Monday, January 19, 2015

Signature Holdings Group: NOLs, Aluminum, and a little Promotion

An investment theme I continue to like is companies with significant net operating loss carry-forwards (NOLs), they are typically small and have ownership restrictions in order to stay in compliance with IRS NOL rules making them out of reach for larger institutional funds (meaning less competition).  Signature Holdings Group (SGGH) is an NOL shell company formed in 2010 after one of the worst sub-prime operators Fremont General emerged from bankruptcy.  Since emerging as Signature, the company has been through two different proxy contests, the second one ending in the summer of 2013 with Craig Bouchard taking the CEO and Chairman roles with the backing of Sam Zell's distressed debt fund (same one as Par Petroleum).  It's main asset is roughly $890MM in NOLs which should keep it from paying income taxes for the better part of a decade in the most optimistic scenarios.

Signature Holdings aims to be an acquisition platform targeting the transportation, food, water and energy sectors to utilize the company's NOLs which begin to expire in 2027.  In order to fund these acquisitions, they plan to use the Covanta (CVA) playbook of raising equity through serial rights offerings in order to stay within NOL ownership restrictions.

GRSA Acquisition
In October 2014, the Bouchard led management team landed their first large scale acquisition (after bidding and losing 6 deals previously) with the purchase of the Global Recycling and Specifications Alloys ("GRSA") business of Aleris Corporation for $525MM.  GRSA is the largest aluminum recycling business in North America and Europe (largely fragmented industry), with this purchase Signature is hoping to ride the trend of auto companies using more aluminum over steel in order to meet their government mandated fuel efficiency standards.  The Ford F-150 is just one high profile example of this but expect more makes and models to start switching in the coming years.

The headline acquisition multiple was 6.5x EBITDA, but how did they arrive at this figure and how many adjustments were made to an already non-GAAP figure?  The below table is from page S-22 of the company's recent prospectus:
That's a long list of EBITDA adjustments!  Including even a line item for extreme weather as last winter's polar vortex drove up the company's natural gas energy costs.  There's also a little deception stripping out some SG&A above the GRSA business unit at Aleris, some of that overhead is necessary to run a business even if it's not directly related.  Signature has about a $9.5MM SG&A run rate, so I'm going to subtract that from their adjusted number and come up with about $72.5MM (after also adding back weather and other adjustments) in EBITDA; maintenance capex is pegged at around $35MM annually, so free cash flow is around $37MM.

One look at Signature's balance sheet before the acquisition announcement would make it clear that they don't have the $525MM necessary to close this transaction.  With only $44MM in cash, the plan is to take out significant debt, tap their asset-backed credit line, conduct both an equity issuance and rights offering, and a $30MM in non-convertible preferred note to Aleris in order to pay for GRSA.  Additionally, Signature sold its only small operating business NABCO for $78MM to raise cash, with a net of $56MM after paying off the debt associated with the business (NABCO was purchased for $37MM in 2011 by prior management).

The bond issuance ended up being fairly expensive, $305MM sold at a discount of 97.2% at a 10% coupon rate, and well in junk bond range with a B3/B rating by Moody's and S&P respectively.  I think the aluminum recycling business might be a little more cyclical than Signature lets on in their presentation materials.  Without knowing too much about the aluminum industry, it just strikes me as being heavily tied to capital spending, a heated automobile market (we've all seen the subprime auto loan numbers) and potentially the Chinese economy too which scares me.

So what does the proforma EBITDA, earnings, and free cash flow look like?  Below are my back of the envelope numbers:
There are a number of moving parts in this acquisition, so please double check my numbers, the main assumption is around the upcoming rights offering happening in the next month.  I'm assuming the NABCO net proceeds are coming out of the original $125MM Signature intended to raise via both the rights offering and the stock offering that's already been completed.

It certainly looks cheap on the surface, the current price is around $8 per share which is in between the prices paid in the two equity offerings ($10.00 and $6.50).  Signature has also stated they want to do roughly one acquisition of similar size a year which should provide some additional operating leverage as some of that corporate level SG&A can be spread over a larger base.  Plus it sounds like they see some increase in GRSA's EBITDA through both organic growth and bolt on acquisitions.  But I'm on the fence on whether it deserves a spot in my portfolio, on top of the cyclical nature of the business and the potential for further declines in their earnings, something just doesn't feel authentic about management.

Promotional Management
CEO Craig Bouchard is a charismatic serial entrepreneur who has run several successful companies in a variety of industrial sectors (Shale-Inland, Esmark, NumeriX) and written two books, including a children's book for charity.  Clearly he's a talented individual, but I can't shake the feeling that his individual brand comes before all else.  He has his own personal website that reads very promotional, including a quote that he seems shy about when he's saying it, but continues to throw it out there that "one outcome (of Signature Holdings) would be to become a mini-mini Berkshire Hathaway."  That's one cringe worthy goal that I'm sure has gotten some his investor base excited.  Then there's his LinkedIn profile, it's rare that someone of his accomplishments flat out brags, such as the line about becoming the 3rd fastest to SVP at First Chicago (regional bank that is now part of JPMorgan), who keeps track of that and then who brags about it 20 years after the fact? And how Esmark was the highest appreciating stock in 2008; hopefully he didn't write is own profile.

Additionally, smaller things like their cheesy PowerPoint templates and use of overly promotional language like "the World's Largest" are picky, but still strike as questionable.  Sure, Signature needed/needs to raise a lot of capital and other companies have done much worse, but it seems to be in the DNA.

There is still quite a bit to like here, curious to see how the rights offering shakes out and what others have to say.

Disclosure: No position