Wednesday, January 10, 2018

MMA Capital: Externalizing Management, Transforming into BDC-Like Vehicle

Woke up to some fun news Tuesday, MMA Capital (MMAC) is selling its asset management business and some other assets to Hunt Investment Management for $57 million resulting in Hunt becoming the external manager of MMA Capital.  Once the dust settles, if you squint hard enough, MMA Capital will look like a BDC or yieldco but maybe without the high dividend to attract in retail investors.  Even though my thesis is almost played out (original idea: this was a pile of assets that was hidden by GAAP accounting choices, maybe one day becomes an operating company), the current price may offer a short term opportunity as the series of transactions with Hunt are completed.

Here's the deal deck (try not to cringe, MMAC clearly didn't pay high priced advisers):

Who is Hunt Investment Management?
Hunt is a privately held asset manager that focuses on real estate and infrastructure sectors, they specifically mention they manage $12B in real estate related assets and have some expertise in public-partnerships, military housing, and other sectors that might have some parallels with MMA Capital's affordable housing and solar energy verticals.  All of MMAC's employees will move over to Hunt and keep their same employment contracts which still do call for much of management's bonuses to be invested in MMAC's stock in open market purchases.

The new management fee agreement is the biggest concern I see in the deal, it's 2% annually (0.5% quarterly is how its presented, hate that optics game) of shareholder equity up to $500MM and tiered down to 1% annually after that.  We're a long way from $500MM, so its effectively 2% for the foreseeable future.  Plus Hunt will get a 20% carry on shareholder returns above 7%, so this is a fairly standard (bad) external management agreement like you'd typically see in the BDC industry. There is a carve out for this year that adjusts the equity value up to the proforma book value of ~$33.50 shown in the presentation when calculating 2018 fees and will be adjusted to exclude the effects of the companies NOLs in the event the valuation allowance is removed and a deferred tax asset is recognized.  There's also a termination payment of 3 years fees, so yes, while this is standard and I assume Hunt required this to protect their $57 investment, its far from a shareholder friendly deal.

What's Left?
This transaction removes the main remaining 'hidden asset' the company had, the asset management platform it had built in affordable housing, South Africa multifamily, and solar energy.  What's remaining is the bonds themselves, their investment in one of the South African funds, and two real estate projects.  Additionally they have ~$400MM in NOLs that are worth less under the new tax code.  If they ever are realized it'll be because MMAC was able to raise capital, scale up, and generate some taxable income (their plan), but that also means a higher share count and the value of those NOLs will be significantly diluted to current shareholders by the time their realized.

In their own words:
The new strategy sounds very much like a specialized BDC (maybe the altruistic mandate will appeal to some people) attempting to earn a ~10% ROE, general rule of thumb is a 10% ROE financial should trade for roughly book value.  Today it trades for $28.60, leaving 17% upside to the proforma book value, maybe that discount is deserved for reasons discussed below, but I'll continue to hold for now and wait for the dust to settle.

Other thoughts:
  • The company is doing a capital raise with Hunt, where Hunt will be purchasing $8.375MM worth of MMAC stock at $33.50, afterward Hunt will own a little more than 4% of the company.  This is in addition to the $57MM headline number, mostly for PR to show alignment of incentives with the public shareholders.  While not an arms length transaction, still shows someone is willing to pay book value.
  • MMAC is providing seller financing to Hunt for the full $57MM amount, 7 year term at a 5% coupon.  Hunt will be receiving about a $4MM annual base management fee off of the proforma equity base of ~$200MM.  When coming up with a new NAV, might be reasonable to discount it, not necessarily for credit reasons (the base management fee easily covers the annual interest payments) but because MMAC's capital is now tied up in an asset that wouldn't meet its targeted return requirements even if levered up.  They'll have a little drag in the portfolio until its redeemed.
  • CEO Michael Falcone owns over 182k shares (~3.15% of the company) and his lieutenant Gary Mentesana owns over 167k shares (~2.87%), they've been surprisingly transparent on conference calls, structured their compensation to align with shareholders, bought back as much stock as they legally could; they're mostly aligned with shareholders in this deal despite now being employees of Hunt.  I don't see this as a typical dirty BDC-like management stealing the company type move.
  • They didn't specifically touch on it, but the company will likely need to pay a dividend in order to raise capital in the future, that's at odds with most NOL companies mantra to retain all earnings in order to grow and pull the NOL forward as much as possible.  I think a dividend would be the right move once the transactions are finalized, as mentioned earlier, the NOL is going to get diluted anyway, might as well get the valuation uplift from yield based investors.
I started this post with the idea that shares were unfairly undervalued after the deal, but maybe the price is approximately right given the deal closing risks, interest rate risk in the current environment, and the discount applied to externally managed companies.  Most of all, the deal is probably management signaling the heavy lifting is all but complete in bringing MMAC back from the brink after the financial crisis.  So this is more of an update and an interesting twist in this deep value micro cap story, would love to hear from other MMAC shareholders too.

Disclosure: I own shares of MMAC


  1. Good analysis. I think you hit home on the points. I actually think it would have been a straight sell of the company to Hunt if it were not for the NOL's. In some ways all the hidden value of the company has been effectively sold, so it will now turn into an externally managed (misc.) debt company. How the (SMALL) amount of market participants view this may create some opportunities depending on the share price . The $33 kind of created a ceiling??

    I'm still not exactly sure what business model they intend to employ on growing in the future, if at all. It seems like their affordable housing debt portfolio is burning off (deals originated 10+years ago) and the affordable housing lending market is very competitive at the yields they desire. The solar lending market has more opportunities but how much and for how long given some sunset provisions in the tax code.

    I'm also curious has anybody done analysis on what the total expenses will be for this entity going forward (payroll and management fees). I agree that I think the management fee is very high since there are so few remaining assets that need intensive management but it's unfortunately market.... My hope is the overall expenses will be much less since economies of scale w/ Hunt managing the books and assets, and now that the most intensively managed business units are no longer part of this company/entity. If not, that's a big problem.

    Overall, I feel that Falcone and the board have been shareholder focused. I can't imagine it being totally easy transitioning senior management to Hunt's orders.

    1. I haven't done the math on internal vs external, but good thoughts around their portfolio and the future of those asset classes, maybe that's where Hunt comes in? Help them pivot to something similar that's actually growing/sustainable?

      Agree on Falcone, great job, think this is him signaling the chunky gains are over with.

  2. Definitely could be opportunity on Hunt, or rather Hunt wanted the LIHTC business line and just agreed to manage/take the rest. Time will tell. There may be some wildcard to the upside in long range vision of Hunt having this little debt fund with significant NOL's.

    I'm maintaining my position but not increasing. I would consider increasing but the share price would need to drop some since I think $33/$34 is the upside for some time (probably years).

    1. I just don't see how the NOLs have a ton of value to current shareholders under this setup. A 10% ROE on $200MM equity is $20MM in net income against $400MM in NOLs? In a low corporate tax environment? If they decide to make a dent in the NOLs, would have to significantly raise capital, diluting the effect on the NOLs to current shareholders. I don't think that should really be much of a factor in their game plan, go full BDC, raise capital, pay out a dividend. Clearly best for Hunt, probably best for shareholders too if yield based investors came into it.

    2. The dream scenario for the NOls would have been almost an opposite transaction, where the manager maintains the NOLs, is able to scale up the business and raise AUM; capital-lite consistent revenue stream. I'm guessing Falcone and team decided that wasn't a realistic option anytime soon and this was the best way to get close to fair value in a reasonable timeframe.

    3. While this is admittedly speculation, could there be gains from selling the real estate MMAC still holds that the NOLs could be used to offset? $21.5M in carrying value, so guess the takeout would have to be at a relatively large premium to move the needle.

    4. Thanks - Yeah, doubt there's enough left to move the needle, otherwise wouldn't you wait to do the Hunt transaction rather than let them in on unrealized gains? Jonathan W is likely right, capped around $33 for a couple years.

  3. They have been talking about NOL's but never had a strategy over the past five years. As a side note, it makes no sense for them to invest in tax exempt bonds w/ NOL's... In addition, the only thing the NOL's may do is that it will probably prevent them from looking into becoming a REIT. Why bother since no corporate tax is on the horizon....

    Their really only option is to look for investments out there that have much higher tax losses (phantom income) than cash flowing that others avoid and get a good price on them. I occasionally see them since I work in this field but they are far and few between (and generally small).

  4. VICI coming public officially. given bid, this looks like a slam dunk @ ipo price right?

    1. Hmm.. I don't know if I'd be a buyer at $21, doesn't seem like a ton of upside left? But I should revisit and look through the S-11, didn't get to that yet today.