any shares outside of the initial options they were granted in the offering, plus there will be extra expenses UCP will incur as a stand alone public company.  

But I think the positives and the valuation outweigh the negatives.  I'm generally positive on real estate still, there will be pauses as interest rates rise to a more natural level, but with pent up demand from years of low household formation and long term demographic shifts away from the midwest and to places like California, UCP could be a good short-to-medium term investment.

Disclosure: No current position in UCP, I own shares of PICO