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): https://mmacapitalmanagement.com/wp-content/uploads/docs/MMAC-Shareholder-Presentation.pdf

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