Friday, July 31, 2015

WMIH Corp: KKR Controlled NOL Shell

A simple and brief investment idea today, it's been teased and mentioned a few times in earlier posts on other NOL companies.  WMIH Corp (WMIH) is the remaining shell of the former subprime lender Washington Mutual which became the largest bank failure before most of its assets were sold via the FDIC to JPMorgan Chase in September 2008.  What remains in the old corporate shell is approximately $6B in net operating losses, a small reinsurance business that's in runoff, and $600+MM in cash set aside for a future acquisition.

KKR is effectively in control of the company via the $600MM convertible series B preferred stock issued in January of this year, the proceeds of which are in an escrow account.  KKR is one of the original leveraged buyout shops and gives WMIH Corp access to deal flow and an experience management team.  SPACs and "platform companies" are a current rage, add that with the M&A reputation of KKR and any WMIH acquisition could be met with investor enthusiasm.

WMIH Corp has cash of $670MM to use for an acquisition, $600MM in escrow and $70MM at the corporate level (I'm ignoring the cash and investments inside the runoff reinsurance company).

Let's assume KKR will just use the escrow funds and leave the $70MM for liquidity, they could make an acquisition using half equity, half debt for a $1.2B operating company generating $200MM in pre-tax earnings.  Using a 10% discount rate and assuming 3% annual growth rate in the pre-tax earnings the NOL could be worth an NPV of ~$750MM.  That's probably on the low side, 1) KKR will likely make a larger initial acquisition and raise capital via a rights offering (similar to GRBK, PARR, RELY) to bring forward the NOL value, and 2) there will be additional bolt-on acquisitions over time that will increase earnings at a faster clip than 3%.  But to be conservative, let's use the $750MM value for the NOL.
Assumes 3% earnings growth rate
WMIH Corp has also granted warrants for 61.4 million shares at an average exercise price of $1.38 per share which will raise nearly $85MM.  Add that with the $670MM in cash, plus the $750MM NPV of the NOL, totals $1.5B for WMIH.

The current share count doesn't include the dilution of the various warrants and convertibles in WMIH Corp's capital structure.  KKR's series B preferred stock will convert to equity at the time of an acquisition at a price of $2.25 creating 266,666,666 shares, add in the 1 million shares of Series A convertible preferred stock and the warrants will add another 61.4 million shares to the current outstanding 202.3 million, or a total of 531.4 million shares.  Using the $1.5B valuation number, that works out to $2.82 per share versus about $2.50 today.  So you're merely getting an okay deal today for the shell, but the incentives and potential leverage in an acquisition are such that there could be substantial value creation once a deal is commenced.

  • KKR is unable to find a suitable acquisition, pays the wrong price, or just simply takes too long creating an opportunity cost for investors.
  • At the time of an acquisition, there will probably a rights offering, so keep that in mind when sizing a position.  Trading around deal announcement, rights offering, and deal closings have been extremely volatile in these NOL shells, so even when there is good news, could be a wild ride.
Disclosure: I own shares of WMIH

Tuesday, July 7, 2015

Graham Holdings: Undervalued Parent ex-Cable ONE

Graham Holdings (GHC), formerly The Washington Post Company, has transformed in the past two years as they’ve sold their namesake publishing business to Jeff Bezos, completed an asset swap with Warren Buffett’s Berkshire Hathaway and most recently spun off of their Cable ONE (CABO) broadband business to shareholders.  The Cable ONE spinoff came with a lot of attention as another round of consolidation happens in the cable space, it's basically assumed (and priced accordingly) that Cable ONE won't be independent for long.  The spinoff has created an opportunity to buy the remaining Graham Holdings stub for an attractive, low-risk price.  What remains is a cash and securities heavy balance sheet with a collection of diverse businesses including 5 television broadcast stations and for-profit educator Kaplan along with the largest overfunded pension plan in the Fortune 1000.

Owner/operator Donald Graham and his family control the company and have filled the board with many respected investing minds including Thomas Gayner (Markel), Barry Diller (IAC, Expedia), and Chris Davis (Davis Select Advisors).  Don Graham also has close relationships with Warren Buffet and was formerly on the board of Facebook giving him additional access to advice and deal flow.  I'll break out the assets/business segments by easiest to the most difficult to value, but with a market cap of about $4.1 billion, an investor is roughly buying the cash, securities, discount pension asset and TV broadcasting segment while getting a nearly "free" option on Kaplan's turnaround, SocialCode's growth and a hodge podge of other businesses.

Cash, Securities, and Over-funded Pension
After the spinoff of Cable ONE earlier this month, which paid a $450 million dividend back to the parent, Graham Holdings should have around $1.1 billion in cash (including restricted cash) plus $215 million in securities - backing out the $400 million in debt equals a net cash position of $917 million.  If history holds, the company will use its recently increased share repurchase plan (659,219 shares or ~11% of the share count) to continue cannibalizing itself - the share count is down nearly 40% over the last 5 years.

Graham Holdings enjoys the enviable position have having a massively overfunded pension plan, most know the back story of a younger Warren Buffet purchasing shares of The Washington Post Company in the 1970s and convincing Katherine Graham to shun the traditional pension plan asset allocation model and instead invest in a heavily concentrated portfolio, including a big slug of Berkshire Hathaway.  That advice proved valuable and now Graham Holdings is sitting on a $1.15 billion prepaid pension asset on its balance sheet.   While its difficult to monetize such an asset, it does give Graham Holdings flexibility and potentially could lower its cost of capital when continuing to acquire smaller industrial companies that may have legacy unfunded pension liabilities.  For the purposes of a sum of the part analysis, I'll apply a 50% haircut to pension asset, or $575 million.

Graham Media Group (TV Broadcasting)
The company owns five local television broadcasting stations located in Houston (NBC), Detroit (NBC), Orlando (CBS), San Antonio (ABC), and Jacksonville (Independent).  I've spent some time this year on other broadcasting companies, it's a fairly stable high margin business with several tailwinds (2016 elections, spectrum auctions).  There are plenty of pure play public comparables and its a segment I could see Graham spinning off in similar fashion as Cable ONE.  There is a lot of consolidation activity happening in the broadcast space and a spinoff would allow for a tax efficient sale of the business unit.
Graham Media Group will do about $210MM in blended '15/'16 EBITDA, putting a 9x multiple on that fetches a $1.9 billion valuation.

Kaplan (For-Profit Education)
The most controversial of Graham's business lines is the for-profit education segment, Kaplan, which makes up the bulk of the post-cable spin revenues but comparably a much smaller piece of the profit and current value.  The for-profit education sector is a hated one, and a lot of that is for good reason, many in the industry are simply diploma mills that use aggressive marketing to appeal to low income students who are easily taken advantage of and rely almost exclusively on government guaranteed student loans to fund their tuition.  Many don't finish school and end up with hefty loan payments and no degree, those that do finish, end up with a degree of questionable value and limited job prospects.

Kaplan's business is broken up into three segments: Kaplan Higher Education (US based online university and professional education prep), Kaplan Test Prep (SAT, ACT, MCAT, GMAT, etc), and Kaplan International (a growing diverse set of businesses across mostly developed countries).  The US business is under tremendous stress as enrollment numbers have been cut in half over the last five years.  The business is a potential turnaround, it has sold its physical locations to focus primarily on the online market, and with the job market picking up, sentiment and job placement numbers should improve, the for-profit space is a highly cyclical business coming out of a deep trough.  Turnarounds in the public markets are extremely difficult as investors/analysts focus on quarter to quarter results.  As part of Graham, Kaplan's results are slightly hidden from view allowing them to take a longer term view in the face of increasing regulations.

In the 2014 annual letter, Don Graham makes the case that increased regulation might have a positive effect on Kaplan by taking out the bad eggs/weaker players in the market and increasing the barriers for new entrants.  Politically, the for-profit sector has a place as its going to be too difficult for any politician to take a firm stance against expanding college accessibility (and loans) to low income students.  Kaplan's name hasn't been as tarnished as others and with the backing of a strong holding company should be able to survive to see the light at the end of the tunnel.
Public comparables for Kaplan are all over the place, but with a blended EBITDA of $152MM across the three business segments, I'd argue it's worth at least 7x EBITDA, or $1.06 billion, with some upside to the multiple and EBITDA as earnings normalize across the industry.

Other Businesses/Real Estate
Then Graham has a grab bag of smaller businesses, a couple of which seem to be an odd fit and a couple of which could turn into something more substantial in the coming years:
  • SocialCode: The most promising of the other business is SocialCode which describes itself as a social media marketing technology company that helps companies manage social advertising on platforms like Facebook, Twitter, LinkedIn and Instagram.  In the 2014 annual letter - stated it's now "significant to our company".  With social media companies ramping up the monetization of their platforms with advertising, SocialCode could be in a position to take advantage of that advertising dollar shift.  Don Graham's daughter is the founder and CEO of the company; The Washington Post did an interesting story on the company in late 2014 - they have 25% gross profit margins and over $300MM in revenue, given private market valuations for technology startups SocialCode has some upside optionality via a sale or spinoff, a nice option that I just wouldn't want to pay up for.
  • Trove: This segment is a news aggregator app similar to Flipbook where you can pick and choose news topics you're interested in, I've been playing around with it the last few days and it doesn't appear too useful.  I'll look for a topic I'm interested in, say a sports team, and a very generic "Trove" exists with dated articles. It's hard to tell what the revenue model is as well and how scalable that is for a company the size of Graham?  Maybe it's higher quality than I'm giving it credit for; again SocialCode and Trove would likely be a lot more valuable as private startups given today's frenzy in that market.
  • The Slate Group, The FP Group:  These are two online magazines, Slate is moving its content behind a paywall and having reasonable success but its hard to make money in the online publishing world.  Both are nice properties, but probably not worth a whole lot.
  • Celtic Healthcare, Residential Healthcare: Celtic and Residential both provide home health care and hospice services.  Given the aging demographics of the United States and the "mom and pop" nature of senior and home health care, there's an opportunity to roll up smaller players and make this a larger business.
  • Forney Corporation: An industrial company that makes safety related equipment for power plants that Graham acquired in 2013 from United Technologies.  Since then they've done a few bolt on acquisitions with Forney including Damper Design and FlameHawk in 2014.  Seems like a nice small business (potentially insignificant) but we don't have much information on its profitability or how it really fits with the rest of Graham Holdings.
  • Joyce/Dayton Corp: Another small industrial company that Graham recently purchased, Joyce/Dayton manufactures screw jacks, linear actuators, and the like for the energy, metal and mining sectors.  What's the bigger picture with these two industrial companies?  On the one hand Graham is selling and spinning off major business segments but collecting smaller ones under the Berkshire decentralized holding company management haven philosophy.
Graham's financial disclosures aren't the best, all of these businesses are grouped together making them hard to value separately (maybe now that Cable ONE has been spun out and SocialCode is "significant", it will become its own reporting segment).  To be extra conservative, I'll use the book value of the assets of the "other category" in the latest 10-Q of $488 million.

Graham Holdings also has a small deferred tax asset, given their past tax savvy moves I'm comfortable using the full $74 million valuation allowance.
I come up with a value of $858 per share, which I consider a fairly conservative valuation depending how you choose to value SocialCode and the other businesses.

  • Conglomerate/Controlled Discount: Until recently Graham Holdings wasn't concerned about conducting transactions that would expose value, but after a busy two years, will the deals now slow down?  We also haven't really seen what Tim O'Shaughnessy's capital allocation acumen is like since they haven't done a deal since he's come on board in late 2014.  Conglomerates deserve some discount, I feel like that should be adequately accounted for in my estimates.  Graham Holdings also has a dual share class structure with the class A shares in the hands of the Graham family and having 10-1 voting rights.
  • Nepotism: Donald Graham is a former DC police offer, now heads the company his mother once controlled, late last year he appointed his son-in-law, O'Shaughnessy (founder of LivingSocial), to be the President.
  • For-Profit Education Stink: It's a hated industry, and what Graham Holdings is primarily known for now, but if you zero out the value of Kaplan completely, you simply have a fairly valued company.
The downside seems pretty limited, the company will be in the market buying back shares and you have a BoD and management squarely focused on increasing shareholder value.  Graham Holdings has run up a little since the spin, I bought it on the day it started trading regular way (7/1/15), but I think it has upside from here and have the intention of making it a core long term position.

Disclosure: I own shares of GHC

Gramercy: Switching to Plan B

REITs have been under pressure the last few months as interests rates have ticked up on the expectations of a fed funds rate hike later this year.  The triple net lease sub-sector has been particularly hard hit since their leases are typically longer term and act more like bonds.  With Gramercy's July 2016 ($36 minus any dividends paid) incentive agreement looking more out of reach, and equity raises off the table as a result of the stock's slide, management seems to be switching to plan B and unfortunately moving away from their bread and butter industrial focus.

Life Time Fitness
The first move away from the original industrial focus plan was the early June acquisition of 10 Life Time Fitness facilities as part of Life Time's private equity buyout which was in response to activist pressure to either sell the company's real estate or do a REIT conversion.
Fitness clubs, which Gramercy is classifying as "specialty retail", are notoriously difficult businesses with increased competition coming into the space from the likes of SoulCycle and CrossFit style offerings.  These are big box facilities in suburban locations that would take significant capex to repurpose into an office building.  Doesn't seem like an attractive enough deal to move off message for?  With a straight line cap rate of 7.5%, its only relatively neutral compared to where they raised significant capital earlier this year, maybe a slight positive with the operating leverage gained.

Chambers Street Properties
A former private REIT, then known as CB Richard Ellis Realty Trust, Chambers Street has been a disappointment since entering the public markets in 2013.  The incentives of the private REIT world encourage management to grow assets quickly (and collect fees) at almost any cost and sell these investments to unsophisticated retail investors looking for monthly dividends (similar to the shareholder bases of mREITs and BDCs).  The result tends to be an unfocused mess of a portfolio with many lower quality assets.

On 7/1/15, Gramercy announced a "merger of equals" with Chambers Street where Chambers Street will actually be the one acquiring Gramercy, but will change its name to Gramercy Property Trust and use the GPT ticker after the transaction.  The Gramercy management team will run the show at the new combine entity (Chambers Street was previously without permanent CEO) and waived the change of control provision in their incentive agreement.
Chambers Street and Gramercy have different shareholder bases, CSG shareholders revolted at the thought of their monthly dividend being cut without a sense of the bigger picture and as a result dragged down GPT with it due to the proposed all stock transaction.
Gramercy's asset management business has always seemed overstaffed compared to their revenue on the KBS contract, DuGan found a way to utilize this large team with CSG that has previously been working down the BofA bank branch portfolio over the past two years.  Gramercy plans to sell between $500-$700 million worth of the office properties (hopefully the multi-tenant ones) over the first year and reinvest that capital into their (previous) industrial focus.  The Chambers Street portfolio also includes some European assets that potentially moves up the timeline for listing that vehicle.

Overall, not entirely excited about this transaction, but it makes sense given the current REIT landscape and the mid-$30s share price goal a year from now.  Think of this transaction more of a backdoor capital raise in buying a scattered cheap net lease portfolio that they have staffing to work down and reinvest in properties they otherwise would have needed to access the capital markets at uneconomic levels to purchase.  My back of the envelope math shows Gramercy currently trading at 11-12x core FFO, too cheap for a management team that has until 6-8 weeks ago delivered on nearly every promise they made since the beginning in 2012.

Disclosure:  I own shares of GPT