Year End 2018 Portfolio Review

I'm ready to close the books on 2018, it was a difficult year for my personal account with a loss of -20.46% versus the S&P 500 at -4.38%.  The only significant winner was the DVMT tracking stock, otherwise it was mostly all losers with the worst of them being Green Brick Partners, Caesars Entertainment and Wyndham Worldwide (pre and post split).  Despite the poor results here, 2018 was a positive year both personally and professionally, thanks to everyone I've interacted with online and offline, Happy New Year.

Here are some thoughts on each one of my holdings, I think most of them are especially undervalued if we avoid a recession in the near term (some of the prices might be stale as I wrote this over the last week).

Thoughts on Current Holdings
Caesars Entertainment (CZR)
It all started with a nervous answer from Mark Frissora about hotel room demand in Las Vegas on an earnings conference call, but Caesars Entertainment has been cut in half in short order despite a few positive catalysts on the horizon: 1) the company is a rumored M&A target; 2) Mark Frissora, the much maligned CEO, is out as of 2/8/19; 3) legalization of sports betting rolling out nationwide, breathing fresh life into the company's regional casinos.  In October, Tilman Fertitta's Landry's made an offer to merge with Caesars at a $13 per share valuation, obviously that's a bit suspect as its more a reverse merger and the $13 is only apples-to-apples depending on how privately held Landry's valuation is determined.  But it showed interest/value in the mismanaged assets here, others have been rumored to be interested in Caesars although a deal might be too complicated to get to the finish line.  I'd like to see them pursue former Pinnacle Entertainment CEO Anthony Sanfilippo in the meantime, focus on refreshing their portfolio and pursuing the remaining low hanging fruit capex projects, but wouldn't mind a takeout, although not counting on it.  A word of warning, lots of leverage here via traditional debt (much of it floating) and their lease obligation with VICI Properties.

CorePoint Lodging (CPLG)
LaQuinta Holdings (LQ) was a nice small win earlier this year as I initially sold the lodging REIT spinoff, CorePoint Lodging (CPLG), on the day it hit my account for ~$28 ($14 pre-reverse split) per share.  I should have left it alone from there, but after CPLG's first quarterly earnings report came out and the stock traded down to about $20, I started buying and have been buying small amounts all the way down to where it trades today at $11.70 per share.  Why has it fallen so sharply?  I'm not entirely certain (which may be a red flag), 2018 results have been about in-line with what should have been expectations as the company recovers from the 2017 hurricanes and finishing up their repositioning efforts pointing to a strong 2019 recovery.  What at first looked like management sandbagging due to incentives to keep the price "down" on the first day of trading (in hindsight, more than double the current price, they'll end up paying a lot more in taxes than they should have), now just looks like a management team that doesn't know how to properly tell their story to investors (a big issue when you're a REIT and rely on raising capital to grow).  This is a strange asset for public markets, it has the second most rooms of any lodging REIT (behind industry behemoth Host Hotels (HST)) yet one of the smallest enterprise values.  The market is valuing their rooms at ~$40k, versus ~$150k and above for some of their peers in the limited service hotel segment.  It's trading at roughly 47% of fully depreciated book value, almost unheard of for an internally managed REIT with decent enough corporate governance.  If we conservatively estimate EBITDA at $215MM next year and exclude any remaining tax payments to be received from Wyndham Hotels or insurance recoveries, CLPG is trading at just 7.8x EBITDA versus peers a couple turns higher.  Again, this is a taxable spinoff without the two year safe harbor, if the share price doesn't turnaround quickly, I could see CPLG receiving pressure to put the company up for sale.

Donnelley Financial Solutions (DFIN)
We're up to 3 publicly unhappy shareholders (here, here and here) in "DFIN" (that's their new go-to-market brand to disassociate themselves from their former parent) as the market has grown impatient with their attempt to transition from a print based company to SaaS model.  Despite the market volatility, transactional volume in financial markets appears to be strong, several big unicorns are scheduled to come public in 2019 which should be positive for DFIN going forward.  Their top competitor in the print space, privately held Merrill Corp was sold in September, indicating there is an appetite for the declining side of the business.  Probably doesn't mean anything, but DFIN's sister spinoff, LSC Communications (LKSD), announced it is being purchased by Quad Graphics (QUAD) shortly after its safe harbor expired.  DFIN is trading at 5x EBITDA today and guided to being able to grow the topline low single digits over the next several years at their analyst day, if true, this business is trading too cheaply.

GCI Liberty (GLIBA)
In 2019, we could see the merger of GLIBA and LBRDA (maybe a spin of the TREE stake at the same time?) that could set the table for the inevitable but long awaited merger of Liberty's publicly traded Charter Communication stakes back into CHTR itself.  The GCI piece of GCI Liberty received some bad news earlier this fall when the FCC decided to reduce a subsidy payment GCI receives for providing communication services to health care facilities in the Alaskan Bush, a $27.8MM reduction that has a similar cut to EBITDA.  Much of the discount quoted for GCI Liberty assumes that GCI is worth what Liberty Ventures paid for it, however that might be a faulty assumption given Liberty Venture's need for an asset to complete their conversion away from the tracking stock structure (reasonably makes sense to have overpaid) and this news from the FCC.  But I continue to hold, Charter should have a good 2019 from a FCF standpoint as the merger integration of Time Warner Cable and Bright House Networks is completed and the capex spending subsides paving the away for more buyback activity.

Green Brick Partners (GRBK)
Even Dallas, Green Brick's home market, is now showing significant signs of a slowing housing market after years of growth, however GRBK's earnings are up 62% year-over-year, but that doesn't matter at the moment and the stock is down 37% year-to-date.  Green Brick is responding by pivoting to building more entry level homes in the Dallas area as millennials continue to move out of the basement and start families, but interest rates and student loan debt are impacting affordability.  The NOL is essentially gone opening up some M&A possibilities (no Section 382 restrictions), it is now David Einhorn's 3rd largest position (when formed GRBK was a rounding error for Greenlight Capital) and it trades for about 7x fully taxed trailing earnings or 80% of book value.  If the housing market is in for more of a pause than a true downturn like the previous cycle, then GRBK should do quite well from here.

Hamilton Beach Brands (HBB)
We'll know more about Hamilton Beach's progress after their 4th quarter earnings release, but HBB is one of those cases where a poorly performing business (in this case, retail chain Kitchen Collection) is masking the true profitability of the core small appliance business.  HBB as a whole is trading at 14-15x trailing net income, but if they could full extract themselves from the Kitchen Collection business, the core small appliances segment is trading at more like 11x trailing earnings which they expect to "increase substantially" in 2018 over 2017.  HBB has been actively managing Kitchen Collection's leases to the point where all their leases will soon be a year or less in term (essentially pop up stores) and they'll be able to reduce their fixed costs and get their losses under control.  There are some legitimate concerns about Amazon Basics/Alexa empowered devices entering this market, plus this is a family controlled company, so I'm not convinced HBB is an immediate take out target after their two year safe harbor period expires in September, but HBB is cheap enough to overcome these risks and if management executes on their long term growth plan it could be a significant long term winner.

Howard Hughes Corporation (HHC)
The slowdown in housing has hit Howard Hughes (WSJ reported on a Las Vegas slow down recently), its stock price is down over the last several years and it once again appears really cheap (similar to early 2016 when the oil downturn really hit Houston) at $95 per share.  HHC's net asset value is a bit abstract (I'd peg it at about $150-170) but it has almost certainly grown over the years and should continue to grow into the future as their assets mature.  The Seaport should begin to show its worth in 2019, I'd expect HHC to do some kind of transaction to monetize the asset, perhaps sell 49% to a partner in order to mark the asset for investors (e.g., Chelsea Market was bought by Google for $2.4B) and de-risk their asset concentration.  Management here is also incentivized to get the stock price moving, CEO David Weinreb put up $50MM of cash out of his own pocket to buy warrants exercisable at $124.64 per share on 6/15/22, or 30% higher than where it trades today.

KLX Energy Services (KLXE)
KLXE has gone on a wild ride since their spinoff from KLXI as oil prices took another leg lower threatening their business if O&G exploration companies back off their drilling plans.  Management here also abandoned their debt free balance sheet which initially appealed to me and levered up with $250MM of expensive 11.5% coupon debt in order to make an acquisition (reminder, same management built their energy business in 2013-2014 through a series of untimely deals before the bottom fell out in oil).  But I still like the incentives at play, management is taking their salaries in shares, its a taxable spinoff, KLXE has tax attributes that should shield much of their income, and they've guided to $190MM in 2019 EBITDA.  That puts their current multiple a bit above 3x, now that's somewhat misleading as another deal must be in the works, you don't raise 11.5% debt and only put half of it to work, but either way KLXE is exceptionally cheap if results pan out.  I've received a lot of feedback from people smarter than me in the energy space (low hurdle) that this is a bad business, people don't like their assets, it's a tourist trap for event-driven investors, etc.,  as a result I'm continuing to keep this one a small piece of my portfolio.

Liberty Latin America (LILA/K)
The perennial wait until next year stock, Liberty Latin America looks cheap at just ~7 EV/EBITDA with much of the hurricane recovery/noise behind them in Puerto Rico and FCF hopefully inflecting positive.  The story here generally remains the same as its always been, cable in the Caribbean/Latin America is under-penetrated along with a fragmented market featuring sub scale operators, while incomes are growing and the middle class is expanding.  Will 2019 be the year LILAK stops becoming a running joke and actually starts to work?  Let's hope so.

MMA Capital Management (MMAC)
At the beginning of the year, MMA Capital announced the sale of their management company and some other assets to Hunt with the publicly traded shares becoming an externally managed vehicle focused on ESG debt investments that resembles a BDC.  The remainder of the year was spent finalizing the transformational transaction and cleaning up the portfolio to free up additional capital to make additional solar energy loans.  Additionally, the company recently won shareholder approval to change their corporate structure from an LLC to a C-Corp which should make it eligible for index inclusion next year (a positive of not being a BDC as they're generally excluded from index funds).  I would also suggest a name change is in order, since the "capital management" company was sold and they are moving away from the tax credit business (MMA was the stock symbol under old the MuniMae name), something that signals green or ESG and less cage fighting is probably better to market the shares.  Either way, shares remain cheap at $25.25 when book value is approximately $35, the company and management themselves continue to buyback stock as well.

(They announced a name change today, they should have gone further with something that describes the new business strategy.)

Par Pacific Holdings (PARR)
Par Pacific's stock performance has been a head scratcher for me in recent months, it closed on a game changing acquisition of the only other refinery in Hawaii, an isolated market, for pennies on the dollar because they were the only available buyer for the asset.  Shortly after announcing the Hawaii deal they announced the acquisition of another refinery and related logistical assets in Washington state that would link their current two markets (Hawaii and Wyoming) together and provide additional opportunities for bolt on M&A going forward.  All while they've maintained profitability for many quarters in row now, seemingly hitting an inflection point in their roll-up strategy and have signaled to the market that their $1.4B NOL will finally be put to good use once the dust settles, yet it's trading at near multi-year lows.

Perspecta (PRSP)
Perspecta seems to be a recent victim of the government shutdown and could be an excellent opportunity for an investor looking to buy a cheap stock in an industry relatively insulated from the general economy.  PRSP is currently trading for 7.5x EBITDA, peers trade for 9-11x, the one risk most investors focus on is their largest contract ("NGEN") is being split in two by the U.S. Navy, management on the most recent earnings call mentioned they expect the services side of the contract will be as large as the current contract is today.  That reassurance plus general growth in government budgets should provide a floor to Perspecta's business as it moves forward as an independent business in an increasingly consolidating industry.

Spirit MTA REIT (SMTA)
It looks like Shopko is going to file bankruptcy in the near future, possibly soon after the books officially close on the holiday season.  In November, SMTA took out $165MM in non-recourse financing against the previous unencumbered Shopko properties to "put a floor" under the valuation which looks smart now and they must have known something was in the works (their $35MM B-2 term loan will likely be worthless, but one rationale for providing that financing was to receive timely financials).  In their spinoff investor presentation, they laid out a $12.80 per share "NAV" for the MTA equity minus the preferred share that's likely still close to reality given where the other net lease REITs have traded in the meantime.  If Shopko is going to liquidate and the boxes SMTA owns end up being turned over to the lucky new lender, the reason for SMTA existing will be gone.  SMTA will owe a termination fee of ~$1.80+ per share if things are wrapped up within 18 months of the spin, but SMTA also has ~$2.40 per share in unrestricted cash after the special dividend.  There's potentially a fair amount of upside on a stock that trades around $7.25 today even in a Shopko bankruptcy scenario.

Spirit Realty Capital (SRC)
The parent and external manager of SMTA, Spirit Realty Capital (SRC), is now a vanilla triple net lease REIT primarily focused on single tenant retail properties.  Its portfolio looks very similar to peers like Realty Income (O), National Retail Properties (NNN) and STORE Capital Corp (STOR), its valuation however does not, SRC trades for just under 10x FFO, while those other three trade for 15-19x FFO.  SRC is less than half the size of the smallest of those (STOR), it might make sense for one of them scoop up SRC at a nice discount using their own shares as a currency.  If it decides to go it alone, at 13x FFO, it's a $47 stock, 35% upside compared to where it trades today around $35 (FYI -- SRC recently did a reverse split).

Wyndham Destinations (WYND)
What a roller coaster year for the timeshare industry, at one point all these stocks traded for 10-12x EBITDA, now its more like 6-7x EBITDA, amazing what a shift in market sentiment can do to an incredibly economically sensitive sector.  We always fight the last recession, but timeshares have remodeled their business to where they look less like a real estate developer and more like a hotel management company.  I expect these businesses to do better through the next recession, but the stocks will likely get hammered anyway.  I did some trading around my WYND position, bought some LEAPs and then sold my shares at a loss 31 days later to tax loss harvest.  If sentiment improves, shares could move up 50% if EBITDA multiples return to 8-9x for the sector, seems like a good bet if we avoid recession.

Wyndham Hotels & Resorts (WH)
Wyndham Hotels is the steadier business of the two Wyndhams, it features more of a franchise model compared to a franchise and management model of their larger peers like Marriott (MAR) and Hilton (HLT).  In the franchise model they take a percentage of revenue, in the management model it's a combination of revenue and operating profit, thus the franchise model should be more resilient to changes in economic conditions.  WH trades for under 10x EBITDA when it's closest peer in Choice Hotels (CHH) trades for 12.5x.

Mitek Systems (MITK), Northstar Realty Europe (NRE) and Voltari Corporation (VLTC) are all new additions and not much has changed since their original posts.

Portfolio as of 12/31/18:

Performance Attribution:

Closed Positions:

• BBX Capital (BBX): I rushed into this one without fully appreciating how awful management has been, the BXG IPO was also a signal the timeshare multiples were at their peak.  I sold to free up some capital for other ideas, good timing, as the stock went a lot lower, but so did the rest of my portfolio.  An activist is now having fun with Levan and team over at www.bbxfacts.com, worth a read if you haven't seen it yet.
• Dell Technologies Class V (DVMT): Enough ink has been spilled about Dell's unfair treatment of the tracking stock in Dell's recently completed Class V Transaction.  It was by far my biggest winner of the year, but still left a bad taste in my mouth of what could have been if Michael Dell had any integrity at all.  DELL shares might be cheap, but I have enough exposure to overly leveraged companies elsewhere in my portfolio, I closed out a few weeks prior to the deal closing.
• iStar (STAR): Someone asked me about iStar in my NRE post, but to summarize here, I've soured a bit on the company, might come back to it at some point as it is extremely undervalued on an asset basis but hard to know when or how that asset value gets realized with the current management.  Also a bit concerning here is the commercial real estate finance book, much of it is construction and development loans to hotel/condo developers in formerly hot coastal markets like New York City and Miami.  A better way to own similar cheap exposure to the net lease and land development without the CRE loan book might be to barbell something like SRC and HHC together, both have managements I trust a lot more than iStar.
• Tropicana Entertainment (TPCA): The deal with Eldorado Resort (ERI) and GLPI closed on 10/1, Icahn ended buying the Aruba property himself limiting the upside on the "uncertain amount" aspect to this merger arb, hard to say if he gave us a fair shake or not, but guessing not.  Either way, it worked out well and closed a couple months sooner than initially expected.

Disclosure: Table above is my blog/hobby portfolio, I don't management outside money, its a taxable account, and only a portion of my overall assets.  The use of margin debt, options, concentration doesn't fully represent my risk tolerance.

Voltari Corp: Tiny NOL Shell, Icahn Taking it Private

Voltari Corp (VLTC) is a tiny nano-cap (~$5MM today) and not actionable for many people, but it was once a mobile internet advertising company that pivoted to a triple net lease real estate strategy in 2015 after a rights offering where Carl Icahn gained control of the company.  Why was Icahn interested in the company?  They had somehow managed to rack up almost $500MM in federal NOLs and several hundred million in state NOLs.  Entities controlled by Icahn own 52.7% of the common stock and 98% of the preferred stock.  That preferred stock accrues interest at 14% (13% prior to 1/1/18) and has been paid-in-kind since inception, today the redemption value has grown to over $65MM, essentially wiping out the common equity over the last 3+ years.  Additionally, an Icahn entity is the lender on a $23MM revolving note used to finance the company's triple-net acquisitions, which there have only been three: 1) JPM Chase branch in Long Branch, NJ; 2) a 7-Eleven store in Flanders, NY; 3) and a more sizable office building leased to McClatchy in Columbia, SC.

One could say he's been slowly squeezing the value out of the company for several years and on 12/7, he delivered the final blow to equity holders, offering to buy the remaining 47.3% of the company he doesn't own for $0.58 per share or for a total of about $2.5MM.  For that $2.5MM, he'll presumably gain sole access to the NOL and can start putting it to real use ( VLTC hasn't generated taxable income since Icahn gained control).  I'm far from a tax expert, but I'm guessing either his preferred stock or the passage of the 3 year look back is enabling this move without busting the NOL.

He has a history of doing this sort of thing, Cadus Corporation (KDUS) was another Icahn controlled nano-cap where he bought a dozen or so luxury homes in south Florida into an NOL shell, it generated no revenue during this period and Icahn offered to take out the equity for $1.30 per share prior to the first property sale, eventually bumping it twice to the final takeout of $1.61 per share.  We could see a similar bump with VLTC, what's a few hundred thousand more to secure access to a $500MM NOL?  But I'm also not counting on it, there are only 4 board members, 2 of which are affiliated with Icahn including the Chairman, although he's somehow considered independent despite being on many Icahn controlled boards and owns zero shares -- there are no friends to minority shareholders here to provide much resistance.  Also, the equity (placing no value on the NOL) isn't worth anything after deducting the revolver and preferred stock.  Despite all that, given Icahn's history and recent moves to clean up his empire, I think the offer will at least hold with a slight chance of a bump to secure it getting done.  Today it trades for $0.50 per share, offering an absolute return of 16% over 6-9 months it'll take to complete.

Disclosure: I own shares of VLTC

Mitek Systems: Elliott Bear Hug

Mitek Systems (MITK) is a small software company that a decade ago invented the image capture technology enabling check deposit now embedded in almost every bank's mobile app.  The product is loved by both banks and their consumers, for banks it is much cheaper to process a mobile deposit than to maintain the ATM/branch infrastructure and for consumers they can make a deposit instantaneously from anywhere without needing to stand in line.  While growing -- Mobile Deposit is 65-70% of Mitek's business -- mobile check deposits only make up a small percentage of the overall number of bank transactions, however paper checks continue to decline in use and Mitek needed a second act for its image capture technology.  They turned to mobile identification verfication; to open a bank account in the U.S., banks need to complete a series of steps to "Know Your Customer" (KYC) and that includes getting a government ID.  If banks or other regulated entities want to source customers through their mobile app, they need a way to verify their identity, opening up another growth path for Mitek.  The user takes a picture of their government issued ID and a selfie, Mitek's software compares to the two to confirm a match and also ensures the government ID is valid.

It's an interesting business and a nice little growth story, but what makes it especially interesting is Elliott Management (via a portfolio company called ASG Technologies) has made a hostile bid for the company, first at $10/share and now at $11.50/share in cash, MITK trades a touch over $10 today.  Elliott is of course a famous large activist investor known for getting their way, I personally recall how quickly American Capital (ACAS) changed course and folded to their demands a couple years ago before being pushed into the hands of a strategic buyer.  Mitek is a much smaller company at ~$370MM market cap, no debt, and no controlling shareholder.  Until recently, the company didn't have a CEO or a CFO, presumably that's when Elliott smelled blood and made their initial bid for the company.  Prior to the bid becoming public, but after it was made privately, Mitek did a strange thing and established a shareholder rights plan to protect the NOL, despite the NOL being only $27MM and thus insignificant to the value of the company.  More likely they were trying to prevent Elliott from acquiring a significant stake in the company in order to buy time and possibly end up in the arms of someone of their own choosing.  Mitek issued a statement regarding the most recent $11.50 offer, in it they disclosed that "other parties have expressed interest in Mitek" and also disclosed that Elliott is looking to replace the board with its own slate of directors.  With the shareholder base turning over quickly to arbs and others sympathic to Elliott, management is likely overmatched here.

At current prices you have low teens upside to Elliott/ASG's $11.50 offer, with the potential for more if the board is able to squeeze out a third bid from Elliott or able to quickly find a white knight strategic partner willing to pay an even higher premium.  If not, the stock probably falls temporarily but with the growing business providing some downside protection as mobile deposits continues to grow and identity verification gains traction.

Disclosure: I own shares of MITK

Northstar Realty Europe: CLNY Out, Reviewing Strategic Alternatives

Northstar Realty Europe (NRE) is kind of an odd duck, it's a U.S. listed REIT that is externally managed and only owns assets as the name would suggest in Europe.  Specifically, NRE owns 23 buildings, primarily Class A office buildings in Germany, France and the United Kingdom.  There are plenty of European listed REITs that own European assets and U.S. listed REITs that own U.S. assets, so it's hard to see the logic in having one that crosses the two.

In 2014, the old Northstar Realty Finance (NRF) spun off their management company, Northstar Asset Management (NSAM), which was a popular move at the time, hoping to create a permanent capital asset manager that would trade at a high multiple.  After the initial spin, NSAM wanted to create several externally managed vehicles to generate fees, thus NRE was formed via a second spinoff from NRF in November 2015.  This model ultimately failed because the market rightly valued the externally managed REITs at a substantial discount to NAV preventing the manager from growing their fee revenue streams.  Only a few months later, in June 2016, NSAM and NRF entered into a complicated merger with Colony Capital (CLNY) without NRE that ended up orphaning the REIT and left it to continue to trade below NAV with the new Colony as the manager.

Between the NSAM/NRF/CLNY merger and a few weeks ago, the company slimmed down their portfolio from a grab bag of sectors and countries down to something more streamlined, repurchased $83.4 million of shares well below NAV, restructured the management agreement to be more favorable to shareholders, and some activists got involved (read the Senvest letter here) pushing the company to liquidate or sell itself.  

I know what you're probably thinking, this sounds a lot like NYRT did prior to the liquidation and didn't that blow up?  Painful memory!  But hold onto that thought.

In early November two important events happened that make this situation particularly interesting today:

1. NRE sold their largest asset, Trianon Tower in Frankfurt, for approximately $762MM.  Trianon makes up 37% of their published NAV and NRE expects to net $360MM after paying off the property level mortgage and transaction costs.
2. NRE announced a process to review strategic alternatives and more importantly reached an agreement with Colony to terminate the external management agreement for $70MM effective upon the consummation of a sale of NRE or if there's no sale, an internalization of management.

Today it trades for approximately $16 per share with 50.1 million shares outstanding for a $800MM market cap.  After the sale of Trianon closes, NRE will have $425MM in cash (there was $65MM as of 9/30), then subtracting out the $70MM owed to Colony, and NRE will be sitting on roughly $7 per share in cash.

European REITs publish an NAV in accordance with the European Public Real Estate Association's (EPRA) best practices guidelines, think a trade association similar to NAREITs guidelines around AFFO and FFO standardization.  NRE's published NAV utilizing a third party firm was $20.85 as of 9/30 (likely down slighly due to currency movements) or about $19.40 after subtracting out the termination fee due to Colony.  We can gain a little comfort in the NAV calculation in a few different ways: 1) Trianon, again their largest asset by far, sold inline with the NAV valuation; 2) over the past several years NRE has been selling assets and on average they've been above the stated NAV at the time; 3) it's performed by an independent party in Cushman & Wakefield.

Here's a sample of a REITs located in NRE's markets that report EPRA NAVs and their current premiums/discounts:

I don't necessarily expect NRE to be taken over by a public REIT, but I gain some additional comfort in that most of larger office REITs in Europe trade within a reasonable range of their reported NAV.  On the flip side, NAV is used as the fee basis for CLNY's management fee so there's some incentive to goose it a bit and shouldn't be fully relied upon.

So unlike NYRT, where the largest three components of the asset value (1WW Plaza, Viceroy Hotel, and 1440 Broadway) all had some hair on them, needed repositioning or were underperforming.  NRE's portfolio has now been substantially de-risked with the Trianon sale, the next largest asset has a book value of approximately $170MM, meaning substantially smaller chunks remain.  The portfolio is also 97% leased, a weighted average lease life of over 6 years and we have reasonable debt levels with $7 per share in cash.  NYRT also paid out a dividend that wasn't covered (typical of an external REIT) that limited their ability to reinvest in their properties, NRE's dividend policy has always been reasonable allowing them to make improvements to drive leasing and rent growth activities.  NRE's downfall was more the initial management contract that stalled growth and permanently assigned a discount to the shares than the performance/management of the underlying assets which was solid.

I don't see internalization of management as a real alternative, the company is simply too small to make it a viable path forward, the likely outcome now that Colony is out of the way is a sale of the company in pieces or preferably in its entirety.  There's probably $2.50-3.00 of upside on a $16+ stock in the next 3-6 months.

Disclosure: I own shares of NRE

KLX Inc: Boeing Merger, KLX Energy Services Spin

KLX Inc (KLXI) is familiar to many special situation oriented investors, it was a December 2014 spinoff of BE Aerospace (BEAV), BEAV has since been acquired by Rockwell Collins (COL) in April 2017.  KLXI combined two unrelated businesses, Aerospace Solutions Group ("ASG") which is a distribution business to the aerospace industry and Energy Solutions Group ("ESG") which is an onshore oil and gas services business.  Both segments were rollups designed with the underlying theme of providing mission critical products/services that were relatively low cost in the context of the overall project, but for which the cost of failure is high enabling higher margins for KLXI.

Fast forward to today, Boeing (BA) is purchasing the ASG business for $63 per share in cash.  KLXI originally wanted to sell both the ASG business and ESG business to separate parties but couldn't come to agreement with any buyers for ESG.  As an alternative, KLXI is going to spin off ESG as KLX Energy Services (KLXE) simulatenously with the closing of the ASG deal with Boeing (guided to a Q3 close).  I have zero expertise in energy related businesses, most of the time I've dipped my toe into the sector I've gotten my face ripped off, but this deal reminds me quite a bit of LaQuinta/CorePoint (LQ/CPLG) that I've decided to give it another try in hopes to expand my circle of competence marginally.

How is it similar?  First, the deal will be taxable to KLXI shareholders, thus removing the tax-free two year safe harbor on a business that management clearly wanted to sell in the first place.  Second, the management team is moving to the spinoff and in this case, foregoing cash compensation to take stock in the spin which will likely trade poorly initially due to typical spinoff dynamics when management knows that they'll be looking for a buyer.

A little more on KLXE, the form 10 can be found here, it was formed as a rollup of 7 regional players, all the deals were done in the 2013-2014 timeframe before oil prices collasped for a combined price tag of ~$700MM.  The business did $100MM EBITDA in 2014 before the bottom fell out completely, with oil prices rebounding the past year, they're guiding to $110MM for 2018 which is significantly more than the $27MM in EBITDA in 2017.  During the sale process, they received bids for the ESG business in the range of $250MM to $400MM, the leading bid was a SPAC, so mostly financial buyers were interested.  The proxy pointed to the poor trailing twelve months results and a lack of credit available to finance energy deals as reasons for the disappointing bids for ESG.  The management team is interesting here as well, Amin Koury is 78 years old, lives in Florida (no major onshore energy basins there as far as I know), he's getting cashed out of ASG and was already cashed out of BEAV, his son runs his family office and isn't involved in the energy business, this is the last and smallest piece of his empire, all signs seem to point to KLXE not being a public company for long.

KLXI trades for $72.75 today, backing out Boeing's $63 cash offer and KLXE's implied market cap is ~$500MM, it will have no debt and KLXI is gifting KLXE $50MM in cash immediately prior to the spinoff.  So the implied EV is about ~$450MM, using the $110MM EBITDA estimate, and we come up with a 4.1x EV/EBITDA multiple, certainly cheap for any viable business.  Most oil services businesses trade a lot higher, I don't know of a perfect comp, but a similar setup to look to could be Dover's recent spinoff of Apergy (APY) which has done well since the spin.

Of course the problem with these types of ideas, they're hard to size up, even if we assume KLXE is worth 8x EBITDA, then the pre-spin KLXI is worth $81 or about 11% higher than today's trading price, not a home run, but I think it's an interesting short term idea that gives you a toehold position in KLXE at a cheap price.  After the deal closes you can decide to sell or add to the stub, that's my plan at least.

Other thoughts:

• As far as I can tell, the taxable piece is fairly straight forward at this point, similar to LQ you'll receive cash and shares in the spinoff, the taxable amount will be $63 + KLXE's share price on day one over your original basis.  At the corporate level, KLXE has a tax basis of $600MM, if the day one value of KLXE is above this amount, then KLXE will be on the hook for any taxes.
• KLXE will have a tax shield of approximately $32MM per year due to amortization of intangible assets, if you want to get cute on the valuation you could put an NPV on the tax attributes and KLXE would look even cheaper.
• Cash at KLXE will also likely be higher than $50MM, KLXE is entitled to any free cash flow generated from 5/1 to the closing date.
• KLXI is not an S&P 500 component, but it is in aerospace indexes and not in energy indexes, so along with dropping down in market cap indexes, it'll be removed from industry ones as well, potentially creating some forced selling from ETFs.  I would imagine there are few holders of KLXI that were involved for the energy business.

Disclosure: I own shares of KLXI

Dell Technologies: Dell Class C Reverse Merger via DVMT

Today we received the answer to the question of how much of a discount Dell was going to force down on the DVMT tracker? Turns out, quite a bit!  While I'm disappointed in the result as the discount is essentially unchanged from the day after the Dell EMC deal closed, the current price bakes in a significant discount for the Class C shares and you might see activists push for an even better deal.

Dell bought EMC in the fall of 2016, EMC owned 80% of VMWare (VMW) and Dell issued a tracking stock (DVMT) for much of that 80% VMWare ownership position that in spirit was meant to be economically equivalent to one share of VMW.  Turns out that was a lie!  Maybe lie is too strong of a word, Dell always had several options available to it in the DVMT documents to provide less than VMW value to DVMT share holders, but its certainly against the intention of the tracker and the EMC board should be a little embarrassed, with today's new, Dell essentially engineered a way to pay a lot less for EMC/VMW.

Here are the terms of the deal, as of Monday afternoon, DVMT is trading for ~$91.50, a 16% discount to the headline $109 number and a full 43% discount to VMW's current price of ~$160.  Even at the full $109 number, DVMT shareholders are accepting a 31% discount to VMW:

Dell Technologies is a private company, the main goal of the DVMT conversion is to do a reverse pseudo-merger with the tracking stock to bring Dell Class C public again without going through the costly traditional IPO process.  The headline number is $109 for DVMT with an election between cash or Dell C Shares, although if you pick cash you'll likely be significantly pro-rated (cash is capped at 41% of the total).  Coinciding with this transaction, VMWare is going to pay a special dividend to its shareholders (including Dell Technologies which owns 81% of VMW) and then Dell is going to turn around and use the $9B they receive from VMW to finance the cash consideration portion of the transaction with DVMT.  Smart, Dell is using VMW's own cash to buy DVMT at a 31% discount to VMW, an immediate gain to Dell Technologies' equity value.

Valuing the Class C shares get a little tricky.  Dell has a significant amount of debt and owns stakes in three publicly trade subsidiaries (VMWare, Pivotal, Secureworks).  Dell provides a slide using the $109 headline number:

If you recreate this slide and plug in $91.50 at the top, the implied equity valuation of Dell ex-public subsidiaries drops from $17.5B to $750MM.  Core Dell has about $32B of net debt (not including their financing subsidiary or debt at VMW) and did $6.9B in EBITDA over the last 12 months, with the $750MM implied market cap today, the market is placing a 4.75x EBITDA multiple on the old Dell/EMC businesses, seems quite punitive to me.  Or even more ridiculous (maybe just meaningless) but at a $750MM market cap, Dell's P/E off of their "adjusted net income" ex-public subsidiaries number would be less than 1x.

Now there could be good reasons for the discount.  Class C shares have essentially no voting rights, so while the tracking stock discount will be removed when the new shares are issued, the "Michael Dell minority shareholder" discount will still be present.  Similarly, but does the old tracking discount just move over to being a HoldCo discount at Dell Class C?  About half the enterprise value and the majority of the equity value at Dell is its stake in VMWare, will it trade at a big discount like we see other HoldCo's trade at today?  That's the more likely answer, the whole enterprise is being discount, not just the legacy business.

Reading the press release, you can see that management is spinning the conversation away from the DVMT/VMW discount and referencing the headline premium to Friday's close.  In fact, if you flip through the presentation, its almost like DVMT wasn't intended to ever track VMW, no mention of "track" or "tracking" anywhere, just a pre-IPO roadshow deck .  Elliott Management and Carl Icahn both own DVMT, Dell's press release states that Dell consulted with owners of 40% of DVMT and "received feedback", doesn't say that those giving their feedback agree with the consideration DVMT shareholders are receiving, so I wouldn't be surprised if one or two put up a stink about accepting such a large discount.  DVMT shareholders will get to vote on a deal in October, maybe this transaction goes through as is but something just feels a bit wrong accepting such a wide discount two years after the tracker was issued.

I'm continuing to hold as the market seems to be overly discounting the new Dell shares and under estimating the potential for some additional shareholder pressure to sweeten the deal.

Disclosure: I own shares of and call options on DVMT

Mid Year 2018 Portfolio Review

It's halfway through 2018 already, time to check the scoreboard, and its not pretty, during the first half of the year my personal account dropped -6.44% compared to a positive 2.56% for the S&P 500.  I have nothing too insightful to say, made some mistakes, waiting on a few situations to fully play out and just going to keep moving forward.

Updated Thoughts:

• Green Brick Partners (GRBK) looks pretty cheap again.  To recap, Green Brick is a homebuilder that did a reverse merger with an NOL shell in 2014, its essentially controlled by Greenlight Capital and is run by veteran Dallas based developer Jim Brickman, who is a close business friend of David Einhorn.  To begin 2018, Green Brick had only $67MM in NOLs remaining and will likely come close to burning it off this year, if not early 2019.  Once the NOL is gone, the reason GBRK exists as a public entity will cease and restrictions around its ownership will no longer limit the company's strategic options to either be acquired or use its stock and merge with another homebuilder.  Third Point, who had owned ~17% of the company, recently did a secondary to sell their position and the news took GRBK's stock down from the low-to-mid $12s to the low-to-mid $9s.  Initially the company planned to raise capital alongside Third Point, but then reversed that idea when the secondary priced at $9.50.  Why the company would want to raise equity capital is a bit of a head scratcher, every quarter management puts out a slide showing how their leverage is lower than everyone elses and how they plan to add leverage but that curiously never happens.  Green Brick will earn at least $1/share (GAAP) this year and likely more, meaning the shares trade at a sub 10 P/E despite a high growth rate, strong balance sheet, and operating in blistering hot job markets.  It doesn't seem that Jim Brickman is ready to retire for a second time, but given Greenlight's performance woes, they might need a win and push the company to be sold once the NOLs are gone.  One lesson learned here so far, stay away from NOL shells that are trying to become the next mini-Berkshire and instead look for ones that make one acquisition that instantly generates taxable income.
• Earlier this year iStar (STAR) made what looked like a weak effort at evaluating strategic options and has opted to accelerate the divestment of their more liquid legacy assets and continue to grow their core businesses of CRE loans and net leases (which is basically status quo, but with more effort!).  The one interesting thing to note is they've all but announced a dividend, stating several times that they're evaluating one and even amended their bank debt to remove previous dividend restrictions.  iStar has been disappointing so far, CEO Jay Sugarman seems overly distracted by their ground lease vehicle SAFE which only makes up a small fraction of iStar but seemingly takes up far more of his time.  Additionally, we've gone through a couple CFOs over the past two years and disclosures remain opaque making it hard for the market to value their assets.  It's still stupid cheap on a sum of the parts basis, but hard to know when that narrative will change, I thought it would by now, but we could be in the same situation in another 2-3 years still talking about monetization of legacy assets.
• I've owned Dell Technologies Class V (DVMT) shares, which are meant to track VMWare (VMW), since Dell completed the purchase of EMC in 2016.  In early February, news broke that Dell was considering its either going public itself or doing a complicated merger with VMware that might or might not include the DVMT tracking shares.  The market reaction was all over the place, the craziness fired up my animal spirits and I bought some July options that will likely expire without much fanfare as the negotiation drags out between Dell, VMW and DVMT holders on how the tracker discount will get divided up.  I'd still fall on the side of Dell being somewhat fair to DVMT holders (maybe a 20% discount to VMW) as his reputation and that of is his PE partners is still important, plus you've got activists lining up on both sides of the DVMT/VMW trade ready to sue if either side feels too much pain.
• Earlier in June, the SEC approved a rule that will change the default notification option for mutual fund investors from physical mail to email starting in 2021 (sounds further away than it is in reality).  Donnelley Financial Solutions (DFIN) is one of the largest printers of mutual fund materials and stands to lose a fair amount of business once this rule takes effect, its not unexpected as it was discussed in detail at their recent analyst day (guided to a ~$12MM hit to EBITDA if the rule passed), but its just another in a series of setbacks for this spinoff as they try to stabilize themselves as a standalone company.  Shortly after, Groveland Capital and Denali Investors appeared on the scene with strikingly similar letters (here and here) to the board of directors asking DFIN to explore strategic alternatives as the market is valuing DFIN at a 6x EBITDA multiple.  October 1st will mark the two year anniversary of the spinoff, opening up a few more options for DFIN, but I'm skeptical anything will happen as management seems set on pursuing (attempting?) the difficult print to SaaS company transition.

Closed Positions:

• Exantas Capital (XAN), formerly known as Resource Capital (RSO), was one of my favorite ideas for a while but the more I tried to do the math, the less confident I became that XAN could trade at book value, at least anytime soon.  XAN's manager, C-III, also did a couple of unfriendly things with their management agreement: 1) they locked in a fixed base management fee for 2018 after redeeming the preferred shares and 2) they reset the incentive fee hurdle which was previously all but out of reach. The base management fee reverts back to a bps calculation at the end of 2018 does put a little fire under management, they've changed the corporate name, are out there giving investor presentations and have a new CRE CLO in warehouse.  But I still struggle with how this gets close to a 10% ROE at its current size given the risk profile of their assets and the expense drag, I recently sold.
• La Quinta Holdings (LQ) worked out almost perfectly as expected, I sold the REIT spinoff CorePoint Lodging (CPLG) the day following the spin at $28, only wish I would have sized this idea up more and look forward to what Wyndham Hotels & Resorts (WH) can do with the LQ brand -- I'm still very optimistic on both WH and WYND despite them trading poorly after the spinoff (maybe S&P 500 selling pressure?).
• I sold LGL Group (LGL), they hinted at an acquisition of their operating business around the same time as the rights offering, that didn't come to pass and their disclosures around the process seemed woefully absent, so I sold for about my cost basis.  This is hopefully my last "micro cap NOL shell that's pursuing acquisitions to utilize their tax asset" idea, seen enough of these flounder to have had enough.
• Along with being 'done' with NOL shells, I think the same could be said for reverse morris trusts (RMTs), I was originally attracted to Entercom Communications (ETM) for the RMT and related discount through CBS, but stayed for the free cash flow story management was spinning along with the incredible insider buying that continues to this day by the founding Field family.  But I don't actively listen to terrestrial radio, if I do its a much more passive experience, with streaming/podcasting options I'm getting exactly what I want which is what makes it more valuable to advertisers.  Even with sports or news, many will point to this being an issue in today's divisive society, but I can listen to a podcast that matches my view, whether its a sports team or a political view, that kind of targeting is hard to compete with in traditional radio.  I should have stuck with my gut on it and sold after the deal was completed, but instead I got punished by thesis drift, this is a heavily levered company that will likely report poor earnings again for Q2, might be more interesting to re-enter then?  But yes, RMTs, less attractive than spinoffs, they seem to be even more levered that spins as they need to keep the 51/49 ownership structure and then a common misconception seems to be that former CBS holders are indiscriminately selling here but CBS holders elected to take ETM stock, it didn't just appear in their account like a normal spinoff.  Entercom might turn out well, but I decided to sell and move on to other opportunities.
• VICI Properties (VICI) is a the REIT that was created out of the Caesar's Entertainment (CZR) bankruptcy, my thesis was simple, it traded slightly cheap to gaming REIT peers because it was listed over-the-counter and wasn't yet paying a dividend.  Both of those have changed and its bounced around a bit to actually trading expensive to peers do to its perceived independence compared to MGP which is controlled by MGM.  I made out with a small profit.
• The management buyout of ZAIS Group (ZAIS) was completed and I was cashed out of that position for a nice profit.  

Current Holdings:

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

Disclosure: Table above is my blog/hobby portfolio, I don't manage outside money, its a taxable account, and only a portion of my overall assets.  The use of margin debt/options/concentration doesn't represent my true risk tolerance.

Perspecta: DXC Government Services Spin, CSRA 2.0

On 6/1, DXC Technology (DXC) completed the spinoff of its U.S. government services business and merged it with Vencore and KeyPoint, two PE owned government services businesses, to form Perspecta (PRSP).  There's been a lot of M&A in this industry, DXC was formed in 2017 via the combination of Computer Services (CSC) and Hewlett Packard Enterprise's (HPE) services business, prior to that merger, CSC had spun off its government services business as CSRA in November 2015 only to re-enter the business via the HPE deal.  Then in February, General Dynamics (GD) came in bought CSRA at a rich 12x EBITDA or 18x earnings multiple. Now once again DXC/CSC is returning to the same playbook and spun off its government services business.

Several years ago I profiled and owned several of the government spins (EGL, XLS, VEC, CSRA, LDOS), large defense contractors were dealing with the draw down of troops in the Middle East and sequestration started pinching Federal budgets by spinning off their lower growth and lower margin services businesses.  Now that the Federal budget is in growth mode again, projected at 1.5-2.0% annually through 2022, government services multiples are on the rise and you're seeing the opposite M&A trend taking place with GD buying CSRA.

If anyone in the industry reads this they'll likely cringe, but from an investment standpoint, most of these government services are very similar with nearly indistinguishable strategies making them fairly straight forward to value.  This kind of M&A in any industry would likely be disruptive to clients, but here deal teams work on individual government contracts and have more of an identity with the contract than the cute name currently on their business card.  It's a very competitive business where valuation multiples should converge over time as its nearly impossible for a firm to have a clear competitive advantage.  The nature of the business also makes these firms a bit of black box, many of their contracts are classified and its hard for the average investor to shift through the contract re-compete pipeline.

Perspecta is pitching their margin profile as their differentiating factor due to their heavy weight towards firm-fixed price contracts compared to peers.  This is partially the nature of the IT services business, CSRA featured similar EBITDA margins.

Fixed contracts are where the government and the contracting firm agree upfront on a price/value of a given engagement and its up to the contracting firm to make it profitable.  These types of contracts are potentially more lucrative if a management team can squeeze costs out as those savings don't have to be shared with the government (at least until the next re-compete).  But this can cut both ways, if Perspecta were to run into issues with cost overruns and or just flat out misprice a fixed-price contract in a competitive bid (animal spirits can get the best of anyone) then they could be stuck in a negative margin position unable to get out for several years.  Whereas the cost-plus contracts are safer, but with lower more predictable margins, as the contracting firm and the government agree on a specified margin upfront and the total value fluctuates with expenses (think timeshare resort management or Nacco's coal mining operating agreements).

As mentioned, all these independent government service providers trade in a pretty tight range, Perspecta has moved up a bit this week, but still remains at the bottom of the table on both an EV/EBITDA and P/E basis.

Perspecta has one large contract with the U.S. Navy servicing their intranet and related communication needs ("NGEN") that is coming up for re-compete, its a $3.5B 5-year contract, or roughly 17% of Perspecta's pro-forma $4.1B annual revenue base.  They're the incumbent on the contract through predecessor firms (was DXC, before that HPE, before that EDS) since the program was established in 2000.  The Navy is splitting the contract into two, one will be the services and the other the equipment side of the contract, Perspecta is likely to give up some of this revenue either by adding additional subcontractors to the team, or losing one side or the other, and then just general competitive pressures will decrease the profitability of NGEN through the re-compete process.  They're projecting flat revenue growth over the next year, given the healthy budget backdrop, I'm guessing its less the integration/new public company focus they've stated, and more an acknowledgment that NGEN will be rolled back for them this time around.  In the Form 10, the old DXC government services business ("USPS") had a 90% historical re-compete win rate and Vencore has a 97% historical re-compete win rate.  It's unlikely that the Navy would move completely away from Perspecta, incumbents are hard to beat, but that headline risk is out there and is potentially a reason why the stock is cheap.  I don't think the market is intentionally doing this but if you were to back out the NGEN contract entirely, Perspecta is trading for roughly the same multiple as its peers.

Perspecta has 165.6 million shares (old DXC shareholders own 86% of the company) and net debt of $2.7B, if it were to trade at a peer multiple of 12x EBITDA, the shares are worth $33/share versus the $24.25/share they trade at today.

Other thoughts:

• DXC is a S&P 500 constituent, I haven't seen an announcement kicking PRSP out, presumably because there's nothing to announce if PRSP is just simply not added to the S&P, but we've likely seen some forced selling by index funds since the 6/1 spinoff.
• Mike Lawrie is the CEO and Chairman at DXC, he'll be the Chairman at PRSP, since taking over CSC a few years ago he's done a tremendous job for shareholders in both creative M&A and operating performance.  Good manager that is worth following.
• One thing about NGEN that feels a bit wrong to me, it's barely mentioned in the Form 10, and not in the risk section for concentration risk, despite being a material 17% of revenue.  Could be an intentional oversight because the risk of losing the contract is minimal, or a bit deceptive, I'm not entirely sure which?
• Perspecta's leverage will be a little higher than peers to begin with which is pretty typical for spinoffs, the company is projecting $1.5B in operating cash flow over the next three years and have slated 35% of that to pay down debt which would get them to the lower end of their target range of 3 to 3.5x EBITDA.
• Vencore filed an S-1 last year before pulling the IPO, the S-1 is worth reading, Vencore is more of a mission services business versus the IT services at DXC's old USPS business.  KeyPoint, the smallest of the three being merged together, is the leader in background checks and security clearance, good little niche.  Perspecta believes they can go after contracts they previously weren't qualified for now that they've merged the three entities (combining mission and IT services), that's possible, but doubt it moves the needle much.

Disclosure: I own shares of PRSP

Tropicana Entertainment: Deal with GLPI & ERI, Merger Arb

This won't be actionable for some readers, but Tropicana Entertainment (TPCA, 84% owned by IEP) announced a deal today where Gaming & Leisure Properties (GLPI) will purchase the real estate and Eldorado Resorts (ERI) the gaming operations for a combined total of ~$1.85B, subject to adjustments.  One of those adjustments relates to Tropicana's Aruba property which needs to be sold or spun-off prior to the closing.

So here you have a controlled company, with an illiquid stock, entering into a complicated deal with two parties and an uncertain final cash amount all leading to a potentially attractive merger arbitrage spread.  If the headline number is correct, using the current share count of 23.8 million shares, gets you to $77.61 per share versus under $70 today.  Unpacking that number is a little more complicated, from the 8-K today:

(a)                                 $640 million, which reflects the consideration paid by Parent in respect of the Merger;

(b)                                 plus $1.21 billion, which reflects the Real Estate Purchase Price received by the Company;

(c)                                  plus the amount of net proceeds received by the Company in connection with the distribution, transfer or disposition of its Aruba Operations;

(d)                                 minus the Real Estate Purchase Tax Amount (as defined in the Merger Agreement); 

(e)                                  minus 50% of the Estimated State Income Tax Amount (as defined in the Merger Agreement), which Estimated State Tax Amount is limited to a maximum of $38 million;

(f)                                   minus the excess, if any, of the Estimated State Income Tax Amount over $38 million;

(g)                                  divided by 23,834,512, which reflects the aggregate number of shares of Common Stock that are issued and outstanding.

Without taking into consideration any net proceeds associated with the distribution, transfer or disposition of the Aruba Operations which is reflected in clause (c) above, the Company has estimated that the aggregate merger consideration, as adjusted to take into account the amounts set forth in clauses (d), (e) and (f) above, will be approximately $1.77 billion.

Couple things here, ERI is paying $640 in (a) and GLPI is paying $1.21B in (b) totaling up to $1.85B and from there we adjust down for taxes (there are NOLs at TPCA) but those are almost entirely offset by the expected sales price of the Aruba resort.  The footnote at the bottom, even if Aruba is valued at $0 then the total consideration is estimated at $1.77B or $74.26 per share, still a decent spread from today's price.

Tropicana Aruba is a fairly small operation, its a short walk from the beach (read: not beachfront) on 14 acres with 360 hotel rooms they've been renovating and converting into timeshare units over the past several years, there's also a 4000 sq ft casino property that mirrors what you see at a many Caribbean resorts.  In the financials, Aruba gets lumped in with their Baton Rouge and Greenville casinos making it difficult to determine what the property is worth, but at the $1.85B headline number its being valued at $80MM.  That feels high, but maybe I'm anchoring to the original thinking that Aruba was simply an option to build a larger property.

The deal is expected to close by the end of 2018, if we call the range of potential (positive) outcomes $74.26 - $77.61 on today's close of $69.75 that's a 6.5% - 11.2% absolute return in less than 9 months.  Unfortunately I sold last year into the tender, but given my comfort with the company and the attractive deal spread, I repurchased a position today.

From the buyers perspective, both are out touting the benefits of the transaction, GLPI is receiving $110MM annually in rent for their $1.21B investment for a 9.1% cap rate or 11x EV/EBITDA, and Eldorado is quoting a 6.6x pre-synergies (BYD is paying 6.25x for certain PNK/PENN casinos) and 5.0x post-synergies multiple on the operations that includes some net cash and cash build until close.  At 9.75x 2017 EBITDA of $190MM, Tropicana received a great deal (TPCA was trading at 4-4.5x EBITDA in 2013) that really touts the benefits of utilizing the REIT structure and its lower cost of capital to consolidate the industry.  But as someone invested in the gaming sector, is Icahn marking the top here?  He timed the cycle well pre-financial crisis, let's hope his timing isn't quite as perfect this time around and he has other motivations as it appears he's piling up cash throughout IEP.

Disclosure: I own shares of TPCA

CorePoint Lodging: Form 10 Notes

Today I'm doing another update, this time on La Quinta's upcoming REIT spinoff, CorePoint Lodging (CPLG), based on the long awaited update (at least on my part) to their Form 10 and the merger agreement between La Quinta (LQ) and Wyndham Worldwide (WYN).  Quick recap, La Quinta announced last year their intention to separate the hotel management business from the real estate, initially that was a straight forward spinoff of the real estate into a REIT, but Wyndham came along and offered to buy the management company for $1.95B in cash.  Later in Q2, La Quinta shareholders will receive $8.40 per share from Wyndham for the management company and shares in the REIT spinoff, CPLG.

The setup for CPLG checks off a lot of boxes, it's likely to sold/trade cheaply as a taxable spinoff, plus it will have the dual benefits of EBITDA growth and a multiple that needs to come up.  When I've gotten in trouble with spinoffs or just special situations in general, its usually because the spinoff is a dressed up melting ice cube, I believe the opposite is true in CorePoint's case.

CorePoint will have 317 hotels with over 41,000 rooms across the United States (all of LQ's international hotels are franchised or managed) and is positioning itself as the "only public REIT focused on the midscale and upper midscale self-service lodging segment."  That's more happenstance than design, but self-service hotels feature more consistent and wider margins than their equivalent segment full-service competitors (fewer employees, 99% of revenues from room rentals).  On the negative side select-service hotels are viewed as easier to build, CorePoint pointed to the fact that midscale hotels are the fastest new build segment (its pitched as a positive), that's good for Wyndham has a management company but likely bad for operators like CorePoint as more suppy comes onto the market.  The majority of their hotels are located near suburban office parks, airports and along interstates, mostly avoiding urban and resort locations that could be more impacted by AirBnB and HomeAway like room sharing services (but again, easier to build new supply in suburban locations).  As a REIT, CorePoint technically can't operate the hotels under the typical franchise arrangement Wyndham uses and instead the hotels will be managed by Wyndham for a 5% of revenue fee (plus your typical royalty, reservation, and marketing fees you'd see in a franchise arrangement).

Quick screen shots from the Form 10, listing the locations and chain scale, much of the economy bucket is exterior corridor hotels that they've been selling off in recent years, but as you can see, a reasonably diversified hotel base for a one brand REIT.

At the time of my brief post on the idea in January, we didn't know the proforma capital structure at CorePoint and it muddied up the valuation a bit.  CorePoint is taking out $1.035B of CMBS financing that is secured by their hotel properties and then paying a dividend to LQ/WYN of $983.95MM subject to the adjustments listed below from the Separation and Distribution Agreement:

Section 3.6. Cash Payment. Upon the completion of the Financing Transactions and immediately prior to the Effective Time, CPLG shall transfer to LQ Parent or the applicable member of the LQ Parent Group, as directed by LQ Parent, an amount equal to $983,950,000, as such amount may be adjusted pursuant to this Section 3.6, such amount of which will, substantially concurrently with the Distribution and the Merger, be used by LQ Parent to satisfy a portion of the Liabilities outstanding under the Existing Debt Agreements; provided that:

(a) in the event the Closing Existing Net Indebtedness exceeds the Estimated Existing Net Indebtedness, the Cash Payment shall be increased on a dollar-for-dollar basis by the amount of such difference;

(b) in the event the Estimated Existing Net Indebtedness exceeds the Closing Existing Net Indebtedness, the Cash Payment shall be decreased on a dollar-for-dollar basis by the amount of such difference;

(c) in the event the amount of accrued but unpaid Transaction Expenses as of the Distribution Date exceeds the Estimated Transaction Expenses, the Cash Payment shall be increased on a dollar-for-dollar basis by the amount of such difference; and

(d) in the event the Estimated Transaction Expenses exceed the amount of accrued but unpaid Transaction Expenses as of the Distribution Date, the Cash Payment shall be decreased on a dollar-for-dollar basis by the amount of such difference.

The Estimated Existing Net Indebtness is listed as $1.665B in the agreement, as of 12/31/2017, LQ had net debt of $1.53B, reducing CPLG dividend payment down to ~$850MM.  The cash position at the time of the spinoff will then be something in neighborhood of ~$185MM ($1.035B - $850MM).  Proforma CorePoint earned $208MM in (adjusted) EBITDA for 2017, using my previous 12x multiple, gets me to about $14/share for CPLG.

$14 + $8.40 from WYN when the deal closes, gets you to $22.40 per share, or put another way, the market is currently valuing CPLG at a little under 10x EBITDA (no internally managed lodging REIT trades that cheap) at today's $18.84 share price.

Sources of Upside:

• The cash balance will likely be higher than $185MM, we should assume some additional cash build from the beginning of the year until the deal closes (although maybe not due to rebuilding efforts after the hurricanes).  Plus as part of the Tax Matters Agreement, CPLG will receive any excess between the actual tax due and the $240MM amount Wyndham agreed to escrow as part of the management company deal.  I can't quite figure out what the cost basis is for LQ itself (I saw an analyst note that pegged it at $1.7B but can't source it for myself) so if you know what the amount is, please let me know.  Let's say that $1.7B is correct and my EV on the first day is correct at $2.5B, the Tax Matters Agreement assumes the tax rate at 24.65%, which would be about ~$200MM of the gain, meaning $40MM could come back to CPLG and potentially more if really trades down day 1 (most likely as I doubt it'll trade at 12x EBITDA to start).
• This will also be taxable for shareholders, your taxable gain will be $8.40 + CPLG's first day price over your own tax basis, so all current LQ shareholders (including 30% owner Blackstone) should be cheering for the shares to get dumped the first day and then hopefully recover once the proforma numbers are clearer.
• The spinoff is maybe ~2 months out and we don't have a CorePoint specific shareholder presentation, I haven't seen a lender presentation (which makes sense since they went the CMBS route) or heard about a road show, maybe there has been one but its certainly under the radar, it seems pretty clear to me that management isn't going to try and pump the stock up ahead of time.
• This is quite the interesting dynamic where the lower the price, the better for everyone involved, management appears to know this and hasn't put out any forward guidance for the spinoff leaving the market to anchor to 2017's numbers.  2017's numbers could be deceptively low for three reasons: 
1. The 2017 hurricanes significantly impacted La Quinta's owned hotels in Florida and Texas, in Florida more than 3000 rooms were out of service for the last four months of the year, and as of 2/28, 5% of CPLG's rooms remain out of service as they undergo repairs.  They disclosed a $36.7MM revenue impact due to Hurricane Irma closures in 2017, and on the Q4 call translated this into an annualized estimated EBITDA loss of $28-35MM (to be recouped through insurance proceeds which should add to the cash balance as well).  This could be a short term risk to the stock price depending on how quickly their Florida hotels get back online, but eventually the insurance proceeds will come in and the hotels will reopen.
2. LQ initiated a big capex program in late 2016, they identified 50 hotels to renovate with the hope to move them from midscale to upper-midscale and capture greater room rates.  With this renovation project, many hotel rooms were out service and are just now re-opening, the renovation project cost $180MM and is expected to be largely complete by the time of the spinoff, what return will that investment make going forward?  On the Q4 conference call, managemend stated that remodeled hotels had on average a 13% increase in RevPAR upon reopening.
3. La Quinta has always been a standalone brand without a larger rewards group.  La Quinta Rewards has 15 million members, by joining Wyndham Rewards and their 55 million members, WYN will funnel more travelers to CorePoint's properties.  They'll also potentially see some margin benefits from shifting a few percentage points away from OTA's to their direct reservation sites being part of Wyndham.  Additionally, there could be some opportunity to rebrand some of CorePoint's La Quinta hotels that are upscale or on the high end of the upper mid-scale segment to one of Wyndham's upscale brands.
• Let's pretend forward EBITDA is closer to $235MM for 2019 (hurricane recovery, renovated hotels coming back online at higher rates and WYN synergies) CorePoint could be worth over $16 per share, or over 50% upside from today's implied price.

Other Thoughts:

• I've received some pushback on this idea due to the "one brand" risk, however with a hotel REIT, I think some of that risk is overblown.  CPLG as a hotel REIT is not taking the credit risk of LQ/WYN unlike some of the triple-net lease REITs that were spun off with one master lease tenant.  Hotels change the logo on the outside of the building not infrequently; brand diversification makes for a nice investor relations slide but how important is it really?  Quick service restaurant franchisees usually specialize in one brand, although Papa Johns franchisees maybe wished they also own Dominos stores, I think of the hotel REIT business similarly, more about locations, markets and value/price over single brand risk.
• CorePoint will have geographic market concentration risk, 23% of their hotel rooms are in Texas which caused the stock to drop significantly during the oil downturn in 2014-2015, and more recently their concentration in Florida resulted in significant disruption after Hurricane Irma.  Mr. Brightside, both markets are recovering and should provide a tailwind to CorePoint's results post spinoff.
• There will be a 1 for 2 reverse split ahead of the transaction, keep that in mind when it actually starts trading, my $14 estimate becomes $28.  In the Form 10, a purging dividend is mentioned but its expected to be minimal.
• CorePoint mentions they intend to be an acquirer, initially that seemed strange, but given the potential cash position at the spinoff, it might make sense to play consolidator for a minute in the fragmented midscale segment (another source of growth).  Either way, with the spinoff being taxable and the presence of a 30% private equity owner, I'd expect CorePoint to be acquired in relatively short order (6-24 months) after the spinoff.

It might be better to wait for the spinoff to occur and get some more color around the Florida hotel recovery speed before diving in but I have a position now and expect to add to CPLG when it begins trading.

Disclosure: I own shares of LQ and WYN (plus WYN calls)

Wyndham Hotels & Resorts: Form 10 Notes

Once again, apologies for being somewhat repetitive, but the Wyndham Hotels & Resorts Form 10-12 came out today and I wanted to update my numbers for a few changes and add some additional thoughts around the spinoff.  The biggest change from my post last week is it appears Wyndham Worldwide (WYN) already incorporates the timeshare-to-hotel group royalty fee in their segment results, which mutes some of the multiple arbitrage upside of creating an expense from the lower valuation company into a revenue of the higher valuation company.

Removing the double counting of Hotel EBITDA brings down the overall valuation a few dollars.

*Edited from original, proforma net debt was incorrect

It was also disclosed in the Form 10 that Wyndham Hotels & Resorts will have $1.888B in net debt at the time of the spinoff, essentially all the purchase price of La Quinta's management and franchise business will be placed on the spinoff which makes sense.  By incorporating the net debt number, we can infer what the target price of each side will be after the spinoff (using my multiples above) which might be useful as there's often significant volatility around the when issued and spinoff dates.

*Edited from original, proforma net debt was incorrect

Other thoughts/notes from the Form 10:

• After the closing of La Quinta's management business, Wyndham Hotels & Resorts will have over 9300 hotels in their system, making them the largest franchiser in the world by the number of hotels and #3 in hotel rooms (economy hotels tend to be smaller in size).
• The typical franchisee is a first time hotelier and single property owner, Wyndham has 5700 franchisees for their 9300 hotels, this is a small business in a box type service.  This is likely good and bad, good in that they're not exposed to any one large franchisee and bad in that the net worth of their franchisees is likely minimal outside of their hotel, leaving them more susceptible to distress.  Their value proposition is the single property owner can work with Wyndham and receive the marketing, reservation and technology system of an upscale hotel but for the economy and midscale segments.
• Royalty fees are typically 4-5%, plus marketing fees of 2% and another 2% of gross revenues for rooms book through their reservation system.  Here's a good place to point out that the economy segment is less pressured by the Online Travel Agencies (OTA's) as the upscale and luxury segments, many of Wyndham's guests are drive-up, meaning they book their room the night of based on which hotels in a particular destination have vacancies.
• Their two main strategic priorities going forward will be to grow in the midscale segment (to a lesser extent the upscale segment as well) and grow internationally.  Growing outside the economy segment helps strengthen Wyndham Rewards, their loyalty program, by keeping more people within the system, they don't want loyal guests being forced out of the Wyndham system because they don't have a mid or upscale hotel in a desired location.  International growth is an obvious given, about 70% of U.S. hotels are branded, while only 46% internationally, creating a growth runway for the entire industry.  Wyndham could also receive a tailwind from the growing middle class in developing markets, the middle class leisure traveler is the primary target demographic of economy chains.  Their recent purchase of La Quinta's management and franchise business hits both the moving upscale and international boxes.
• This is the dream asset-lite "compounder" type business model.  Capital allocation will be split between a dividend, share buybacks (starting out of the gate with a repurchase plan in place) and M&A.  They've been an active acquirer over the past few decades:
  
• Completing a spinoff isn't cheap, one-time costs add up to $330MM here with $280MM on the parent and $50MM on the spinoff.

Disclosure: I own shares and calls on WYN