Year End 2015 Portfolio Review

2015 was a good but frustrating year, most of my gains were front loaded in the first quarter and since then I've been treading water.  Owning several big positions in real estate companies wasn't the best positioning in a year when the Federal Reserve has finally began to tighten rates.  Value added spinoffs and NOL rich companies drove my returns this year.  No cash was deposited or withdrawn from the account and to reiterate the overall portfolio goal is to generate a 20% IRR over the long term.

Below is a breakdown of the attribution of each holding during the year to my performance, which is interesting at least to me, the grayed out holdings were closed during 2015:

Miscellaneous Position Comments:

• Graham Holdings: This was my biggest loser for the year and I ended up selling mainly for tax reasons around $550.  I made a similar mistake as with News Corp the year before, Graham is a cheap pile of assets within a family run holding company structure, nepotism, etc - basically a value trap sum of the parts story.  Eventually the value might be unlocked but you have to wait for the next spin/asset sale and enter it at a more substantial discount than I did around $700.  Now might be that time for those new to the name, I could see it being a beneficiary of the January effect, you're basically getting paid to take the for-profit education/Kaplan segment at today's prices.
• Rentech: My other loser pick that I acquired this year, with Rentech I just went outside of my swim lane, didn't fully understand the business or the challenges it faced.  Plus, I was skeptical of the MLP structure to begin with but hoped the market would hold up long enough for Rentech to dispose of their yieldco MLP and convert the stub to an MLP, it obviously didn't.  Thankfully, I sized this one small from the beginning and exited before things got really bad for the company.
• Computer Sciences/CSRA: The original plan on this spinoff was to sell CSRA and hold CSC in hopes that it would be sold to a competitor or private equity.  But as the spinoff happened, CSRA (the government services business) fell seemingly everyday until it hit around $26 and has since bounced back somewhat.  Another curious thing that I haven't fully gotten answered, none of the tax basis went over to my CSRA position, so I called an audible and sold the CSC piece (free/unearned tax loss as it stands now) and will hold onto CSRA as it's the better business and despite the rebound still substantially undervalued compared to its peer group.  The peer group has traded up a bit since the November spin, now averaging around 10x EBITDA, which would value CSRA at $38-39/share and that could move higher as they realize the merger synergies with SRA and use free cash flow to delever their balance sheet.  There's been several similar situations that have worked out well in the government services space; CSRA is one of my favorite ideas for 2016.
• Par Pacific Holdings: I'm working on a more comprehensive PARR update, but if one isn't an energy expert (me) and still wants to find a way to participate in the industry's distress, PARR is a perfect way to do that.  I've been trying to figure out who the eventual winners will be in both energy and mining, every few days it seems like another company is announcing asset sales, a good question to ask is who will be on the other side of these forced sales?  One such buyer is PARR, they've raised capital, have a strong sponsor/deal maker in Sam Zell's investment arm, and a cost of capital advantage due to their large NOL.

Other Random Thoughts:

• I hate being in battleground names, which American Capital (ACAS) has become, it's just usually not worth the effort as there are shorter hurdles to jump.  So I hope that someone (Ares? Fortress?) takes out ACAS one way or another and bails me out.  My official stance is I like Elliott's involvement and how quickly ACAS announced another strategic review, think it gets to ~$19, but it's a dicey time for high yield and risky leverage loan assets.  I'm preparing for this to be another mistake.
• MMA Capital Management completed their GE tax credit portfolio acquisition and posted an investor presentation to go along with it (more detailed than I've seen from them in the past).
• I participated in a couple of the big exchange offers this year (GE/SYF and DOW/OLN, missed DHR/NTCT), going to do more of that (and other small opportunities, CVRs, etc) next year as it might be another tough one for the broad market indexes, makes sense to take some small wins here and there.
• I've been on the lookout for further dislocations in the credit markets, especially in vehicles that gave retail investors a way to invest in illiquid hairy high-yielding assets.  One that I've mentioned in the past that's starting to get interesting to me is Oxford Lane Capital Corp (OXLC) which is a BDC-like company that almost exclusively owns CLO equity.  CLOs unlike BDCs don't mark-to-market their assets and thus are less at risk for being forced sellers when markets decline, if credit worries stay contained to the energy sector, CLOs should continue to perform well despite their current drop in price.  No position yet, things probably get worse in these leverage loan vehicles, everything takes longer than you'd expect to play out.
• Another idea I've been researching is Baxalta (BLXT), its a pharmaceutical company that's focused on rare diseases like Hemophilia, they've had a couple key drug approvals recently and look cheap on a forward P/E basis.  Additionally, Shire (SHPG) has been stalking the company since it's spinoff from Baxter this past summer, one of the reasons for the deal is Baxalta is a U.S. taxpayer and since Shire has already inverted they could remove some of Baxalta's tax burden.  

Current Portfolio:

Thank you to everyone for reading and happy new year.

Disclosure: Table above is my blog/hobby portfolio, its a taxable account, and a relatively small slice of my overall asset allocation which follows a more diversified low-cost index approach.  The use of margin debt/options/concentration doesn't represent my true risk tolerance.

Hawaiian Electric: NextEra Merger, ASB Hawaii Spinoff

Hawaii Electric Industries (HE) is the primary electric utility serving over 95% of the state's residents, interestingly they also own the third largest bank in Hawaii, American Savings Bank.  Oil is used to generate Hawaii's electricity (already more expensive than natural gas or coal) and given the islands remote location, additional transportation costs lead to resident's electric bills being very expensive, up to 3x more than the average household on the mainland.  Environmental and political pressures have led to the ambitious goal of generating 100% of the state's electricity from renewal sources by 2045, with interim goals between now and then.  It's admirable goal, however Hawaiian Electric is a small inefficient utility and isn't up to the task both operationally and financially, they need a bigger partner.

In December 2014, they announced a merger with NextEra Energy (NEE) with Hawaii Electric shareholders receiving a combination of NEE shares, cash, and most appealing to me shares in Hawaiian Electric's thrift bank subsidiary, American Savings Bank (ASBH).  Federal banking laws restrict commercial businesses from owning banks, however Hawaiian Electric's ownership of American Savings Bank had been grandfathered in leading to an odd pairing of an electric utility and a sleepy saving bank.  But with the merger, the grandfathered status goes away and HE/NEE is forced to spinoff the bank to shareholders as a condition of the merger.

The merger details are as follows, on the closing, Hawaiian Electric shareholders receive:

• 0.2413 shares of NextEra Energy (NEE)
• $0.50 special dividend
• 0.3333 shares of ASB Hawaii (ASBH)

Hawaii is a lovely place to visit, but it's an odd place to do business, especially as a government regulated utility serving the state.  Many residents in Hawaii are extremely protective of their unique culture, history, and way of life - politically its a hard sell to have a mainland utility come in and takeover the largest publicly traded Hawaiian company.  They also view the utility as a communal company and not a for-profit corporation which needs to serve the best interest of their shareholders.  The governor is publicly opposing the merger, there are many websites devoted to blocking the merger, and yet, they also want to free themselves of fossil fuels and generate more of their power within the state.

So what's likely to happen is each interest group is going to extract a promise or two out of NextEra, to not lay people off, to keep electricity prices low, to invest a certain amount of dollars into clean energy infrastructure, etc.  Eventually this deal gets done, it's just a matter of when.  The last and biggest hurdle is getting approval from the Public Utilities Commission in Hawaii, they're currently conducting hearings through December 26th and have committed to a ruling by June 2016, but it could come sooner.

American Savings Bank Hawaii (ASBH)
In Hawaii there are four banks that control the market and none of them are branded as the big money center banks that you would typically see in other US markets, this goes back to Hawaiian's maintaining their unique culture.  The two largest are Bank of Hawaii (BOH) and First Hawaiian Bank which is owned by Bank of the West which is then owned by BNP, a distant but still meaningful third and fourth place are split between American Savings Bank and Central Pacific Financial (CPF), which is also publicly traded.

Hawaii is a pretty attractive banking market, it's seen healthy mid-single digit growth in both loans and deposits in recent years in an otherwise growth strained national banking backdrop.  The real estate market is strong, relatively constrained by their island geography and having much of the land zoned as national parks, most of the building is up not out (see HHC's Ward Village).  The economy is driven by two main sectors, federal defense spending and tourism, both of which were reasonably resilient during the 2008-2009 financial crisis.  Plus, I like the added benefit of being remote and a closed off market for other players, it's unlikely that the four banks in Hawaii would see a new competitor come in and start a pricing war.

American Savings Bank specifically is run as a fairly conservative thrift bank, it holds a considerable amount of residential loans (Hawaiian mortgages typically fall under the jumbo category) and its funded exclusively with low cost deposits.  ASBH feels like a combination of a spinoff with elements of a mutual bank conversion.  As part of Hawaiian Electric, American Savings Bank distributed income up to the holding company in order to support the dividend in lean years, as a standalone company they'll have individual discretion on their capital allocation without the outside of interests of a cash strapped electric utility.  There's also an interesting regulatory upside as a result of the spinoff, in 2010 as part of the Dodd-Frank legislation, the Durbin Amendment limited fees charged to retailers for debit card processing.  It contained a waiver for banks below a certain asset threshold, as apart of Hawaiian Electric the bank had it's fees capped, but as a smaller standalone entity, American Savings Bank will no longer fall under the restriction leading to an additional ~$6MM in revenue (mostly falling straight to the bottom line).  Management is likely to become more aggressive as a result of the spin, compensation will be easier tied to the bank's performance and they plan to branch out into more profitable lines of business.

Valuation
As I'm writing this, NEE trades for $100.03 and HE trades for $28.60, doing some algebra and (of course assuming the deal gets approved) one could synthetically create ASBH for $3.96 per share of HE or $11.89 assuming the 3 shares of HE for 1 share of ASBH ratio.  That equates to a market cap of $426MM for a bank with a tangible book value of $557MM.  As mentioned above, ASBH has two easy public comparables in BOH and CPF that do substantially all of their business in Hawaii.

Bank of Hawaii is a serial share repurchaser, when you buyback shares above BV it reduces the BV per share even if it's otherwise accretive so it appears BOH is trading for a rather absurd BV multiple.  Central Pacific Financial is probably a better comp anyway, they're roughly the same size and have similar performance metrics, if ASBH were to trade for the same P/TBV multiple it would be worth $7.50 per HE share, or almost twice as much as it's being valued today (admittedly much of the discount is the merger arb spread).  If you took CPF's P/E ratio and applied it to ASBH, you'd get $8.69 per HE share.  At the time of the deal, HE and NEE pegged the value of ASBH at $8, so somewhere in that range seems reasonable.

The problem for me at least is how to structure the trade/investment?  One could short 0.2413 shares of NEE for each share of HE, but the capital required to create a meaningful position synthetically in ASBH is somewhat prohibitive.  One could also wait until after the spinoff, there are likely to be many forced sellers (utility focused funds/ETFs) and other retail investors that might indiscriminately sell a small unwanted bank position.  But I'm a little impatient, and have established a medium sized long position in HE (unhedged), with hopes of picking up some of the spread when the deal gets approved and then buying more of ASBH post spin if it's still cheap.

Disclosure: I own shares of HE

MMA Capital: Update, Balance Sheet Revealing Itself

Another update on a big position I haven't mentioned in 2015, quick background:

• MMA Capital Management (MMAC) is essentially a pile of assets (mostly tax advantaged low income housing bonds) selling well below their true net asset value.
• In 2015, the company has been recognizing large gains by selling off low basis real estate acquired during the financial crisis via foreclosure and then starting up a solar energy lending business with a JV partner where they'll ultimately park $50MM dollars while also earning a management fee.
• Cost accounting, consolidation rules, and it's inability to recognize the sale of the LIHTC business for GAAP purposes has artificially reduced the reported book value of the company.
• Some of my earlier posts from 2014: http://clarkstreetvalue.blogspot.com/2014/10/mma-capital-update-new-name-up-listing.html, http://clarkstreetvalue.blogspot.com/2014/03/municipal-mortgage-equity.html

MMA Capital released their Q3 results on Friday (11/13), they're hosting a call on Thursday (11/19) so if there's anything new that comes out of that I'll update this post as well.  The company's reported book value is up to $15.55/share, this time last year it was $9.25/share, the increase is mostly a result of monetizing low basis real estate, but if you take the time to read the 10-Q (not an easy read), there are two additional items that happened after 9/30 that increase their book value even higher making the current share price a bargain even after an impressive run this year.

Preferred Stock Investment

MMA Capital owned $36.6MM in preferred shares in a mortgage servicer, it had been held on the books for $31.4MM, but in the 10-Q, MMAC revealed that it been redeemed at par:

On October 30, 2015, the Company's investment in preferred stock were fully redeemed by the issuer at par value of $36.6 million and, as a result, the Company terminated the two aforementioned total return swaps and will recognize a gain of $5.2 million during the fourth quarter of 2015.  Refer to Note 6, "Debt", for more information.

Now $5.2MM might not seem like a lot, but on an $89MM market cap it's pretty significant, it's an additional $0.79/share in book value and also reduces the company's debt, and confusing TRS arrangements.

IHS Bankruptcy Estate
International Housing Solutions is MMAC's South African investment/property manager arm, up until recently there was a small minority ownership that was collapsed and wrapped up into MMAC during the second quarter.  In the latest 10-Q, another sizable gain occurred:

On November 12, 2015, the Company reached an agreement to acquire at a significant discount from the bankruptcy estate of one of the co-founders of IHS, all interests held by such estate in the Company's subsidiaries or affiliates, including notes payable and other debt obligations of the Company that had a carrying value in the Consolidated Balance Sheets of approximately $4.4 million as of September 30, 2015.  Among other provisions, such purchase agreement provides for the release and discharge of the company from its payment obligations associated with such deb instruments.  As a result, and based on all consideration to be exchanged under the agreement, the Company will recognize during the fourth quarter of 2015 a net gain in its Consolidated Statements of Operations that is estimated to be between $3.0 million and $3.5 million.

Let's call it $3MM on the low side, or another $0.45 per share in book value.  So without anything additional, and assuming no big market disruptions/losses, we know the year book value will be at least $16.79 per share.  It's trading at $13.79 or 82% of that adjusted/current book value.

Additional Items Not Included in GAAP Book Value:

• $418.2MM in NOLs, at a 35% tax rate that could be worth ~$145MM, more than the entire company. It's hard to imagine them utilizing in current form, but on previous conference calls they've emphasized their understanding of its potential value and back in May adopted a Rights Plan to reduce the change of control risk.
• In 2014, they sold their LIHTC asset management business to Morrison Grove Management, but retained the yield guarantee and included an option to purchase Morrison Grove starting in 2019. They provided seller financing to Morrison Grove, the balance of which is now $13 million, but that's off balance sheet (I forget the reason, either the yield guarantee or the option to buy). The option to buy the company in 2019 could be valuable in itself and another operating business to generate taxable income.
• The carrying amount of their remaining real estate is $25.1 million, they estimate it to be worth $29.2 million, it could be worth more as they've put some of their real estate into JV's with developers who are re-purposing the assets and hopefully generating more value.

The MGM seller financing and the real estate at fair value would add another $2.61/share to the BV above the two post quarter adjustments we made earlier for an all-in value of $19.40/share.

The same management that created all this mess is still in place, MMA Capital seems to be the one example of management knowing where all the bodies were buried and actually being able to extract significant value out for shareholders.  There's still a lot to be done, the ongoing businesses are basically break even, they still need to develop a sustainable business plan to move from being valued as an NAV pile to more of an operating business.  The new MMA Energy Capital business might be a step in that direction.

Disclosure: I own shares of MMAC

Green Brick Partners: Update, Guide Down, Shares Look Cheap Again

Update time, I haven't discussed Green Brick for about a year - quick background:

• Green Brick Partners (GRBK) is a former NOL shell (BIOF) which David Einhorn engineered an interesting reverse merger in 2014 with a home-building operation founded by Jim Brickman.  David Einhorn came to know Jim Brickman on the old Yahoo message boards discussing Allied Capital, Brickman's analysis helped fuel Einhorn's short crusade against the company and afterwards they became close friends/partners.  Einhorn is now the Chairman of Board and Brickman is the CEO of Green Brick.
• The company has an $83MM deferred asset as a result of the old BioFuel Energy net operating losses, meaning it won't pay income taxes for the next several years.
• The low float (Greenlight owns 49%, Third Point 16.5%), initial rights offering, secondary raise, and other events have led to a lot of stock price volatility.
• Some of my earlier posts from 2014: http://clarkstreetvalue.blogspot.com/2014/11/follow-up-on-green-brick-partners.html, http://clarkstreetvalue.blogspot.com/2014/09/biofuel-energy-green-brick-partners.html
• On 7/1/15, the company completed a secondary offering of 17.45 million shares at a price of $10.00, with Greenlight and Third Point fully participating in the offering to maintain their ownership percentages (important to keep the NOLs in place), the cash raised fully paid off the expensive 10% term loan the company had in place with Greenlight when it completed the reverse merger with the old BioFuel Energy.

On October 30th, Green Brick Partners fired their COO and took down their 2015 pre-tax income guidance from the $29-32MM range to $22-24MM, since then about $210MM in market cap (stock price was as high as $14.94 this summer, now $6.60) has been sliced off the company leaving the shares trading at a discount to book value (which includes the DTA).  The Q3 conference call held on 11/13 didn't provide much reassurance as the company admitted to misjudging their customers in Atlanta and building too high-specification homes that just weren't selling (fixable).  Combined that with their labor shortage issues in their Dallas communities (fixable) and the stock market has harshly penalized management who made the mistake of just reaffirming their original guidance in a mid-September investor presentation.  Where does that leave us now?

Homes aren't a fad product like say a GoPro camera or a FitBit wearable device where a guide down in the later half of the year could signal much larger demand problems.  We knew that Green Brick's revenue was going to be back loaded this year with the opening of two large communities (Twin Creek in Dallas and Bellmoore Park in Atlanta) happening in the fall.  While it's disappointing that both of these developments are facing issues at the same time, I get the sense that the revenue will simply get pushed back into 2016 and the current washout is a buying opportunity.  Both Dallas and Atlanta are high demand, growing, sun belt markets, and the housing market seems to have finally burned off most of the excess supply built leading up to the financial crisis.

With their unlevered balanced sheet, Green Brick should be in a position to additionally make acquisitions, there was a hint of that in the Q3 press release below, but I didn't catch any further commentary during the conference call. 

"We are continuing to find attractive "A" location land investments that should translate into profitable growth for years to come. Since the summer of 2014, we have quietly been finalizing entitlements and planning on numerous land development opportunities. In the coming weeks and months, we expect to utilize our strong balance sheet to opportunistically pursue attractive land purchases and other prospects to improve long term shareholder value and accelerate our growth in 2016 and beyond." - Jim Brickman

These land investments would presumably be above and beyond what they already have projected to open in 2016 and 2017, including a "~30%" increase in communities next year:

Net income figures below are projections pulled from Bloomberg and then Green Brick's own lower guidance, if I'm right about profits being pushed out to 2016 the shares look very cheap at just 13.5x 2015 pre-tax earnings, 90% of book value, and essentially a clean balance sheet.

I listened to people smarter than me and sold down some of my position around $12, but still held quite a bit through this slide and today bought back in at $7.00 most of what I sold.  Green Brick is of course partially a jockey play on David Einhorn (who is having a self admitted terrible year) and Jim Brickman, both remain impressive to me, and the structure of the company keeps them involved and encourages them to create long term shareholder value.  I wouldn't lose faith in either just yet off of a $~8MM drop in near-term guidance.

Disclosure: I own shares of GRBK

Computer Sciences: Gov Services Spinoff, Commercial Business For Sale?

Computer Sciences Corporation (CSC) is primarily an IT services firm that is spinning off its U.S. government services business (targeted by the end of November) and immediately merging the spinoff with SRA International which is another contractor in an industry that's seen a lot of spinoffs and consolidation activity.  The spinoff will be recapitalized and paying out a special dividend to shareholders (versus the typical scenario where the spinoff dividend goes to the parent) of $10.50 per share.  There's been a lot of takeover speculation regarding both the parent and spinoff, that along with the dividend to shareholders leads me to believe the parent might be sold thus completing a breakup of the company.

Overview

CSC was founded in 1959 and today it is a $9B market cap global IT services company, they partner with various hardware/software providers (including some in-house) to provide clients with customized outsourcing and IT solutions.  This is a highly competitive business, CSC is in the midst of a turnaround similar to competitors IBM, HP, Xerox, among others.  Revenues continue to fall at a double digit pace and have each year since 2012 as the company changes their mix and moves towards the hot buzzwords - big data, cloud computing and cyber security. The company does have rocky recent past highlighted by the nearly $200MM fine the SEC imposed on them in June (that really muddies up backward looking earnings) for accounting fraud charges as the former management inflated earnings starting in 2011 and generally hid a troubled contract with the U.K's National Health Service.  In early 2012, Michael Lawrie joined the board and became CEO replacing disgraced management, he has both an IT services background (Misys PLC, IBM) and was also briefly a managing director at the hedge fund ValueAct.

CSC reports in three segments, each contribute roughly the same amount of revenue:

Global Business Services is the consulting and services piece of the business, it has respectable 10% operating margins; Global Infrastructure Services provides data center management, cloud, infrastructure as a service type offerings, its more product/hardware intensive and has the lowest operating margins of the three at 6%; North American Public Sector is the U.S. government contractor business, almost entirely IT services offerings and has the highest operating margin at 14%.  There's been speculation that the company has been looking to sell itself; In September 2014, Bloomberg reported that CSC had contacted private-equity firms to gauge interest in an LBO and then this past February DealReporter said CSC is in talks to sell itself in a two-part deal to a foreign strategic buyer and a private equity firm.  It seems like the two-part deal might be in play as in May, the company announced plans to spinoff the North American Public Sector unit as Computer Sciences Government Services (many government contracts have restrictions against foreign contractors), leaving the two commercial/international business behind to potentially be taken out.

Computer Sciences GS + SRA
I tend to like government services businesses, they have low capital requirements, fairly consistent and predictable revenues as once you win a contract it's hard to be unseated as the incumbent.  As a service provider, most of their expenses are personnel and many government contractor personnel are more tied to the individual contract versus the actual employer.  If you lose a contract rebid, the staff either gets reassigned, moved to the new contractor, or are laid off.  So given the predictable revenue steam and low capital requirements, the business can sustain a high debt load and use the free cash flow to delever, ultimately accruing more value to shareholders.

Along with the spinoff, CSC is immediately merging their government services business with competitor SRA International which is owned by private equity and management.  I like these multi-step spinoff and merger transactions (think ATK/ORB and SSP/JRN) as it shows a little more foresight and thoughtfulness to the corporate action, rather than just doing a "garbage barge" spinoff, management is putting together a company that's setup to succeed.

Notably the spinoff is assuming SRA's debt adding even more leverage to the company, although still at reasonable 3.75-4x EBITDA levels.  The company will be roughly split 50-50 between defense/intelligence contracts and civil agencies, SRA's book of business is a little more diversified than legacy CSC further reducing concentration risk to losing any one large contract.  When announcing the SRA merger, management provided some expense synergy and EBITDA numbers for the combined entity along with some easy public comparables of very similar businesses.

CSC Government Services will have $2.7B in net debt, plus they're taking the $400MM pension liability with them in the spinoff, for a total adjusted net debt of $3.1B.  For EBITDA, I'm taking out the expected synergies for now and using proxy/estimates swags for earnings and FCF.  Their competitors are all of relative similar size, similar debt levels, and trade within a tight range of 9.5-11x EBITDA.

Sorry if that's a bit small, but I wanted to try and show the industry's valuation using a series of multiples and give a fairly conservative valuation to CSC Government Services, using a 9.5x EBITDA value I'm coming up with a market cap for the spinoff at $5.08B.  Current CSC shareholders are going to own 84.68% of the spinoff, so net to CSC shareholders the spinoff should be worth approximately $30.55 per share, add in the $10.50 special dividend for a total of $41.05 per share in value.

Computer Sciences Commercial Business
I feel pretty comfortable valuing the government services business, much less so with the remaining commercial business, but if you net out the government business using the above comparables, the remaining parent looks very cheap despite the industry headwinds.  The purple row in the table below is showing just that, netting out the $41.05 and holding the current price constant at $64.62 (went up more today) the stub is trading at: 9.1 P/E, 3x EBITDA, and a 14% FCF yield, all very cheap metrics that would be enticing to any potential financial or strategic buyer.

In yellow, I put the remaining CSC at 6x EBITDA and come up with a $7B market cap, or $50.09 per share, in purple (netting GS out of the current price) it's $23.57 per share, so a lot of the value creation could come from this gap closing.  In the meantime, CSC continues to make bolt-on acquisitions (UXC Limited, Furition Partners, Fixnetix) in the commercial business as they continue to move towards higher margin offerings.  The company will be hosting an investor day on November 5th, hopefully they provide a little more clarity on what the plans are for the remaining business, but at today's prices I think you're paying a cheap price for a fair business that's likely an acquisition target.  Sum of the parts gets me to $91.14 pre-spin for a ~40% upside, although I'll probably sell for something close to $80 per share.

Disclosure: I own shares of CSC

American Capital: ACAP Form 10 and Proxy Notes

I was starting to get nervous there that American Capital (ACAS) would miss their own self imposed September deadline to file the Form 10 for their proposed BDC spinoff American Capital Income (ACAP), but on 9/30 ACAS filed a draft proxy statement (along with the Form 10) with several proposals to put to a shareholder vote that will move the long anticipated spinoff forward.

To recap my earlier post, American Capital will be spinning off a BDC that will pay dividends (hopefully attracting retail investors and raising the valuation), leaving ACAS with the management company that will have almost $23B in AUM inclusive of the spinoff (most of which is permanent capital).  The company pegs its current NAV at $20.35 per share, which includes the value of the management company, the stock currently trades for $12.50, a ~40% discount to NAV.

American Capital Income (ACAP)
There's a bifurcation between the valuation of internally managed BDCs and externally managed ones, with internally managed BDCs being valued at slightly over NAV, and externally ones below NAV, in some cases substantially under.  BDCs require shareholder approval to issue shares below NAV, so there's a strong incentive over time for externally managed BDCs to increase their share price through fee reductions, share repurchases or simply better performance.  Below is a table of prominent BDCs (and less prominent ones like ACSF) to give an idea of how they currently trade.

The BDC spinoff, American Capital Income (ACAP), will be one of the largest BDCs and has a close peer in Ares Capital Corp (ARCC).  Both implement a similar strategy, are roughly the same size, externally managed, and the external managers are publicly traded.  But besides a more stable history, ACAP has a few hurdles to overcome before it can trade inline with ARCC's 92% of NAV.

1. ACAS, the asset manager, is going to charge ACAP a 1.75% base management fee on assets (not equity and including cash) plus incentive fees which will charge ACAP an additional 20% of gains as long as they hit the 8% hurdle rate.  The base management fee is 25 bps more than Ares Management charges Ares Capital, but the incentive fee has a slightly higher hurdle rate (7% versus 8%), in most circumstances ACAP will be paying 0.35-0.50% more in fees for comparable performance as ARCC (remember, it's an extra 0.25% on assets not equity).  While it's good for ACAS, hopefully they reconsider and move the base management fee down to 1.5%, management will be disproportionately invested in ACAS going forward but much of the value creation from the spinoff is coming from ACAP moving closer to NAV.
2. The ACAP portfolio is going to initially be a little funky with about $1B in equity/control investments that were previously sourced by American Capital's "One Stop Buyout" program, which they've shuttered.  Since they won't be able to raise equity for a while the equity investments can be a source of funds, the plan is likely to exit these over time and reinvest in middle market and syndicated bank loans creating a more diversified, simpler to value portfolio.
3. ACAP's proforma leverage is around 140%, well below peers, which along with the equity slug and relatively overweight senior bank loans (where they're parking the leverage) means it's going to under earn initially until they get their portfolio ramped up and more inline with peers.

Even given these challenges, ACAP should at least trade for 80% of NAV, or $3.3B, inline with its sister BDC in ACSF (which is a dedicated bank loan BDC) within a quarter or two of reinstating the dividend and overtime close the gap with it's closest peer ARCC.

New American Capital (ACAS)
ACAS will be primarily an asset manager with some assets set aside to seed new strategies/funds before they eventually get sold into those vehicles.  Including the new BDC, ACAS will manage 4 publicly traded companies, two BDCs in ACAP and ACSF, and two mortgage REITs in AGNC and MTGE, along with 14 private funds (private equity and CLOs primarily) totaling $22.75B in fee earning AUM (in some of their strategies they only get paid on the equity, not the assets).

82% of American Capital's assets will be in permanent capital vehicles which should garner a premium over time.  I have a hard time determining if they're good investors, but it's fairly clear they're good asset gathers.  Interest rates are likely to stay low for some time, forcing investors to chase yield, and most of American Capital's strategies cater to those yield chasers.  ACAS puts a value on the asset manager each quarter, the latest was $1.1B, I tried unpacking that in my earlier post in February so I won't rehash that now.  They're also going to include roughly $1B in investments on the balance sheet of the manager.  My guess is the asset manager is going to be the preferred security of the two and should be valued at close to $2.1B.

Using the fully diluted share count of 283 million shares = $11.53 (ACAP) + $7.41 (ACAS) = $18.95 per share, or 50% upside from current ~$12.50 prices.

Incentive Plan & Option Tender Proposals
One of the primary knocks on ACAS is they pay themselves handsomely, siphoning off value from shareholders and re-directing it to insiders and management via stock options.  Many of their options were issued deep in the crisis, and don't expire for 10 years, just look at the CEO's:

Even at today's depressed prices these options have a current value of $24MM, and they've created an overhang on the share price.  Adding to the dilution pain, because of the spinoff, employee options holders are forced to exercise their options (issuing shares below NAV) prior to the spinoff:

"... we are prohibited under the 1940 Act from issuing options in ACAP stock to American Capital employees."  

"... because option holders are not able to participate in the spin-off and option holders have thus had to exercise vested options earlier than necessary and at lower than optimal prices, the options previously granted under our existing plans have lost significant retention value."

In their second quarter investor presentation they laid out the impact of employees exercising their stock options earlier:

This dynamic has created some forced sellers in the market, presumably ACAS employees don't want to exercise their options ahead of the value unlocking spinoff, but they have to, potentially putting unwarranted downward pressure on shares recently.  On August 5, the company announced they would buyback $300-600MM worth of shares, in part to counterbalance the options being exercised and as of the end of the third quarter they bought back $134.6MM at an average price of $13.82 per share.

Tucked into the proxy, ACAS is proposing an interesting solution that would help both employees looking to exercise their in-the-money options and current shareholders who want to reduce the dilutive effects of the options.  By law BDCs can't issue shares below NAV without shareholder approval.  Typically this is a great protection as it prevents managers from increasing the share count, and more importantly their fees, at the expense of current share holders.  ACAS is requesting the ability to tender employee stock options and issue shares covering only the net after-tax gain amount on employee's options, versus the entire amount via exercising the option.  Essentially this would drastically reduce the amount of shares that would be issued below NAV due to employee stock options.  This maneuver may also additionally reduce the selling pressure by encouraging employees to hold onto to their newly issued shares.  They won't need to sell for tax reasons (the company would pay out the amount due in taxes in cash), and you'd reasonably assume that if they haven't exercised their options and sold already, they believe the shares are undervalued and would continue to hold their exercised shares.

Here's the example they use in the proxy filing:

Using current market prices and the actual ~32 million options outstanding number should actually produce a better result than the example above since options are worth less at the $12.50 stock price, meaning less cash for taxes and less shares issued below NAV.  It seems like a win-win both for share holders and employees, and I hope it passes.

Since the employee stock options will either be exercised or out of the money after the spinoff, another one of the proxy proposals is for the 2016 incentive plan.  The plan calls for an additional 8% of shares to be set aside for employee options and another 0.5% for non-employee board members.  This might strike some as just another round of management raiding the cookie jar but if the current management options are gone, then this new plan kind of presses the reset button, almost like a new spinoff issuing the new management "founder" incentive options.  Not ideal, but not completely terrible either as they're not immediately dilutive, although issuing any shares/options below NAV is going to be dilutive, so it's a careful balance.  I'm willing to give them a break on it.  Management's record of share buybacks and now the tender offer tells me they're not quite as bad as their reputation suggests.

At this point, my biggest concern is around the timing of the spinoff.  It's been a long time in the making and if the option tender proposal isn't approved, I'm worried that management will put off the spinoff to allow additional time for employees to exercise their options and that would put more downward pressure on the share price.  Back in July I added some calls that expire in January, seems now that was a little optimistic hoping the spin would happen before then.  Either way, this is still one of my favorite ideas and I'll likely add to it before the year is done.

Disclosure: I own shares of ACAS (and Jan '16 calls)

Journal Media Group: Sold to Gannett

Two of the (very) recent publishing spinoffs are going to continue the industry's consolidation trend; Gannett (GCI) announced last night the purchase of Journal Media Group (JMG) for $12/share in cash for nearly a 50% premium.  The purchase price values Journal Media at around ~6x my swag of EBITDA.  I previously mentioned that Journal Media made a natural acquisition target for Gannett before it was spun out of the Scripps/Journal Communications transaction back on April 1st.  Journal was setup for an acquisition with no debt, no controlling shareholder and papers that fit well into Gannett's portfolio of mid-sized city publications.  Sounds a lot like Cable ONE (CABO) which was recently spun out with the implied purpose of being acquired.

The timing of the transaction is somewhat surprising as spinoffs typically wait two years before being acquired to avoid IRS scrutiny around their tax free status.  But Journal Media has provided its former parent E.W. Scripps with an opinion reaffirming the tax free nature of the transaction.  Gannett looks a little bit cheap here, but along with New Media (NEWM) they'll be the consolidators in an industry that I don't want to hold through the next recession (whenever that might be) as advertisers move toward other platforms.  The broadcast/newspaper spinoff trade has worked out well this year, but time to close it out, I sold my shares today and will let arbitragers get the last percentage points.

Disclosure: No positions

Sycamore Networks: Activists Pursuing NOL Shell

This is a small opportunity that's not suitable for everyone, but it has significant upside if recent activists get their way and could be interesting as a small addition to an NOL shell basket. Sycamore Networks (OTC: SCMR) is a former dot-com optical networking darling that at one point was valued at $44.8B before the bottom fell out as late 90s internet traffic estimates ended up being wildly optimistic.  In 2013, the company sold the last of its operating businesses, shareholders voted to dissolve the company and commenced a liquidation.  Today, Sycamore's market capitalization hovers around $15MM.

Sycamore uses liquidation accounting and estimates the potential payout to investors each quarter.  The main sticking point to wrapping up the company is the 102 acres they own in Tyngsborough, MA that's under contract but the closing date keeps getting pushed back.

Companies in liquidation tend to overestimate their expenses, so it's likely that the final outcome will be slightly higher than $0.33 per share, maybe something closer to $0.40 per share.  It's trading for around $0.50, so why is it interesting?  It has a large NOL in comparison to it's market cap, from the 10-K:

As of July 31, 2014, the Company had federal and state net operating loss ("NOL") carryforwards of approximately $856.46 million and $34.9 million, respectively.  The federal and state net operating loss carryforwards will expire at various dates through 2034.  The Company also has federal and state research and development credit carryforwards of approximately $11.31 million and $9.98 million, respectively, which begin to expire in 2020 and 2015, respectively.  The occurrence of ownership changes, as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"), is not controlled by the Company, and could significantly limit the amount of net operating loss carryforwards and research and development credits that can be utilized annually to offset future taxable income.  The Company completed an updated Section 382 study through July 31, 2011 and the results of this study showed that no ownership change within the meaning of the Code had occurred through July 31, 2011 that would limit the annual utilization of available tax attributes.  The Company has evaluated the positive and negative evidence bearing upon the realization of its deferred tax assets and has established a valuation allowance of $325.56 million and $330.43 million as of July 31, 2014 and July 31, 2013, respectively, for such assets, which are comprised principally of net operating loss carryforwards, research and development credits and stock based compensation.

Recently two different investors have filed 13Ds pushing for the company to withdraw the liquidation plans and instead raise equity, buy an operating business, and monetize the NOLs.  Lloyd Miller, who fishes in many of these Ben Graham like microcap securities recently disclosed a position and then General Holdings came into the picture too, below is the language General Holdings used in their recent 13D:

The Reporting Persons have engaged, and intend to continue to engage, in discussions with the Issuer’s management and members of the Issuer’s Board of Directors (the “Board”) on multiple topics, including the Reporting Persons’ suggestion that the Issuer should revoke its Certificate of Dissolution filed with the Secretary of State of Delaware on March 7, 2013.  Such discussions have also touched on corporate governance and corporate finance matters, including but not limited to the potential adoption of a shareholder rights plan, additional equity issuances, the use of net operating losses and other suggestions for maximizing shareholder value.  The Issuer has not taken any action with respect to the Reporting Persons’ suggestions described above.

The manager of General Holdings is Andrew Bellas, who was a partner at "Tiger Cub" firm Tiger Global Management where he specialized in technology stocks but left in January 2015 to start his own fund according to the Wall Street Journal.  Some light Googling found that he had been rumored to take a job at Latimer Light Capital, but it's unclear if he took the job or if he just went solo with General Holdings.  My guess is he could be looking to take control of Sycamore, put himself in charge and could use the shell as an acquisition vehicle.

It's difficult to value NOLs, but even after the recent excitement in SCMR shares, the NOLs are only being valued at a $5-6MM, if the company were to switch strategies and somehow utilize the NOL, the company would be worth multiples of it's current value ($5-7 wouldn't be out of the question).  Similar to WMIH, it's hard to point to a specific valuation as a shell, but with a 20% downside to $0.40 if the liquidation continues and a 10 bagger upside if it's reversed, the risk/reward seems worthy of a small position.

Risks
NOL rules are fairly complex, Section 382 of the IRS code stipulates change of ownership rules around net operating loss carryforwards.  I'm not a tax accountant, but I'd be curious if Andrew Bellas and his 14+% stake will limit the use of the NOLs going forward?  Even if the NOLs were limited annually, it wouldn't be the end of the world, the $856MM NOL is so large that it would be difficult for Sycamore to utilize it quickly without a huge equity raise in the first place.

Andrew Bellas and Lloyd Miller aren't the first investors to spot Sycamore's net operating losses, there have been others since it was clear the company was going down the liquidation path to push for a different strategy to utilize the valuable tax assets.  I can't be certain if there are other roadblocks pushing the company toward liquidation versus NOL monetization, but at today's prices its worth a small tracker position that can be added to as the situation becomes clearer.

Disclosure: I own shares of SCMR

LiLAC Group: Liberty Global's New Tracker

I realize LiLAC has been covered plenty on Twitter and other blogs, but I just wanted to memorialize my thoughts along with some of those in our recent CFA Society Chicago's Special Situation Research Forum meeting.  Others have provided far better financial models than I could create, so I'll focus more on the qualitative reasons why LiLAC is attractive and why the opportunity exists despite John Malone's track record.

Overview/Background
LiLAC Group is the tracking stock that began trading on 7/2/2015 to represent Liberty's Latin American and Caribbean ("LiLAC") Group assets.  Liberty Global, is of course the John Malone controlled entity which sought to recreate the original TCI in international markets, that story is mostly complete in Europe now they're switching their roll-up focus to Latin America.  LiLAC Group today is made up of two entities, 100% ownership in VTR (Chile's largest cable company and around 70% of LiLAC's revenue) and 60% ownership in Liberty Cablevision Puerto Rico which recently completed the purchase of Choice in June 2015.  In total, LiLAC passes approximately 4 million homes, has 3.2 million RGUs off of 1.5 million customers.  The accounting is muddied up enough as it is, so I'm going to discuss LiLAC without adjusting for the minority interest in Liberty Puerto Rico, in the end it doesn't make much difference.

Why a Tracking Stock?
Liberty Global co-CFO Bernie Dvorak said at the annual meeting, "LiLAC tracking stock represents another milestone and we're eager to take advantage of this new structure to tap into further growth opportunities in the region."  John Malone seems alone in having success with the tracking stock structure, it's rather rare at least in U.S. markets but it creates a potential acquisition currency, capital allocation flexibility and allow's management to highlight the value of a particular set of assets, all while keeping the tax and cost advantages of one balance sheet together under one corporate umbrella.

• The Latin American cable market is still relatively early in its development, much of the population doesn't have access to broadband, and much of those that do are covered by "mom and pop" type operators. Establishing the tracker gives Liberty Global a pure play currency to offer (LILAK, the non-voting C shares) to acquisition targets that may want to have continued exposure to cable growth story but be relieved of running the day to day operations. 
• John Malone is famous for playing all aspects of the capital structure, most management teams focus primarily on the debt side, structuring their liabilities in such a way to minimize rates, recourse, covenants, etc, but few spend time optimizing the equity cost of capital like Malone.  By creating the two tracking stocks, Liberty Global will be able to simultaneously buyback shares in LBTYA while issuing shares of LILA for acquisitions and more effectively manage each group's cost of capital than could be done with a spinoff.
• By maintaining the larger corporate entity there should be some cost savings, one management team spread out over a larger asset base, more leverage with vendors, greater balance sheet capacity.
• The primary downside being added complexity and if one group gets into financial trouble, it will drag the other with it since they're not formally separated.

Valuation
Thanks at least partially to the recent worldwide selloff, LiLAC is an absolute bargain today at roughly 7.0x a run-rate EBITDA inclusive of the Choice acquisition in Puerto Rico but without any credit given to potential M&A, comparable cable companies trade for 9-10x representing significant upside.  Even with a one turn discount for being a tracker to 8x, LILA/LILAK should be worth $44-45 per share.

• Balance Sheet: $2.4B in debt, $232MM of cash, $1.5B market cap = $3.77B enterprise value
• One question that I still have on the balance sheet, per the 10-Q: "On June 30, 2015, in order to provide liquidity to fund, among other things, ongoing operating costs and acquisitions of the LiLAC Group, a subsidiary attributed to the Liberty Global Group made a $100.0 million cash capital contribution to LiLAC Holdings" - Is this just an initial reattribution for the tracker spinoff or something else?  It didn't appear in the initial S-4 or the LiLAC road show presentation.  Also it clearly signals acquisitions coming soon as it doesn't appear VTR or Liberty Puerto Rico need the cash for their day-to-day operations.
• Comparables: Cable & Wireless (CWC) trades at 9x EBITDA, Malone owns 13% (more $ wise than LiLAC) via Columbia acquisition that was done at 12x EBITDA, one could get folded into the other at some point; MegaCable Mexico trades at 9x EBITDA; Groupo Televisa bought Cablevision Red for 10x EBITDA
• On 3/14/2014, Liberty Global bought out their 20% minority partner in VTR (Chile) with $422MM worth of LBTYK shares, implying a $2.11B valuation for VTR.  If you discount that amount by the depreciation in the Chilean Peso since that time, you still get a value of ~$1.84B for the equity in VTR, versus a market cap of $1.5B for LiLAC which also includes 60% of Liberty Puerto Rico. ** Edit: I might be wrong about this piece, since the VTR secured notes were issued in January 2014, figured that the LBTYA shares were a straight equity swap?  If not, only used it as another valuation data point
• On a per RGU and per customer basis, LiLAC is significantly cheaper than Liberty Global, Charter, or Cable ONE (aware that they're unfair comparisons, but still somewhat interesting to see the relative value):

Upside Scenarios

• M&A, LiLAC has $467MM in liquidity and all signs point to management continuing the successful levered equity playbook by rolling-up Latin American assets using mostly debt; if you run a model assuming free cash flow gets directed toward M&A and their leverage ratios stay fairly constant you can quickly get to some 20-30% annualized returns.
• The June acquisition of Choice in Puerto Rico should provide both cost synergies and revenue growth opportunities since most of Choice's clients were primarily broadband only clients, there's an opportunity to up-sell them video and voice services.  In the Q2 earnings presentation, management quoted a 3.5x net leverage ratio giving proforma effect for the Choice acquisition.  I had a hard time squaring that number, but using a $2.1B net debt position, that means OCF is ~$600MM?  Seems like they're projecting some significant growth from Choice.
• VTR Wireless - they currently only have a little more than 100,000 customers, or 1% of the market in Chile, but there should be some opportunity to cross sell and create a 4 play model (video, internet, land based voice, wireless) to increase RGUs.
• Eventual full spinoff once the LiLAC business matures, closes tracker discount, or Liberty Global could sell LiLAC to another industry consolidator like Altice or Cable & Wireless.

Risks
LiLAC has some unique risks, it's a highly leveraged emerging market company in an industry that some have technology disruption concerns about:  

• LiLAC in typical Malone fashion is a heavily levered equity, does it work in countries with a high cost of capital?  70% of revenues are in Chilean Peso (remainder in USD - Puerto Rico) which is near 12 year lows against the dollar thanks the slide in commodities; VTR debt is in USD, but hedged into Chilean Pesos through 2021, the all in cost of the debt is 11.1%, management must expect strong growth to overcome that hurdle.  If the dollar does begin to weaken, it could result in a significant tailwind when combined with mid-to-high single digit organic revenue growth.
• Chilean economy heavily tied to copper and natural resources, also in an earthquake zone with the potential to damage infrastructure type assets.  Taxes are also rising in Chile on a laddered basis, topping out at 27% in 2018.  Counter -- Chile enjoys the highest economic freedom in Latin America and the Caribbean (ranked 7th overall, ahead of the United States), generally viewed as the most modern Latin American country.
• Puerto Rico has well known economic problems, in default on debt, may face austerity measures.  Counter -- as CEO Michael Fries is quick to point out, these are not new economic issues for Puerto Rico, LiLAC has been able to consistently grow through them despite the macro concerns. 
• Malone has less than 3% economic stake in LiLAC, owns significantly more of CWC in region, any potential conflicts arise from that?  Counter -- Cable & Wireless provides a natural acquisition partner, opportunity to fold one into the other.
• General technology disruption concerns: cord cutting, OTT, satellite providers, consumers might move down from triple play packages to just two services or down to just broadband.
• Competition for deals: Cable & Wireless, Digicel are active in region, Altice active everywhere, could drive up the price of M&A opportunities.  Are there enough attractive acquisition targets in business friendly countries?

Why Is It Cheap?

Everyone knows John Malone's incredible record, spinoffs are popular and every event-driven analyst is trained to look at them, so why is LiLAC undervalued?

• Tracking stock complexity - as mentioned earlier, it's a rare type of security that many traditional managers aren't going to be interested in from the beginning; it's also unlikely to be in any indexes, doesn't pay a dividend, has a limited natural shareholder base.  If the tracking stock doesn't work out, Liberty Global can either spin it out or fold it back into the parent company and close any tracker discount.
• Small size in relation to Liberty Global Group - shareholders of Liberty Global received 1 share of LILA/LILAK for every 20 shares of LBTYA/LBTYK owned, roughly in line with the size of the entities, LiLAC group is roughly 5-6% of the overall entity, creates some uneconomic selling as investors treat it like a special dividend and sell.
• Dislike for Emerging Markets - Latin American stocks are down roughly 50% from September primarily because of the region's emphasis on natural resources and the China bubble deflating reducing demand for commodities.  South American countries have a reputation for being unfriendly to business and heavily corrupt.

I ended up drinking the kool-aid and started a position on Wednesday around $33, made it a medium sized position that leaves some room to add if the sell-off continues.  My head hurts after looking at this for the past two weeks, if one wants to invest in a Malone levered equity, buying Liberty Broadband is probably a much simpler way to do it, no currency risk, cheaper debt, and much cleaner financials.

Disclosure: I own shares of LILAK

A Few Ideas From My Watchlist

I'm pretty comfortable with my current holdings, mostly just sitting on my hands during this bout of market volatility, but want to highlight a few interesting opportunities that might deserve further research:

Gabelli Securities Group (GSGI)
Mario Gabelli's GAMCO Investors (GBL) is spinning off their event driven alternative funds, research unit, and broker/dealer into a separate company dubbed Gabelli Securities Group (GSGI).  The larger GAMCO Investors has over $45B in AUM, much of it in retail mutual funds which are in secular decline, the event driven alternative fund business has about $1B in AUM, only a tiny fraction of the total and thus puts it on my radar for a potential post-spin dump.  So why do this spin?  Mario Gabelli is a good investor, a great marketer and asset gatherer, has a great brand name, and the event-driven space is a hot hedge fund category.  I'd guess that Gabelli is going to put a disproportionate amount of weight behind selling the spinoff's products in the early going and increase AUM quickly.  So this is a rare combination of a small spinoff that might get sold off by GBL shareholders, but is in fact the growth business of the two.  Mario Gabelli will maintain his 10% royalty on pre-tax earnings of the new entity, and control the company via super-voting shares, so that will limit the upside, as you're effectively paying a hedge fund like fee to invest in his hedge fund management business.

Hemisphere Media (HMTV)
Hemisphere is the owner of the largest Puerto Rican local broadcast station, WAPA, and 5 Spanish language cable channels (Cinelatino, WAPA America, Pasiones, Centroamerica TV, Television Dominicana) that are typically contained within Spanish language add-on packages.  Hemisphere has held up reasonably well in the overall cable content selloff.  It's controlled by InterMedia, and went public through a reverse merger with a SPAC in 2013.  The pitch behind Hemisphere is the young, growing, and underserved Hispanic population in the United States, plus they're pursuing adding advertising to their top cable channel Cinelatino (Spanish-language movie channel) that was previously advertising free.

Hemisphere doesn't appear particularly cheap on the surface, trades at 12x EBITDA compared with larger U.S. cable television peers like DISCA, VIAB, SNI, and AMCX in the 8-10.5x range.  But Hemisphere might deserve that premium as their subscriber counts are growing whereas most networks have seen reductions as cord cutting takes hold.  Additionally, larger peer Univision has filed for IPO at a hefty implied $10B market cap, look for some of that enthusiasm to spill over into Hemisphere Media.

National Beverage (FIZZ)
Not value or a special situation, but an interesting growth name.  National Beverage is all about the push into healthier/lifestyle focused beverages, mostly via their LaCroix sparkling water brand.  In total they're the 5th largest carbonated beverage company in the United States with a market cap just under $1.2B.  LaCroix is extremely hot, I can't log into Facebook without seeing pictures of someone trying out a new flavor or reading an article about the best LaCroix mixed cocktails.  National Beverage also has legacy soda brands that you forgot existed like Shasta and Faygo, the plan appears to be to milk the cash flow from these sugary beverages and direct it to LaCroix and other growth brands.  The company is family run, controlled by Nick Caporella (his son is the president) who owns 74% of the shares, making the float only $300MM or so and out of the range for a lot of institutional investors.

The company's quarterly news releases read like a small town newspaper, and there are very limited financial disclosures in the 10-Qs or 10-Ks, so it's hard to really get a good picture of how the business is doing.  But after Coca-Cola invested in both Monster and Green Mountain, why wouldn't they take a shot at the sparkling water leader too?

Newcastle Investment Corp (NCT)
I've been close to buying Newcastle several times this year, it's basically a forgotten stub after the Fortress controlled mREIT has spun-off three companies in the last 2-3 years - New Residential (NRZ), New Media (NEWM), and New Senior (SNR) - leaving a pool of legacy commercial mortgage loans/debt and a golf course management business behind.  The quick thesis is the pool of debt securities is near term and liquid, it covers the entire market cap and you get the golf business for free.  Fortress estimates the golf business will do $30-33MM in EBITDA in 2015, there's an easy public comparable in ClubCorp (MYCC) that trades for 10-11x EBITDA equaling ~$3.50 per share in value for NCT which trades just below $5.

Golf may or may not be in secular decline, but it's another similar business to New Media or New Senior where it has a long run away of "mom and pop" type acquisition opportunities to create a mini roll-up.  Wes Edens has also mentioned using ERP Properties as a model and diversify away from golf into other recreational real estate assets.  The downside is of course Fortress, and their external management fees and conflicts, its always going to deserve some discount and you have to be careful using their investor presentations as your investment thesis.  All private equity guys are great at spinning a story.

Viad Corp (VVI)
Another company with a history of doing spins is Viad Corp, today it operates in two separate business lines, Marketing & Events Group (mostly conventions) and Travel & Recreation (hotels, lodges, adventure excursions), with no apparent synergies which will eventually lead to either a spin or sale of one of the businesses.  The travel business operates in and around Banff/Jasper, Glacier National Park, and Denali National Park, it's a good but niche business catering to seasonal adventure travelers.  The travel business does about $36MM in EBITDA annually, and would fit nicely into a travel and leisure portfolio like ERP or what NCT wants to build.  If you back out the travel business at 10x EBITDA, the Events/Conventions business is being valued at just under 6x EBITDA (including $10MM of corporate overhead).  Certainly cheap, but it's a cyclical business and a low margin one, it's on my long term watch list as something to return to coming out of a recession.

Side Note: If you're located in Chicago, there's a good special situations/"10-K" group that will be discussing Liberty Global's LiLAC Group tracking stock on Monday at 3:30pm at the CFA Society Chicago's office at 124 N LaSalle, come join, and I'll post my thoughts on the name here sometime next week.

Disclosure: No positions

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.

Valuation

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.

Risks/Other:

• 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

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.

Valuation
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.

Risks:

• 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