Year End 2017 Portfolio Review

Time to close the books on 2017; it was a great year in the markets and for my personal account which was up 31.25% compared to the S&P 500's total return of 21.83%.

My significant winners were Pinnacle Entertainment, MMA Capital, Tropicana Entertainment and NACCO Industries/Hamilton Beach Brands, my only significant loser was New York REIT.  Below is my performance attribution for 2017:

Soon to be Closed Positions:

• Pinnacle Entertainment (PNK) recently announced they are being acquired by rival Penn National Gaming (PENN) for $20 in cash plus 0.42 shares of PENN, a great ~3x outcome 20 months after PNK did their OpCo/PropCo split transaction with Gaming & Leisure Property Trust (GLPI).  If I had to sum up the reasons why this idea worked: 1) leverage, PNK was levered 5-6x coming out of the GLPI deal; 2) strong economic tailwinds, people are spending money on experiences (including gaming) instead of things which drove EBITDAR up high single digits; 3) a well timed buyback, PNK bought back over 10% of its stock in the first few months after spinning off from GLPI when the price was $10-$13; 4) expanding multiples in the gaming industry. PENN is citing a 7.7x EBITDAR multiple post synergies on the deal where Boyd Gaming (BYD) might be the biggest winner, snapping up 3 PNK properties to appease regulators at 6.25x EBITDAR pre-synergies.  Proforma for the deal, I have new PENN trading for 7.2-7.7x EBITDAR (with and without synergies) and still believe in the regional gaming tailwind story (good reason to own CZR as well), but I'm going to sell my position shortly after the new year and set a Google alert for wherever the PNK management team lands next.
• I bought pre-spin January 2018 calls in Hilton Worldwide (HLT) prior to the spinoff of Hilton Grand Vacations (HGV) and Park Hotels & Resorts (PK); HLT has done extremely well over the past year as it moves towards an asset-lite model plus a plan to grow its hotel count by 1/3 while shrinking its share count by 1/3.  I plan to sell in the new year, and potentially roll those proceeds over into other hotel stocks (Hyatt, Wyndham's split and LaQuinta's split come to mind).

Closed Positions:

• The IEP tender offer for Tropicana Entertainment (TPCA) played out mostly during the first half of 2017, but the offer closed in mid-August at $45 per share.  As a long term shareholder of TPCA, I was too quick to sell into the tender, as shares now trade for $56 and interestingly many people I talked to thought the shares would fall after the tender as it would become more illiquid and Icahn threatened to put a 2 year freeze on additional tenders.  The tender offer was a tremendous short term event idea, the shares were trading at a discount almost all the way up to the expiration date with little chance of it being oversubscribed, but that was never my thesis for owning it, and I should have paid more attention to the post-tender entity's investment case.
• My only significant loser this year was New York REIT (NYRT), like many others I relied too much on Michael Ashner's original activist presentation and the value it placed on One Worldwide Plaza.  The other issue with NYRT in hindsight was the tight cap rate environment in New York paired with leverage, tiny adjustments in the cap rate have a magnified impact on the valuation when you're talking 4-5% cap rates.  The conference calls after the Winthrop team took over have been comical (much funnier if I didn't own it) and I'm thankful I listened to people smarter than me and sold before things really got ugly.  This was a classic "do your own work" mistake.  The other lesson might be to throw up a caution flag the next time an attractive liquidation comes up, there's a reason why liquidations are rare, they're unlikely to be worth the time, effort, and expense compared to selling a company outright.
• My post on the NACCO Industries (NC) split received quite a bit of attention, in retrospect the initial thesis had some flaws which thankfully ended up getting fleshed out in the comment section (thank you readers) by the time the spinoff actually occurred.  After the spinoff, shares of the parent company (NC) traded below $25 for a brief period and I was able to snatch up some additional shares that I eventually sold a couple months later around $47.  My original thesis was to sell the spinoff, Hamilton Beach Brands (HBB), and hold NC, but I ended up doing the opposite as the price of NC rose while HBB fell.  I have a poor track record when reversing my initial thoughts on which piece of a spinoff to hold, but hopefully HBB continued to gain traction in higher end higher margin kitchen appliances this holiday season and will make an attractive acquisition target for one of the big consumer appliance/brand rollups.
• My thesis on Vistra Energy (VST) was rather simple (arguably too simple), it was a bankruptcy reorg that was traded over the counter at the time and had limited liquidity.  Since then, Vistra uplisted and then entered into a deal to merge with Dynegy (DYN) in a big all stock deal that will increase Vistra's diversification and also its leverage.  Not knowing the power industry well enough, I figured the idea had played out enough for me and sold shortly after the deal announcement at a similar price to where it trades today.
• Inotek Pharmaceuticals (ITEK) was another simple thesis, it was a busted biotech that was trading below cash and pursuing strategic options.  ITEK ended up doing a reverse merger with Rocket Pharma that should close next year, the stock price shot up, but I sold relatively early and missed out on some of those gains.  Still happy, made money, and don't have many regrets as traditional biotech investing isn't my strong suit at this point.
• I initially thought Merrimack Pharmaceuticals (MACK) was a combination of some the other busted biotech/CVR themes, but management's own thesis changed a couple times for the negative as the second half of 2017 played out.  First they settled a lawsuit with their convertible bondholders which reduced the net cash position, and then they raised capital which effectively diluted the CVR like nature of their future milestone payments in the Ipsen deal.  At this point, I wouldn't be surprised if management went back on their word to pass any milestone payments to shareholders in the form of special dividends.  I sold at a small loss.
• All the small CVR (GNVC, MRLB, INNL) related deals I purchased this year closed as expected, now we just wait for if/when milestones to be met.  The Perfumania (PERF) offer also closed as expected.

Previously Unmentioned New Positions:

• I try to post about every position, but sometimes I don't have anything intelligent to add or everything has been said about an idea by people smarter than me (see Andrew Walker's post on GNCMA/LVNTA: http://www.yetanothervalueblog.com/2017/07/liberty-ventures-gci-merger-set-to.html), but I bought General Communications (GNCMA) in late July as a way to get a discount on a discount on a discount in Charter Communications (CHTR).  The deal to merge GNCMA into LVNTA should close in the first quarter and hopefully eliminates some of the tracking stock discount at LVNTA while providing cash flow from GNCMA to continue Malone's typical levered equity strategy.
• Another position I didn't get around to posting is Molson Coors Brewing Company (TAP).  I did lead the pitch of TAP at a recent meeting I moderate (notes here: https://specialsituationsresearchforum.wordpress.com/2017/10/30/molson-coors-brewing-company-tap/).  Elevator pitch: Molson Coors is trading within a whisper of 52 week lows, significantly cheaper the big beer peers/other consumer staples, just completed a transformational merger from a forced seller at a good price, levered, stable mature business (even if off-trend on craft/spirits).

Current Holdings:

*Additionally I have CVRs related to GNVC, MRLB and INNL

I hope to find some time to update thoughts on long held positions like MMA Capital Management (MMAC) Green Brick Partners (GRBK), iStar (STAR) and Resource Capital (RSO), all of which I continue to like going into the new year.  I don't have any insightful macro thoughts other than I'll probably continue to focus more on near term event like opportunities in 2018.  Thank you to everyone who has reached out, shared ideas, commented on my posts, its all appreciated and makes sharing ideas fun and entertaining.

Happy New Year.

Disclosure: Table above is my blog/hobby portfolio, I don't manage any outside money, its a taxable account, and only a portion 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.

BBX Capital: Bluegreen Vacations IPO

BBX Capital (BBX) is familiar to many investors who fish in the same small cap value and special situation ponds.  Most of the company's (and predecessor BFC Financial) colorful management team and history has been hashed out other places, the company fell off my radar until they recently announced the listing of their timeshare company, Bluegreen Vacations (BXG).  At the mid-point of the indicated range, BBX's remaining 90% stake in Bluegreen would be worth considerably more than BBX's market cap resulting in the remaining assets being valued below zero.  There are a few moving parts here and I know some readers know this company far better than me, but hopefully I got the numbers directionally right.

Bluegreen Vacations Corp (BXG)
The timeshare business is hot again -- Wyndham (WYN) is spinning off their exchange and timeshare business, ILG and Marriott Vacations Worldwide (VAC) are reportedly in talks to merge and Hilton Grand Vacations (HGV) is up ~60% since it was spunoff in January.  Sensing an ideal market for a new issuance, BBX Capital is floating up to 10% of Bluegreen in an IPO scheduled for this week.

Bluegreen Vacations is a typical timeshare business, they have a mix of VOI ("vacation ownership interests") sales from their own developed properties but have moved toward a capital light model where they sell VOIs for third parties for a fee.  Once a timeshare is sold, Bluegreen then provides financing for up to 90% of the cost of the timeshare for a mid-teens interest rate that fully amortizes over 10 years.  Once the timeshares are sold and financed, Bluegreen then manages the timeshare resorts for a fee in a cost-plus model under a long term contract.

The difference between Bluegreen and their peers is in the end consumer they serve.  Bluegreen is primarily focused on "drive-to" destinations and a more value focused/lower end demographic, think more Myrtle Beach and Panama City, less Hawaii and Aspen (although they do have resorts in both locations).  Their average customers income is around $75,000 versus $90,000 for the timeshare market as a whole, certainly below average, but still solidly a middle class demographic and the average timeshare is ~$13k verus $20+k for the other publicly traded companies.  Prior to 2008, Bluegreen didn't utilize FICO scores in making credit decisions on their timeshare loans, basically anyone was given financing, now they have 41% of sales paid in cash within 30 days and those that do finance, have on average FICO scores of 700.  And remember, timeshare lending is a pretty great business, if someone defaults, Bluegreen will generally cancel their timeshare after 120 days delinquent and simply return the points to their inventory to be sold to someone new.   Nearly a friction-less foreclosure process. To reach their target consumer, Bluegreen has partnered with Choice Hotels and Bass Pro Shops (they have displays/reps in stores), as well as promoting their product through kiosks at outlet malls that are often located near drive-to resort towns.  In total, they now have 211k timeshare owners and manage 67 resorts.

The IPO has an offering price range of $16-18/share, there will be a total of 7,473,445 shares (including the underwriter's option) offered, half new shares from Bluegreen and half coming from BBX Capital as the selling shareholder.  After the IPO, public shareholders will own 10% of the company and BBX Capital will own the remaining 90% of shares.  To skip straight to the main thesis: BBX will own 67,261,010 shares of BXG, at the IPO mid-point of $17, that's an implied value of $1.14B for their remaining stake, plus the $63.5MM in cash received from selling their shares via the IPO, that's significantly more than BBX's current market cap of $871MM.

Back to Bluegreen itself, what's the valuation look like at the mid-point of $17/share?  Bluegreen has done $148.8MM in EBITDA over the 9/30 TTM (subtracting interest expense on VOI securitizations), will have cash of $181.6MM after the IPO and $237.7MM of recourse debt.  At the $17/share mid-point, I then have the enterprise value at $1,326MM for a 8.9x EV/EBITDA multiple.  There's probably a bit of apples and oranges going on with the consensus EBITDA multiples on Bloomberg, but timeshare peers (VAC, HGV, ILG) all trade for 10.5-12x EBITDA, so while almost 9x does seem expensive on its own, Bluegreen is relatively cheap compared to peers.  It really is an opportunistic time to IPO it again, getting a good historical multiple while still appearing cheap against comparables.

Rest of BBX Capital
BBX Capital outside of Bluegreen has $140.4MM of cash as of 9/30, following the IPO of Bluegreen,they'll have about $181.3MM in cash with $42.2MM of non-Bluegreen debt.  So again, just the value of net cash and Bluegreen shares is worth about $12.47 per BBX share and the stock trades at $8.50 today.

Additional Assets at BBX Capital:

• BBX Capital Real Estate: Mostly as a result of the failed BankAtlantic predecessor, BBX has a grab bag of real estate that they foreclosed on and are still in the process of redeveloping for future sales.  The real estate is marked at $180MM on the balance sheet as of 12/31/16, but like other similar financial crisis real estate plays, they marked the assets down at rock bottom prices, much of which has recovered since.  Hard to place a value on these assets, but it's likely significantly higher than $180MM.
• BBX Sweet Holdings: Collection of candy companies, the largest of which is IT'SUGAR, purchased for $58.4MM back in July, it has 96 retail stores in 26 states and DC.
• Renin Holdings: Manufactures interior closet doors, wall decor, hardware and other products for the home improvement industry, its tiny, generating $900k in pre-tax income in 2016.

The well documented reason for much of the undervaluation is BBX's Chairman and CEO Alan Levan.  Levan has had an on-again, off-again battle with the SEC over rosy comments he made in 2007 while running BankAtlantic and then being slow to mark down clearly impaired assets as the financial crisis unfolded.  Levan and his Vice Chairman control 76% of the voting power, and as seen in their merchant banking activities, fancy themselves as savvy middle market investors.  The market tends to discount these controlled mini-conglomerates for good reason, but with the IPO of Bluegreen looming (possibly pricing tomorrow, 11/16), some of the discount should dissipate further.

Disclosure:  I own shares of BBX.  I also have exposure to a tiny piece of HGV through my pre-spin HLT call options that expire in January.

VICI Properties: Caesars REIT, OTC Listing, Dividend Catalyst

One of my favorite investment themes are non-dividend paying REITs because they often trade at a discount as a result of being shunned by yield focused retail investors.  Pair that theme with an illiquid OTC listing, plus the REIT's only tenant being a company that I'm already long the equity and you have my attention.

VICI Properties (VICI) is technically a spinoff of Caesars Entertainment (CZR), however it wasn't distributed to common shareholders, instead as part of the bankruptcy reorganization, former creditors of Caesars Entertainment Operating Company (CEOC) received shares in VICI Properties.  Ownership in VICI Properties is essentially the same as being a senior (if not the most senior) creditor in the new Caesars Entertainment's capital structure.  VICI owns the Caesars Palace property in Las Vegas along with 18 other CZR casinos (non-Las Vegas regional ones) that are critical to the operation of the business, absent these casino properties Caesars would struggle to exist.

Without even looking at comparable gaming REITs (MGP, GLPI) -- would you lend Caesars Entertainment money at a 7.4% effective yield with critical real estate as collateral?  I would, again I'm bias because I own the equity too.

Portfolio/Asset Base/Valuation
VICI is starting off with 19 casinos, 32.5 million square feet, ~12k hotel rooms, 150 restaurants, 4 golf courses and 53 acres of undeveloped land near the Las Vegas strip.  Click on the below for a complete list of the properties.

All of the properties are triple net leases (they get reimbursed for property taxes and insurance) with Caesars Entertainment Operating Company (CEOC) as the tenant and the parent company fully guaranteeing the lease.  As part of the lease agreement, Caesars must dedicate a percentage of revenues towards capital expenditures to maintain and keep the properties competitive in their markets.  This is standard for most triple net lease agreements, but still a nice protection against normal wear and tear depreciation.  There are three leases:

• CPLV Lease Agreement: Covering just the Caesars Palace in Las Vegas, the company's flagship property, located in the center of the strip.  Las Vegas is benefiting from positive tailwinds, record visitation levels in 2016, and the opening of the expanded Las Vegas Convention Center.  The base rent is $165MM with an initial 15 year term and a 2% minimum escalator.
• Non-CPLV Lease Agreement: This is a master lease agreement covering all the non-CPLV casinos other than the Joliet property below and generally speaking, Caesars cannot vacate or remove a property from the master lease without triggering a default.  Most of these casinos are mature stabilized casinos, some in good markets, others not, but the master lease agreement helps insulate VICI from regional downturns or other individual location risks.  The base rent is $433MM with an initial 15 year term and a 2% minimum escalator.
• Joliet Lease Agreement: The Harrah's Joliet property (permanently docked riverboat casino) is 80% owned by VICI via a joint venture (other 20% is owned by John Hammons), thus it has a separately lease agreement with Caesars that functions similarly, just without the same master lease protections.  Being somewhat local, I'd consider it a lower end casino in the area, the base rent is $39.6MM with an initial 15 year term and a 2% minimum escalator.

There are additional casinos (Harrah's Atlantic City, Harrah's New Orleans, Harrah's Laughlin) in the queue to drop down to VICI , giving it some built in rent and dividend growth from the start.

VICI also has the right of first refusal on any new domestic property proposed to be owned or developed by Caesars outside of the greater Las Vegas area.  Caesars is itching to grow post emergence and has made it clear they intend to pursue M&A and other greenfield opportunities; partnering with VICI and its lower cost of capital on these efforts makes complete sense going forward.

MGM has its own REIT, MGM Growth Properties (MGP), that is similarly structured although MGM owns most of it as they chose to IPO a piece of it rather than a complete spinoff.  MGP trades at about a 6.25% cap rate, and it's a better credit than CZR, plus most of the value in MGP is Las Vegas versus regional casinos and MGM has better growth prospects internationally.  Gaming & Leisure Properties Inc (GLPI) is about the same size as MGP, but is entirely regional casinos, and is two major tenants are primarily regional operators in Pinnacle Entertainment (PNK, still own this one) and Penn National Gaming.  I would say both are lower credits than Caesars, they operate primarily outsides of Las Vegas, transferred substantially all of their real estate to GLPI (Caesars still owns their non-Caesars Palace Las Vegas real estate), and they don't have the scale or ambition to compete in international growth markets.  GLPI trades for about a 7.3% cap rate.  I'd argue that VICI should trade for only a slight discount to MGP at about a 6.5% cap rate.

VICI Properties

Shares outstanding: 246.2 million shares

Market cap (@$18.50/share): $4.56B

Net debt: $4.61B

Enterprise Value: $9.17B

NOI: $685MM = 7.4% cap rate

FFO: $435MM = 10.47x FFO

EBITDA: $640MM = 14.32x EV/EBITDA

Another way to think of it, annual interest costs are $247.5MM, removing that from NOI leaves $392.5MM for common shareholders or a 8.6% cash yield that should grow (slowly) over time.  Not an incredible deal, but I think investors will find it attractive in today's market?  Over the next year or so as the company joins the ranks of is peers in paying a dividend and up-listing to a normal exchange, it'll pull some of those gains forward.  Due to leverage, small differences in the assumed cap rate change the math pretty quickly, at a 6.5% cap rate, VICI shares could be worth ~$24.  An additional reference point, the Caesars recently issued senior notes at a coupon of 5.25%, others can speak better to the credit differences between the notes and the master lease, but it speaks to the improving credit quality of Caesars post emergence.

Why is it Cheap?

• VICI is essentially a bankruptcy reorg; its in the hands of former creditors (although highly sophisticated ones which explains why it's only marginally cheap) that are not natural long term holders of a REIT.
• The company currently trades over the counter, there's no bid/ask spread that I can see on my limited brokerage platform, its a bit tricky to get shares and liquidity is sporadic.
• It has yet to declare a dividend, there's no company website or investor presentation, nothing that would cater to the eventual retail REIT holder.
• VICI's only has one tenant in Caesars Entertainment, which just emerged from bankruptcy, one tenant REITs tend to initially trade at a discount until management has an opportunity to add to the tenant roster over time, although MGP trades at a premium, but its arguably a much better credit.

Each one of these items will dissipate over time as VICI lists on an exchange (no timetable set as of yet), declares a dividend (again, no timetable), and diversifies its tenant roster with M&A.

Risks

• Rising interest rates will hurt all REITs, especially ones that are essentially long term bonds like a triple net lease. VICI does have CPI linked escalators in their lease agreement with Caesars to help stem some of the blow, but quickly rising rates would hurt cap rates across the industry.
• VICI at the moment is all but in name a long term bond on Caesars Entertainment, that comes with its own risks, it just emerged from bankruptcy, more of a mid-market target demographic in Las Vegas and elsewhere compared to peers.
• Casinos aren't easily repurposed like other types of real estate, a distribution center or fast food outlet can be moved to another tenant fairly easily.  For example, there are several empty casinos in Atlantic City (including the massive Revel) that are boarded up and would take significant capital to repurpose if it can be done at all.

Here's the 10-12 as its a bit hard to find, and no company website yet: https://www.sec.gov/Archives/edgar/data/1705696/000119312517316387/d392523d1012ga.htm

Disclosure: I own shares of VICI and CZR

Entercom: CBS Radio Reverse Morris Trust

Entercom Communications (ETM) is the fourth largest terrestrial radio group in the country with 125 AM/FM stations in 28 markets, its well run but family controlled and operates in mostly middle tier cities.  Next week, Entercom is completing a transformational merger where they will merge with CBS Radio's 117 stations, primarily in the largest markets, via a reverse morris trust structure.  The combined company will be the second largest radio company behind iHeart (IHRT) but with a significantly better balance sheet.  Reverse morris trusts tend to be interesting for a few reasons:

1. The company splitting off the division typically offers shares in the new combined entity at a discount, here CBS is offering shares in the new ETM at a 7% discount in an exchange offer.
2. Due to the above discount and the mechanics of the split-off, there is some technical selling pressure on the smaller company.  Former CBS shareholders will own 72% of the new ETM and pre-deal ETM already has limited float due to its controlled status, the result is a short interest in pre-deal ETM over 50% currently.
3. Most RMTs I've seen feature significant strategic rationale (plenty of easy cost synergies) and a fair amount of leverage, in combination they often lead to great investment results if the deal rationale is correct and management is competent.  I believe both are in place here.

In the deal prospectus, the combined company lays out the case for radio and potentially why it's not a dying industry:

• Highest, most stable reach of any media, reaching 93% of all adults across the United States.
• Radio listenership has remained stable over the past 10 years, growing from 234 million listeners in 2008 to 247 million listeners in 2016.
• Time spent listening to the radio has been relatively stable since 2014 (me: but must be down from 2008?) according to Nielsen's Total Audience Report.
• Radio offers a cost-efficient way for advertisers to reach a broad diverse audience.

This is all somewhat surprising to me and not sure I entirely buy it?  Satellite, streaming services and podcasts all provide more engaging and tailored content to listeners, but it's possible that many people still enjoy free radio that's programmed to cater to a broad audience taste.  To this point, Entercom has historically been growing revenues at mid-single digits despite the negative industry headlines.  CBS Radio on the other hand, with its more heavy emphasis on news programming and sports talk radio (which I think has been particularly disrupted by podcasts?), has been declining mid-single digits in recent years.  Another disruption to think about is less on radio medium itself, and more on the advertising model in general, any media company reliant primarily on ad spend is in competition with Facebook and Google, both of which have a better mousetrap to offer advertisers.

With all that out of the way, the radio business does produce a healthy amount of cash as its generally asset light.  I've been burned before by taking management estimates in proxy's at face value, especially rosy ones in declining industries, but here's what management put forward as the 5 year outlook for the new ETM:

After the merger takes place, there will be 142 million shares, at today's price of $10.55/share that's a proforma market cap of about $1.5B, the company will have $1.8B in debt, for an EV/EBITDA multiple of 6.8x using the 2017 EBITDA number above (2018's $542MM seems bold, but would be closer to 6x).  Comparing Entercom to peers it looks somewhat cheap, IHRT and CMLS are both distressed, I don't have their bond prices handy but I'm guessing the EV's are inflated taking their debt at face value as both will likely be restructured in the coming year.

But I'd still argue that a 6-6.8x EBITDA multiple is a bit low for this type of business, especially if you believe management's estimates are achievable.  I'm skeptical of the revenue growth forecasts, but the below synergies seem fairly reasonable as there will be a lot of overlap between the two organizations.

Management is well regarded, Joseph Field started Entercom in 1968 and still remains on the board, he was a buyer of shares in May and June as the stock slid down to $9.65-$10.25.  His son, David, runs the company today, the Field family is relinquishing formal control of the company through their super voting shares, but will still control about 25% of the vote post merger and 8% economic ownership.

In summary, a marginally cheap business with some technical factors artificially putting pressure on the stock price that should start to unwind in the next few weeks.

Disclosure: I own shares of CBS (exchanging for ETM) and ETM

LGL Group: Gabelli, Rights Offering, Acquisition Proposal

LGL Group (LGL) is a micro-cap ($15MM market cap with a vintage space age logo) that makes frequency control components for the defense, aerospace and electronics industries.  Their market is mostly a commoditized industry but they've been shifting towards higher margin offerings in recent years with some success.  LGL Group has about $10MM in federal NOLs plus some other state and research credits, but this isn't a typical patent troll type NOL shell.  Mario Gabelli is a significant shareholder, not via his GAMCO mutual funds but directly in his/his family's names and his son Marc is on the board.  LGL is a very small holding in comparison to his net worth in GAMCO but like Carl Icahn's involvement similarly small companies, Gabelli has a lot of energy, loves the investment game and especially taking advantage of tax assets.  I think its clear based on the type of business this isn't a vanity project, he owns LGL to make money even if it's small in comparison to his net worth.  I've seen him speak on several occasions and he's always mentioning the tax disadvantages faced by old fashion open ended mutual funds compared to ETFs or especially real estate held for investment.  Plus he loves boring small industrial companies (where he started his career as an analyst), so his investment in LGL Group makes perfect sense.

This is another simple thesis with a near term catalyst, LGL announced a rights offering beginning on 9/5/17 to raise a little more than $11MM to pursue acquisitions, likely to monetize their NOLs without creating an "ownership change", the offering was expected to close on 10/10/17.  The rights offering was a little unconventional because it was announced at a small premium ($5.50 exercise price) to the share price at the time of the announcement and it was going to be tradeable, at a premium, what value would the rights have if you could just buy the shares directly for cheaper?  I looked at it then, as I try to look at all rights offerings, and passed.  But on 10/5, they issued a press release announcing the rights offering would be pushed back until 10/25 because they received a non-binding cash offer for their two operating businesses making the situation a lot more interesting.  Then on 10/23 they pushed the rights offering expiration back again to 11/13, likely to give both sides more time to agree on a deal?

The shares today trade for $5.66, we know that Gabelli was a buyer at the rights offering price of $5.50 as he's essentially backstopping the rights offering and along with the current CEO will have effective control of the company after the rights offering settles.  With the potential cash offer on the table, I think it significantly de-risks the situation:

• On the upside, we could either get straight taken out at a premium or receive a significant cash infusion to the holding company.
• On the downside, the two sides can't come to a deal, you still have an improving operating business, the rights offering closes and the company receives a cash infusion for additional acquisitions knowing that a proven capital allocator is effectively in control of the company.

The company has $6MM in cash and marketable securities on the balance sheet, no debt, and the operating businesses did about $1MM in EBITDA over the trailing twelve months ended 6/30 (but EBITDA for the first six months of '17 was about double '16, so there's some ramp to the business happening), putting the EV/EBITDA at approximately ~10x, not on the surface particularly cheap.  But several things strike me:

1. The investment group submitted their bid after the rights offering was announced so they must believe their offer is the superior path and has some urgency to it; 
2. Gabelli likely can't buy significant amounts of shares on the public market, either for liquidity reasons, or because he has non-public material information, but he can have the company conduct a rights offering and acquire shares that way, oversubscribe, and gain control of the company; 
3. The company is run by a 40+ year industry veteran in Michael Ferrantino, however he came to LGL in 2014 to spark a turnaround, he's 74 years old, the business trajectory is turning for the better, is now the time to cash out and retire?

It's worth noting that the company did receive a similar offer for parts of their operating business in June 2013 and turned it down, but the offer spurred strategic review that led them down their current positive path, so it's certainly possible the same thing happens again and a short term catalyst speculation turns into a longer term bet on the jockey type investment.

Disclosure: I own shares of LGL

Perfumania: Prepack Bankruptcy, Small Equity Consideration

Here is another small special situation -- Perfumania (PERF) is the largest specialty retailer and distributor of fragrances and related beauty products in the United States, they've suffered from the Amazon effect and resulting decrease in mall traffic like many other specialty retailers.  On August 26, Perfumania filed for chapter 11 bankruptcy protection, primarily as a way to bring their mall landlords to the table as they explicitly call out that significant landlords would only negotiate with them if the company was in bankruptcy.  All of their other creditors will be unimpaired including the controlling family, the Nussdorfs, who are both their largest creditor and equity shareholder.

The Nussdorf family owns just under 50% of the equity, they're proposing to pair up with another large investor, the Garcia family, to recapitalize the company and inject $14.2MM into Perfumania.  Their plan is to take the company private and then shutter much of the 226 retail store footprint, instead focusing on the distribution side of the business.  In order to speed things along and ensure a quick stay in bankruptcy, they're throwing a bone to the minority shareholders by giving "the opportunity to receive consideration of $2.00 per share in exchange for completing a shareholder release form."  The company's financial advisers call it a "gift" and that the company has no value on a going concern basis.

There are some NOLs here to protect, and the Nussdorf family has loaned the company $85MM, their interests are somewhat aligned to see this company restructured and perform well moving forward.  But time is critical for any retail turnaround story, hence the need to rid themselves of any delay from angry shareholders.  The opt-in date for the shareholder release form is 10/6/2017, or less than a month away, and shares currently trade for just over $1.80 per share representing a fairly decent short term return opportunity.  There's risk here, if the deal gets pulled or the plan doesn't get approved by the court (both seem unlikely?), we already know the equity is worthless, size appropriately.

Disclosure Statement: https://www.sec.gov/Archives/edgar/data/880460/000088046017000031/exhibit991disclosurestatem.htm

Disclosure: I own shares of PERF

ZAIS Group: Going Private Offer

This news hurt a little this morning, but there's a potential silver lining, I mentioned ZAIS Group (ZAIS) last year on the blog as the external manager of ZAIS Financial Corp (ZFC) that was being merged into Sutherland Asset Management (SLD).  ZAIS Group at the time was a struggling structured credit manager, their flagship hedge fund was bleeding AUM (still kind of is) and their base management fees didn't cover their operating expenses (still don't).  In February of this year, the company announced they were looking at strategic options and hinted at a going private deal which makes sense since this a controlled entity with the founder Christian Zugel maintain voting control of the former SPAC.

Since then, they've issued a sixth CLO and are warehousing a seventh, they've posted positive gains in their two main hedge funds for the year, and as a result are back to earning performance fees.  Their accounting is a little tricky with consolidation accounting for some of their CLOs and not others, plus it was a micro-cap and very illiquid, I tried for a while to establish a position and come up with my own valuation, no real luck.  But this morning, Christian Zugel filed a 13D in a manner similar to what Icahn did over at Tropicana (TPCA), but here he's already entered into a transaction with one major holder of ZAIS shares for $4 and wants the board to consider the $4 cash offer for the remaining shares he doesn't already own.

The stock traded below $2 yesterday, its still just at $3.38, I'm guessing this goes through without much of a problem and its mostly illiquidity, micro-cap, and obscureness causing the wide spread.  Kicking myself for not being more aggressive about buying it earlier, but I bought into today's news.

Disclosure: I own shares of ZAIS

NACCO Industries: Hamilton Beach Spinoff

For the first time in a while there are a number of interesting spinoff situations on the horizon, one of which is NACCO Industries (NC) separating their small household appliances business, Hamilton Beach Holdings (HBB), from their legacy lignite coal mining business.  This split was announced in August with a quick turnaround for the spin to be done around the end of September.  From the surface this spinoff makes a lot of sense, why is a manufacturer of blenders and toaster ovens paired with a coal miner?  Who knows.  Both businesses should trade for different multiples and its no surprise that paired together they trade at a discount to peers.

NACoal/NACCO Industries (NC)
North American Coal Company (NACoal) is the coal mining operating subsidiary of NACCO Industries, despite being in the coal industry its structured as a fairly decent business.  Much of their operations are conducted in their "unconsolidated mines" segment where NACoal functions more as a service provider earning a small cost-plus margin arrangement and avoiding commodity related pricing risks.  How this works is their customers are large electric utilities that run coal fired power plants, often times these coal plants are located on top of or next to their coal power source.  The utility companies will finance and take on the cleanup cost liabilities for the mine, and will contract out the actual operations to NACoal.  There is no pricing risk as each mine exists to service one customer in perpetuity, their contracts are long dated, often times the length of the expected life of the mine.  For accounting purposes these mines are VIEs and since the customer has most (almost all) of the risk in the venture, NACoal is not considered the primary beneficiary and thus doesn't consolidate the results.

The business spits out a lot of cash, but it is declining albeit in a slow fashion.  What utility would invest significant sums to build a new coal fired power plant today?  Very few, if any.  Power plants last decades and even if the current political administration is coal friendly, I doubt many future ones will be the same.  As a result, NACoal's reinvestment opportunities in the coal business are pretty nil, they do have some small side businesses doing mining related services that operate under similar cost-plus arrangements and that's likely where any future cash will be deployed going forward.  Not great, but NACoal shouldn't be viewed as a royalty trust with a finite life.

In valuing the coal business, I think it should more closely resemble the multiple of an independent power producer versus the recently reorganized coal miners, most of which trade for 4-5x EBITDA.  The power plants NACoal services are primarily base load plants, there's some fluctuation in the results due to power demand/pricing, operational turnarounds, etc., but mostly its a fairly steady predictable business.  They should see some uplift in the coming years due to new contracts coming online (maybe the last of the new coal plants?) and something like fellow blog-name Vistra Energy (VST), which actually does its own coal mining, trades for around 7.5x EBITDA.  I think that's a fair multiple for NACoal given the drivers of the business, they did $35MM in EBITDA in 2016, 2017 will be higher, but we'll just go with $35MM, at a 7.5 multiple that's a $262MM enterprise value.

Hamilton Beach Holdings (HBB)
The spinoff will house a fairly popular small household appliance brand (they outsource all their manufacturing) in Hamilton Beach and then a struggling retailer that has little value in Kitchen Collection.  Hamilton Beach makes blenders, coffee makers, toaster ovens, juicers, indoor grills, etc., it sits mostly in that middle ground between a consumer staple and a durable, these aren't everyday purchases, but aren't large appliances that are big ticket items.  In terms of branding, Hamilton Beach sits in the middle again, they sell through Walmart, Target, Kohls, and Amazon, maybe not the best positioning to take, but they are moving more upscale with their recently launched co-branding efforts with the high end Wolf appliances.  That move upscale has flowed through in their results with widening margins and anticipated revenue growth for 2017 (much of their business is weighted towards the holiday selling season).

Kitchen Collection is a small household appliance retailer (they sell other brands in addition to Hamilton Beach) that operates primarily in outlet malls.  The concept has been hit pretty hard by declining mall traffic, NACCO has been closing stores pretty consistently since 2012 when they had 312 stores to just 209 today.  Kitchen Collection about breaks even and is likely of little value, hopefully they can manage the wind down as to not disrupt the overall HBB results.

There are a number of consumer brand rollups, Newell Brands (NWL) or Spectrum Brands (SPB) for example, that would be a logical buyer of Hamilton Beach at some point.  Both NWL and SPB trade for 14-15x EBIT, Hamilton Beach (with no contribution from Kitchen Collection) should do at least $45MM in EBIT in 2017, even putting a discounted multiple on the business of 12x would equal ~$565MM for the spinoff.

Add the two pieces up, $262MM for the parent and $565MM for the spinoff, minus $54MM of net debt (which is at the parent) and you get an estimated equity value of ~$775MM versus a current market cap of $475MM.  Another way to put it, the market is likely putting little to no value on the coal business despite its asset light nature and consistent cash flows.

Other/Risks

• This is a family controlled company, there will be a dual share class at HBB as well, which speaks to some of the discount.  Maybe HBB should be 10-11x then?  Still cheap.
• NACCO did another spin in 2012, Hyster-Yale Materials (HY), which performed great post-spin but has since normalized.  Different business, different time, but I think it shows the lift in multiple possible at HBB after it gets free of the NACCO conglomerate discount.
• There are two mines that are consolidated at NACoal, one is shutdown and in runoff which is causing some impairments and messy accounting, the other, Mississippi Lignite Mining Company is run in a similar fashion as the unconsolidated mines, however NACoal is on the hook for the operating costs.  The majority of the capex for the business is related to operating the consolidated mine.
• Management is pitching the spinoff partially as a talent planning event, current CEO Al Rankin Jr (part of the controlling shareholders) is stepping down as CEO, elevating the two executives who currently run NACoal and Hamilton Beach to CEO of each respective company.  Rankin will then become Executive Chairman of Hamilton Beach and Non-Executive Chairman of NACCO Industries, not quite the same as "going with the spinoff" but noteworthy and sounds like he'll have more of an active role in the spinoff than the parent.
• HBB certainly has some private label risk, some Amazon risk, etc., but doesn't appear to be immediately in the cross-hairs of either.  On the positive side, its a way to "play" the millennials finally moving out of their parent's basement theme, increased household formations, and other demographic tailwinds.  Additionally, HBB's business is mostly domestic, they're making a push to expand to developing markets where there is growth in the middle class.

Disclosure: I own shares of NC

Inotek Pharmaceuticals: Selling Below NCAV, Exploring Strategic Options

Inotek (ITEK) is a rather simple and small idea that adds to my recent theme of buying up the scraps of busted biotech companies.  Inotek was focused primarily on the treatment of glaucoma, an eye disease with a high unmet need, however their only drug, Trabodenoson, failed recent trials and it appears to be the end of the road for Inotek.  They've suspended research and development, hired Perella Weinberg Partners to pursue strategic options, and now sell below net current asset value.

Their balance sheet is now mostly cash and short term investments, offset by some convertible notes:

The current market cap is around $27MM, they'll burn ~$4MM a quarter on G&A and interest costs, and NCAV is ~$57MM.  Inotek does also have $105MM in NOLs, but the company should probably just call it a day and liquidate, hopefully we know more soon, but this seems like a fairly straightforward bet.  The biggest risks are the burn rate being higher than anticipated and/or a bad reverse merger transaction happening, both are more likely than I'm probably baking into the situation.

Disclosure: I own shares of ITEK

STORE Capital: Berkshire Deal, High Risk Lender?

STORE Capital (STOR) is an internally managed triple-net lease REIT, I don't own it (and usually don't like to write about companies I don't own), but Berkshire Hathaway (BRK) recently made a direct investment of $377MM for a 9.8% stake that deserves a closer look.  STORE is acronym for Single Tenant Operational Real Estate, basically it means they lend money primarily to middle market retail and service businesses using a sale-leaseback structure where the single tenant box is the collateral.  While STORE Capital is a REIT, it's closer to a BDC type lender than it is to an office, multifamily or even a mall REIT.  The tenants come to them because they need financing and can't get financing through more traditional bank lending.  The tenants then still control the property, pay the taxes, capex, and insurance, plus these are very long term leases, usually 15+ years.

STORE currently has 1750 properties, they're focusing on service sectors (restaurants, movie theaters, health clubs) as a way to mitigate the threat of online shopping, their largest tenants include Art Van Furniture, AMC Entertainment, Gander Mountain, Applebee's, Popeye's and Ashley Furniture.  Often the tenant is really a local franchisee of Applebee's or Ashley Furniture, and not the parent company.

There are plenty of triple-net lease REITs out there, it's a fairly common structure and a commodity business, if STORE does have a "secret sauce" its their focus on unit level profitability.  From their 10-K (click to expand):

To summarize, they strive to have each location be profitable to the tenant, not just the overall tenant themselves, that way if the tenant does get into financial trouble they'll want to hang onto those profitable locations through restructuring and not hand back the keys to STORE.  Again, think of STORE as a lender and not a landlord, they're not in the business of re-positioning a failed retail box into a higher and best use, just like a bank is not in a great position to manage the sale of a foreclosed home.  To facilitate this level of underwriting, STORE receives unit level financials on 97% of their locations, surely a useful data point that helps manage the growing portfolio.

Where the story gets a little promotional for me, STORE rates the credit quality of each tenant with an internal metric dubbed "The STORE Score".  Their tenants are almost entirely non-rated entities, last year they average an 8% cap rate on new investments, and again, these are entities that typically don't qualify for traditional bank financing.  Yet, based on SCORE's internal metric, 75% of their tenants would be investment grade if rated, or at least default at rates similar to a Baa2 rating.

Here's where I question the validity of the score, if I look at bank loans rated Baa2, I see the average coupon being something like LIBOR + 200 bps, no where near the equivalent to an 8% cap rate that STORE is receiving, what's the explanation?  The management team here is well thought of here, STORE was originally created by Oaktree in 2011 before going public in 2014, they're focused on doing smaller one off deals for the time being (likely will become more difficult as they grow), so maybe its just better management and the ability to do bespoke deals?  Possible, to me it seems questionable that they're tenants are really investment grade but at least STORE is doing their own underwriting work.

But promotion is part of the REIT game, STORE's real product is their own shares, in order for them to continually grow they need to raise more capital by issuing shares.  It's not entirely different than an asset management company marketing their funds and selling the product.  Berkshire Hathaway bought at $20.25, today the shares trade for $23.25, so accepting BRK's stamp of approval lowered their cost of a capital, probably a smart capital raise on STORE's part.  Depending on your assumptions for the fresh BRK capital, STOR trades for about a 6.0-6.5% cap rate today and if they're continually able to invest at 7.5-8.0% cap rates they'd be smart to continue to issue equity.

I'd peg STORE Capital at about fair value today and think it's reasonable to assume a ~10% annual return from here going forward.  Management lays out the math a bit in their presentation, but if you're buying in at a 6.5% cap rate today, levering it, reinvesting some of the cash flows, raising rents 1.8% per year, issuing equity to buy at 8%, dock something for defaults/recovery and the returns lay themselves out pretty well.

This is a better mouse trap than many other alternative investment products out there or a BDC/CEF, at least here you have the real estate as collateral, it should perform close to the overall market with lower volatility.  Given Berkshire's cash hoard, can't blame them for taking that proposition.
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I co-chair a monthly investment research group where we discuss special situations and just general value investing ideas, yesterday the topic was STORE Capital, if you're in Chicago and free on the 4th Monday of every month come join us.
https://specialsituationsresearchforum.wordpress.com/

Disclosure: No Position

Mid Year 2017 Portfolio Review

My portfolio is up 15.75% for the first six months of 2017, pulling up my since inception IRR to 23.74%, and comfortably ahead of the S&P 500's 9.34% gain so far this year.  Significant winners have been Tropicana Entertainment, MMA Capital, Pinnacle Entertainment and Resource Capital, the only significant loser has been New York REIT.

Closed Positions:

• ILG Inc (ILG): In hindsight, this was one of my favorite special situations of the past several years.  ILG (f/k/a Interval Leisure Group) had entered into a reverse morris trust transaction with Starwood prior to the announcement of Starwood's merger with Marriott, thus those that wanted to play the merger arb on the Starwood/Marriott transaction had to short out both Marriott and ILG against Starwood creating an uneconomic selling pressure on ILG's shares.  Since the deal has closed, ILG has run up well over 100%, I unfortunately sold a little too soon in the low $20s as ILG is now being bid up under speculation of a merger with Marriott Vacations Worldwide (VAC).  I'll be looking closely for ideas like this in the future, something similar was the Dell buyout of EMC/VMWare which created a coiled spring in VMWare stock that's caused the DVMT tracker to do very well too.
• Actelion (ALIOY):  The Actelion/J&J deal closed and the development stage biotech company that was created out of the merger, Idorsia, has done very well too.  I bought the unsponsored ADR, there was a short week or two there when the shares dropped and people started speculating on why and if withholding taxes were going to be an issue, I got scared out of my position, ended up making a small amount of money but left some on the table.
• CSRA (CSRA):  CSRA is the government services spinoff of CSC, with CSC I had the right idea at the time of the spinoff, CSC was setup to be sold and it was earlier this year when it merged with a division of HP Enterprises in a reverse morris trust to create DXC Technology (DXC).  I haven't spent much time on DXC, but CSC turned out to be the better side of the CSC/CSRA split.   I ended up selling CSRA earlier this spring in a slight fit as I didn't realize pension income was being included in their "adjusted" EBITDA figure they were presenting.  It caused the shares to look artificially cheap compared to peers and I just missed it, lesson learned.
• WMIH Corp (WMIH):  The white whale of NOL shells, with over $6B in NOLs and apparently no dance partner in sight, it appears like the company's sponsor KKR is unable to find a deal that makes sense, they can walk in January, and will likely use that as leverage to strike an even more advantageous deal with WMIH.  If a deal does happen in the meantime, there still could be money to be made after but I don't see a reason to wait around any longer.

Previously Unmentioned New Positions:

• Miramar Labs (MRLB):  Miramar Labs is another CVR opportunity, and even smaller than the others mentioned on the blog, but they make a medical device that's used to reduce underarm sweat and hair.  It's more of a elective beauty and/or lifestyle product that is sold to plastic surgeons, spas, etc, and its treatments are paid in cash and not processed through insurance companies.  Sientra (SIEN) is buying Miramar for $0.3149 per share upfront and $0.7058 per share in contingent payments for a total just over $1.02 per share.  The contingent payments are a little unique, where the milestone is a cumulative net sales number with no deadline.  Unlike the other CVRs that rely on an FDA approval, here Miramar already has an approved and commercialized product, so unless the sales flop going forward, the payout should occur, its just a matter of when.  The big payout is for $80MM in sales, Mirmar did $20MM in sales last year, but they're seeing some growth, I'm modeling out a 3-3.5 year timeframe to hit the milestone payment which at current prices of around $0.55 per share generates a pretty nice IRR.  Thanks to @yolocapital on Twitter for pointing it out to me.
• Sound Banking Company (SNBN):  Sound Bank is a tiny North Carolina based community bank that is being acquired by another small bank but with high growth ambitions, West Town Bancorp (WTWB).  There are many small bank mergers happening, if I was less capital constrained, or had a lower risk mandate I'd probably be diving head first into more of these as the spreads are fairly wide for what should be low risk deals.  West Town Bancorp is offering $12.75 in cash or 0.6 shares of WTWB for each share of SNBN.  With SNBN currently trading at $13.40, you could create shares of WTWB for $22.33 when they currently trade for $24.45.  There is a cap on the cash/stock consideration, so proration is likely with the stock trading over the $12.75 cash payout, but it still seems/seemed like a good bet, the merger is expected to close in the third quarter.
• Interoil Corp (IOC) Contingent Resource Payment:  I got bored and ended up trying this CRP/CVR the day or two before the merger with Exxon Mobil was completed, no view on how much natural gas is actually in PNG, so its a pure speculation that should be decided in the next quarter.

Current Holdings:

I added a little money earlier this year, the performance figures take that properly into account.

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.

Merrimack Pharmaceuticals: Broken Biotech with CVR-like Optionality

Over the last couple months I've been developing a basket of small broken biotechnology companies that all peaked around the sector's euphoric days in 2015 only to be forced to sell themselves more recently to larger companies as their funding has dried up.  Merrimack Pharmaceuticals (MACK) is one such company, they're focused on developing therapeutics for the treatment of cancer, in 2015 their first commercial product was approved by the FDA, Onivyde, a second-line treatment for those with pancreatic cancer.  Merrimack has struggled to market Onivyde effectively, its current addressable market is rather small as its not approved yet for front-line treatment, and its a difficult proposition to scale a sales force from nothing quickly and efficiently.  Add in the expensive nature of conducting clinical trials for the remaining cancer drugs in their pipeline, and it became clear that Merrimack needed to raise cash quickly.

So Merrimack sold their commercial business in Onivyde (along with a generic version of Doxil) to Ipsen (IPSEY) for $575MM in cash at closing, $33MM in near term milestone payments related to Onivyde sales through their licensing agreement with Shire (originally Baxalta), and up to $450MM in contingency payments based on additional regulatory approvals for Onivyde.  Following the sale, the company's plan was return cash to shareholders via a special dividend, pay off most of their debt, and refocus the company as a development stage biotech again.  The deal closed in early April, a $140MM special dividend was paid and their senior notes have been redeemed.  Today the company's market cap is roughly $200MM, or about the same as net cash following the closing of the Onivyde sale and resulting special dividend.

Merrimack 2.0
The company will now have a few different shots on goal, to be clear, this is all very speculative at this point and I know very little about the chances of any of these milestones being reached or the drugs in their pipeline ever being approved and commercialized.

Merrimack's board of directors has committed to passing through to shareholders any payments received net of taxes related to the Ispen deal in the form of special dividends.  In essence, these will function like contingent value right payments, but they're stapled together with the common shares and the company could go back on their word and find other uses for the cash in the future.

The three milestone payments are as follows:

1. $225MM for FDA approval in first-line pancreatic cancer
2. $150MM for FDA approval in small cell lung cancer
3. $75MM for FDA approval in any third indication

There doesn't appear to be a deadline on any of these, at least one that's worrisome, that's good as it prevents Ipsen from delaying the approvals until just after the milestone date expires.

Milestone 1 is in a phase 2 trial, milestone is just beginning a phase 3 trial, and milestone 3 has a couple in phase 1 or beginning stages of phase 1 trials, translation, all are probably years away from potentially materializing.  Merrimack's financial advisers in the transaction estimated the probability weighted NPV of Ispen's offer at $685MM, with $575MM upfront and the Shire milestone payments of $33MM likely to hit this year, the bankers put the NPV of the contingency payments at roughly $77MM.  Seems fairly reasonable assuming a low-to-mid probability on either 1 or 2 being met in 3-4 year time and then discounting that back pretty heavily.

As part of Merrimack's restructuring, they've narrowed their pipeline to the three most promising anti-cancer products which they plan to focus their attention now as a new development stage company:

These three are also pretty distant catalysts, MM-121 has failed three phase 2 trials in non-small cell lung cancer, ovarian cancer, and breast cancer, so they're running out of options for that drug.  I'm curious to hear others thoughts on these three programs and their prospects as the company even after the restructuring is only funded through the end of 2019 - developing oncology drugs is extremely expensive.

Merrimack also has convertible debt outstanding, as part of the Ipsen deal the company eliminated their senior notes but conveniently left out any mention of their convertible debt, the convertible holders were understandably unhappy with the company.  Merrimack sold off their one commercial drug, bypassed them and distributed cash to shareholders, reducing the collateral backing the convertible notes which significantly increases the probability of default.  Bondholders are suing the company and as a result, Merrimack escrowed $60MM -- or about the amount it would take to redeem the upset bondholders.  The convertible bonds might be an interesting special situation in their own right, they trade in the upper 60s, way out of the money with a strike price of $6.25, have a 4.5% coupon, and if the lawsuit is successful they could be redeemed at par by year end.  If Merrimack is successful however, then the $60MM (or $0.45/share) will be distributed to shareholders as an additional special dividend.

Prior to the special dividend that's already been paid, MACK was trading between $3.30-$3.70 per share, after the $1.06 dividend it sold off down to $1.44 as of today, so roughly $0.80-$1.20 has come off the stock price for no other reason than the asset sale was completed and the dividend was paid.  There are a lot of upset retail shareholders and other day trader types in the stock, but it looks to be cheap and some forced selling happening after the restructuring has taken place as holders reassessed whether they wanted a pre-revenue stage biotech -- its almost like old spinoff selling dynamics taking place after the dividend was paid.

But at net cash, with new management taking over who were just issued a new options package, and the possibility of future contingent payments related to Onivyde, Merrimack seems like an another interesting speculation to add to my broken biotech bucket.  It'll be about 3 years before we know how this bucket turns out and that's likely a big part of the discount, but I think/hope I have the patience and ability to wait it out.

Disclosure: I own shares of MACK

Caesars Entertainment: Finally Emerging in Q3, OpCo-PropCo Split

Caesars Entertainment (CZR) is the largest gaming company in the United States which traces its roots back to the 1998 Hilton spinoff Park Place Entertainment.  Park Place later purchased Caesars from Starwood in 2000, eventually changing its name to Caesars Entertainment before being bought by Harrah's Entertainment in 2005.  A few years later in 2008, Harrah's was taken private in one of the largest private equity deals at the time for $30B by Apollo, TPG, and Blackstone.  While under private equity ownership, it switched the name back again to Caesars Entertainment.  In the near decade since the LBO, Caesars has struggled under a heavy debt load, unable to adequately invest in their properties or effectively compete for development opportunities in new jurisdictions.  It briefly appeared back on public markets before filing for bankruptcy in January 2015.  After a long and contentious reorganization process, Caesars will finally emerge from bankruptcy sometime in the third quarter.  Recently management has been out in front of the press and analysts telling their story as they drum up interest for the post-bankruptcy shares.

I'm buying the story and think reorganized Caesars presents an interesting opportunity for a few reasons:

• Low hanging capex project wins: Caesars has under-invested in their properties since the LBO and financial crisis, anyone who has been to one of their properties in 2010-2014 would agree, but in the last 12-18 months Caesars has begun an extensive room renovation program that will have them hit 50% of rooms renovated by the end of 2017 and 90% of Las Vegas inventory renovated by 2020.  Its a similar theme to Nexpoint Residential Trust (NXRT) renovating their Class B apartment units that's played out so well, Caesars renovating their "Class B" hotel rooms on the strip provides an attractive return on investment as they're able to raise room rates 10-20% after renovation.  Additionally, Caesars owns some land behind (they use the term "adjacent", but it's really behind if you're standing on the strip) the LINQ hotel that they're going to build a mid-sized convention center on to serve their hotels on that side of the strip (Flamingo, LINQ, The Cromwell, Bally's, Planet Hollywood, and Paris).  They won't be competing for the large trade show business (the expansion of the Las Vegas Convention Center is another tailwind though) but adding some convention space should help attract more business oriented customers that typically spend more than leisure customers.
• OpCo/PropCo Split and Management Co growth opportunities: As part of the reorganization, former creditors (not current/old CZR shareholders) will be receiving equity in VICI Properties, the new REIT that will own the property of CEOC (more on the org structure below) which includes Caesars Palace and most of the regional casinos, but not the other Las Vegas casinos which will continue to be owned by wholly owned subsidiaries of Caesars Entertainment.  It's effectively turning the old debt it something that looks like debt, but isn't quite in the form of the triple net lease structure.  We're still fairly early in the OpCo/PropCo structure for casinos, but long term its an effective way to leverage the company and take advantage of REITs lower cost of capital.  Also intriguing to me is the possibility of Caesars using the hotel management model and utilizing truly third party capital to build/operate the casinos while Caesars manages the resort for a fee.  They do this today mostly on Native American reservations, but curious why this hasn't been the structure all along?  Ideally the gaming REITs would look like hotel REITs and not triple net lease REITs, maybe someday.
• International expansion opportunities:  The United States is pretty saturated with casinos, most markets have casinos within driving distance.  Especially on the east coast, where states are geographically smaller creating more jurisdictional competition, as each state fights for its fair share of gambling tax revenue, the pie doesn't appear expand much but rather the slices are getting smaller and smaller.  Caesars missed out on Macau and Singapore, but is actively pursuing opportunities and partnerships in South Korea, Japan, Canada and Brazil.
• Leverage:  This could also could be a bad thing, but after emerging from bankruptcy CZR will be just under 6x leveraged if you include the capitalized lease obligation to VICI Properties - which I give credit to management here, they don't over-emphasize their non-GAAP versus GAAP debt structure like Penn and Pinnacle Entertainment do.  But if you believe in the short term theme in the first bullet or the longer term international expansion theme, then any incremental increase in EBITDA or earnings could substantially increase the equity.  For example, after Pinnacle Entertainment (PNK) did the OpCo spinoff, its share price has increased about 70% in the past year while its EV/EBITDA multiple is only up half a turn and EBITDA has grown mid-single digits.  Of course the opposite can happen just as easily too.

Caesars Entertainment Corporate Structure

I won't pretend to know all the history or legal reasons for the division of the subsidiaries, other than to assume their private equity owners were doing everything they could to protect certain assets from creditors once it became obvious (which was soon after the buyout) that a restructuring would be coming.

I pulled this off of a Caesars Entertainment Resort Properties ("CERP") lender presentation, so the emphasis on that subsidiary isn't intentional.  It's worth noting that the new Caesars will continue to own the real estate of Caesars Growth Partners ("CGP") and CERP which are primarily the Las Vegas properties other than Caesars Palace.  Also, CEOC is only entity in bankruptcy and as a result is deconsolidated on CZR's financial statements, which only adds to the confusion around the situation as there aren't clean SEC financials.

Caesars PropCo REIT, to be called VICI Properties, will include the 18 casino/resorts that were owned by CEOC but not CERP or CGP, plus a few golf course to be placed in the taxable REIT subsidiary likely for tax reasons (the "lemonade stand").  VICI Properties will additionally have the option to buy Harrah's Atlantic City, Harrah's New Orleans, Harrah's Laughlin and has the right of first refusal to the real estate of any U.S. (but outside of Vegas) property that Caesars might acquire or develop.  This REIT will look a lot like Gaming & Leisure Property Trust (GLPI), while casino resorts aren't easily convertible to another use in the case of obsolescence or default, the master lease structure with operating company tenants protects the REIT pretty well.  As long as the majority of the properties are stable and functional, and the operating company healthy, they'll receive their master lease payment plus a 2% step up annually.  I'm curious what the future holds for the REITs, including MGM's, it'll be interesting to see how they handle M&A going forward, thoughts here are welcome.

CZR/CACQ Merger
Another fun complication to the story is the merger of Caesars Entertainment (CZR) and Caesars Acquisition Company (CACQ), CACQ owns a stake in Caesars Growth Partners and previously Caesars Interactive which was sold in a separate transaction to a Chinese buyer.  The merger will happen in conjunction with CEOC emerging from bankruptcy to recombine the company, and give 100% ownership in CGP to CZR.  Lots of Caesars acronyms.

CACQ shareholders will be receiving 1.625 shares of CZR for each share of CACQ, as of today there is a slightly spread (less than 2%) at the moment between the two, probably for liquidity reasons as there's little chance at this point that deal won't be completed.  As part of the reorganization then, current CZR shareholders will receive 8.7% of new CZR, CACQ shareholders will receive 32.9%, and the former creditors will receive 58.4%.

Valuation
The new Caesars Entertainment will look like a combination of MGM without the Asian operations and PENN/PNK but with significant Las Vegas exposure.  Caesars is also more diversified by revenue sources as Las Vegas transforms itself with less emphasis on gaming revenues and more emphasis on entertainment, nightlife, restaurants, shopping and experiences.

The recent analyst day provided a lot of good information in an Excel supplement, I used the below and just plugged in today's stock price with a discount via CACQ.

Comparing the new CZR's to peers:

MGM deserves a premium to CZR, but the question is how much?  I'd probably just guess 1-1.5 turns compared to CZR.  Given the leverage and valuation, even putting a 10x multiple on CZR would generate a low 20% gain from here without any benefit from the hotel renovation project, convention center, general economic tailwinds regional casinos have been seeing, or just Las Vegas momentum in general with the Raiders & NHL, housing market coming back there, etc.

Disclosure: I own shares of CACQ (PNK and TPCA also)

GenVec: Intrexon Buyout, Novartis Partnership CVR

GenVec (GNVC) is another semi-failed biotech (and pretty tiny - only a $14MM market cap), GenVec is being purchased by Intrexon (XON) in a deal that should close by the end of the second quarter.  GNVC shareholders will receive 0.297 shares of XON + contingent payment right equal to 50% of any milestone or royalty payments received within 36 months after closing from GenVec's collaboration agreement with Novartis (NVS).  Assuming the deal closes as expected, the CVR is currently being valued at approximately zero.

Back in 2010, GenVec struck a partnership agreement with Novartis to discover and develop treatments for hearing loss and balance disorders.  The partnership centers around CGF166, currently in phase 1/2 trials, the goal of CGF166 is to regenerate sensory hair cells in the inner ear using gene therapy to restore hearing.  Hearing loss is a big addressable market and many of those suffering don't utilize hearing aids and the like due to social stigmas.  GenVec licensed the rights to this program to Novartis, in return, GenVec received a $5MM upfront payment, Novartis purchased $2MM of GNVC common stock, and GenVec was eligible to receive up to an additional $206.6MM in milestone payments.  To date, GenVec has only received $5.6MM in milestone payments, and none in the past two years.

Sorry if that's too small, but there's $201MM in potential milestone payments out there, plus royalties on any sales, the CVR will split any potential payments 50/50 with Intrexon.

Without knowing much about the probability of milestones being met (let's just go with a very low probability), the interesting thing about this CVR is its success or failure is in the hands of Novartis, a third party not involved in the merger.  The 36 month clock on the CVR doesn't directly relate to anything I can see in the Novartis partnership, so Novartis has less incentive to game the milestone dates, the 50/50 split with Intrexon puts the CVR on equal footing.  Within 36 months, we should know if there's something to CGF166 or not.

There's likely not much value in the CVR, but with a tiny market cap and a long dated non-tradeable CVR, I could come up with some behavioral arguments on why its being completely discounted.  Intrexon feels a bit scuzzy to me, they're highly promotional and did a weird faux spinoff earlier this year, so I'd recommend shorting out the 0.297 shares of XON for every share of GNVC to just synthetically own the CVR.

Thanks to the reader who sent me this idea after my INNL post.

Disclosure: I own shares of GNVC

Innocoll Holdings: PE Buyout, Big CVR Attached

Innocoll Holdings (INNL) recently agreed to be acquired by Gurnet Point LP, a healthcare investment fund headed by Sanofi's former CEO Christopher Viehbacker and backed by billionaire Ernesto Bertarelli's family office, for $1.75 per share plus up to $4.90 per share in contingent value right ("CVR") payments.  The CVR has several milestones based on the approval and commercial success of Innocoll's drug/device Xaracoll which is a biodegradable implant that delivers bupivacaine to provide non-opioid acute pain relief for several days post surgery.  During surgery, Xaracoll is implanted near the incision to provide an initial burst of bupivacaine followed by a slower sustained release that delivers pain relief over 72 hours, and since its biodegradable, it doesn't need to be removed and instead dissolves in the body.

Prior to the buyout offer, Innocoll was troubled and near insolvent.  In 2016, the company pulled the plug on their previously touted Cogenzia (for treatment of diabetic foot infections) after studies failed to show it was effective.  Then late in the year Innocoll experienced another set back when Innocoll received a Refusal-to-File letter from the FDA for Xaracoll causing the stock price to drop roughly 60% in a day.  According to the company, the Refusal-to-File was mostly clerical as the FDA considers Xaracoll a drug/device, not just a drug, thus requires additional information/studies to be performed before the FDA could take it under full consideration for approval.  However, Innocoll didn't have the cash to fund additional studies and was forced to either raise capital or find a buyer, Innocoll found a buyer.

The specifics of the CVR Payment Events:

• First CVR Payment Event: Gurnet Bidco will pay $0.70 in cash per CVR if on or before December 31, 2018, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following open abdominal Hernia repair

The first payment event seems like a low hurdle, they ran a successful phase 3 trial for postsurgical pain following open abdominal Hernia repair, it seems reasonable that once the paperwork is in order, the FDA will approve it.  Innocoll's only other potential pipeline product is CollaGuard which prevents post-operative adhesions, CollaGuard's potential commercialization is farther out and the addressable market appears smaller than Xaracoll (there are over 1MM Hernia repair surgeries annually in the US).  Often the drug or asset contemplated in the CVR is a secondary asset that the seller believes in more than the buyer, but here the CVR is referencing the primary remaining asset of Innocoll and the deal structure appears to be more of a risk mitigating scheme for Gurnet Point than a typical CVR.  If Xaracoll fails completely, the remaining assets are likely worth less than the $1.75 per share cash offer making Gurnet Point incentivized to at least meet this first initial milestone.

• Second CVR Payment Event: Gurnet Bidco will pay an additional $1.33 in cash per CVR if, on or before December 31, 2018, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Soft Tissue repair (and not limited to hernia repair).
• Third CVR Payment Event: If the milestone is met, Gurnet Bidco will either pay: $1.00 in cash per CVR if, on or before December 31, 2019, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Hard Tissue repairs; or, if not $0.60 in cash per CVR if, after December 31, 2019 but on or before June 30, 2020, Xaracoll is approved by the FDA with a label covering indications for the treatment of postsurgical pain immediately following Hard Tissue repair.

The second and third CVR payment events require new clinical trials that Gurnet Point will need to fund.  The phase 3 trial for Hernia repair ran for 8 months, so the timelines given for these events seem reasonable.  However, since Gurnet Point will need to fund these trials, there's a risk that they'll time the trials *just so* to miss the CVR payment date.  That's the primary risk with CVRs, the seller is essentially putting the final purchase price in the hands of the buyer, the incentives are misaligned.

• Fourth CVR Payment Event: If the milestone is met, Gurnet Bidco will either pay: $1.87 in cash per CVR if global net sales of Xaracoll exceed $60 million in any four consecutive Calendar Quarters ending on or prior to December 31, 2019; or, if not, $1.00 in cash per CVR if global net sales of Xaracoll exceed $60 million in any four consecutive Calendar Quarters ending on or prior to March 31, 2020.

I don't feel comfortable handicapping the potential sales of Xaracoll so its hard to have an opinion on the fourth CVR.  There is a competitor in Exparel that combines bupivacaine with a foam in a similar manner and has annual sales above $200MM.  However, opioid painkillers are cheap and they're great at treating acute short term pain, the real opioid epidemic problem revolves around their use for treating long term pain, so its hard to determine if the benefits of Xaracoll would be worth the additional cost?  Maybe for addicts or those at risk to be?

Most likely for today's $2.05 stock price, you get $1.75 cash in the next few months and $0.70 for 1st CVR milestone in ~12 months, plus the optionality of the long dated payment events.  Seems like a reasonable speculation to me, I bought a small amount.

Disclosure: I own shares of INNL