Tuesday, December 31, 2019

Year End 2019 Portfolio Review

It is once again time to close the books on another year (and this time a decade), with a similar caveat to my mid-year update, the 2018 year-end was particularly painful and proved to an easy starting point for 2019 performance numbers.  With that said, my personal/blog account was up 98.63% in 2019 versus the S&P 500's 31.49% total return.  I'm fully aware this performance isn't comparable to any professionals out there managing large or small funds, it reflects some dumb luck and imprudent risk taking in hindsight, but it's still fun to nearly double in a year.  I expect next year to be difficult to put up great numbers considering the starting point (sort of the reverse of last year), but I'll continue to look for interesting corporate actions and other situations that might be obscuring value in some way or another.
Thoughts on Current Positions:
  • Franchise Group (FRG) has really gone a bit bonkers since the tender offer expired in November, not only are they combining four struggling businesses as I discussed, but since my post they've acquired two more including a large $450MM deal announced Monday for furniture retailer American Freight funded with debt.  I can't really explain why the equity has roughly doubled in 45 days, but it does appear that something potentially interesting is happening under the surface, the new CEO is clearly moving aggressively to assemble an asset base to launch his low-end sub-prime lending type business franchise thesis.  It remains very high risk but I imagine there are a number of value creation levers to pull through all these combinations.
  • I tripled my position in Howard Hughes (HHC) this year, which although high conviction had fallen in position size the last few years.  Initially, I bought more in March prior to the strategic alternatives announcement and then again during the fallout of the company announcing the strategy review failed to find a buyer.  The "new" strategy laid out following the failed auction is really the same strategy the company has had all along, just maybe sped up a little, with less overhead (a fair and constant knock against my SOTP analysis) and now with the company returning cash to shareholders through a buyback funded via asset sales that should have been disposed of some time ago.  It's still a great asset with plenty of internally generated growth opportunities, if its chronically undervalued by the public markets, so what, should still provide an attractive long term return to patient shareholders.
    • Yesterday (after I wrote the above), HHC announced a large deal with Occidental to acquire their Houston area real estate assets, including two towers in The Woodlands Town Center.  While not optically in line with the asset disposal strategy, its right in line with their long term thesis in controlling the supply in their master planned communities.  It's one of the few cases where a commercial real estate transaction can provide true synergies outside of just overhead cost cutting as HHC will now own even more of The Woodlands sub-market and can control when and where new supply comes online.  Occidental is a bit of a forced seller as they repair their balance sheet following the acquisition of Anadarko this year.  As part of the deal, they also bought Occidental's 63-acre corporate campus in Houston, they'll be selling the campus immediately, I imagine the net price paid for the additional Woodland's assets will look quite cheap once the dust settles.
  • I still continue to like Green Brick Partners (GRBK) as the home building cycle continues to recover from the recession, it's likely not super cheap as book value is roughly right (all the land bought up cheap following the recession as been built on/sold), but we could easily wake up one morning to news that it is being sold to a larger builder.  The NOL is gone and David Einhorn needs a win after all these years, however it is a confusing/unique builder in its structure and hard to know how a buyer would view some of the related party friends and family type arrangements with the underlying legacy builders.
  • I also continue to like my other large legacy positions in MMA Capital Holdings (MMAC) and Par Pacific Holdings (PARR) but don't have much new to add, always open to questions in the comment section.  Same goes for simpler businesses like Wyndham Hotels & Resorts (WH) and Perspecta (PRSP), both are relatively asset-lite and cheap compared to peers, both did some smaller M&A this year that I think was beneficial and I continue to like them longer term although they're lower down my conviction scale.  My two cable positions I kept steady this year in GCI Liberty (GLIBA) and Liberty Latin America (LILA), I'm a cable noob and mostly cloning others here to mixed results but continue to hold.

Closed Positions:
  • Spirit MTA REIT (SMTA) was one of my biggest gains ever, I was consistently over optimistic on the ultimate value but that gave me the conviction (rightly or wrongly) to size up my position and be rewarded for being directionally right on the sale process outcome.  I did sell out of it prior to SMTA becoming a liquidating trust, management's estimate of the remaining proceeds was below my expectations and the upside relies on the fate of the bankruptcy proceedings of a small day-care operator.  To me it's not worth the pain of no liquidity and dealing with a K-1, but I hope it works out for those left in it and thanks for the lively discussion in the comment sections of my posts, really was beneficial to me and hopefully others.
  • Closed out both sides of my IAA and KAR Auction Services (KAR) trade from the first half that I discussed in my mid-year review, haven't paid too close of attention since then but the KAR side is probably cheap. 
  • Command Center (CCNI), now called HireQuest, worked out essentially as expected following the close of their reverse merger and tender offer.  I sold at roughly today's prices, management doesn't give off shareholder friendly vibes and the company's business model is particularly economically sensitive, figured it was an easy win to book and move on.  While I didn't make a huge profit on CCNI, it did give me the confidence to size up FRG more when that transaction shared a lot of similarities to CCNI.
  • Gannett's (GCI) merger with New Media was announced and closed, I initially closed my position the day of the announcement before the market seemed to digest the news that the combined company would cut their outsized dividend in half.  The stock dropped hard and I attempted to bottom fish (New Media's external manager, Fortress, creates some of the best/most misleading investor presentations), that didn't work out and lost some of my gains, the deal closed and now I'm once again done with newspaper companies.
  • Small merger arb names that closed and mostly worked out as expected (maybe with a few stressful days) were Empire Resorts (NYNY), Northstar Realty Europe (NRE) and Speedway Motorsports (TRK).
  • I cleared out of a few busted spinoffs -- CorePoint Lodging (CPLG), Donnelley Financial Solutions (DFIN) and KLX Energy Services (KLXE) -- that I had sizable losses in and given the good year, needed to offset some gains.  Somewhere in my mind I still believe in the thesis for each, but using tax loss harvesting as an excuse to sell can be a helpful way to reset your brain on a company for a while.  Don't be surprised if DFIN or KLXE make a return visit to my portfolio, but I'm likely done with CPLG as I've replaced it with Extended Stay America (STAY) that operates in a similar market segment plus has the benefit of owning the management company (which will one day be split off). 
    • I've heard others argue that spinoffs are no longer attractive or we're seeing lower quality ones, that might be true, but I don't remember Joel Greenblatt ever saying that all spinoffs should be bought in a systematic way like an ETF factor, just that they can sometimes be mis-priced, good places to fish.  There seem to be fewer of them on the calendar for 2020 (MSG looks interesting but heavily followed and I have a hard time valuing the entertainment company; HDS might be one to look closer at as it separates into two, seemingly under the radar and the MRO business is a quality one), so we'll get a natural break as the cycle continues but I imagine we'll still see some interesting opportunities before too long and its a good place to continue to look for value.
  • Despite my Craft Brew Alliance (BREW) thesis being wrong and AB InBev passing on their $24.50 option to buy BREW in August, AB InBev did come back to the table and offered $16.50 for the company.  I should have been out of the stock using any reasonable risk management parameters, but instead I purchased shares shortly after the deal deadline passed and then further doubled down and bought call options (done for a tax loss, I sometimes like to double down for 31 days using options and then sell the original shares for a loss, mentally this helps me put an exit date to the trade whenever the options expire).  I admittedly got extremely lucky on the timing and the deal announcement happened when I had twice the exposure I really wanted or intended.  I'll be selling my position once the calendar turns over to push the tax bill out another year.
  • In October 2018, I did a similar trade with Wyndham Destinations (WYND) to realize some losses on the common and bought call options that will expire in a few weeks, those worked out nicely as the economic outlook bounced back providing a lift to the economically sensitive timeshare sector.  I'll be selling those as well once the calendar flips, fortunately the gains are long term for tax purposes, which is an additional benefit to buying/holding leaps.
  • Miscellaneous: 1) I participated in the Danaher (DHR) exchange offer for Envista Holdings (NVST) and then sold immediately upon receiving my NVST shares; 2) the Miramar Labs (MRLB) CVR has begun to pay out and should be fully realized in 2020; 3) I own the Celgene CVR (BMY RT) that was issued as part of the Bristol Myers Squibb (BMY) acquisition, I put the trade on with a fair amount of leverage on the closing day, didn't really work out pre-deal like I hoped but I like these kind of risk/reward payoffs in small sizes. 
Performance Attribution
Grayed out are closed positions
Portfolio as of 12/31/19 
No cash was added or withdrawn this year, and to clarify, average cost is my current cost basis and not my historical - this is a taxable account and I try to trade around positions to harvest losses where possible.  If everything goes to plan with some of these smaller merger arbitrage and liquidations, I should have a decent amount of cash (margin free) for the first time in many years, so I'm actively looking for ideas, please send any my way!  Thank you for reading and have a happy and safe New Years.

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.

Tuesday, December 3, 2019

Accel Entertainment: SPAC, Distributed Gaming in IL

I did it, I finally fell for a special purpose acquisition company ("SPAC") pitch -- Accel Entertainment (ACEL) came public via a merger with TPG Pace Holdings (TPGH) and is one of the largest distributed gaming companies in the United States, although currently they only operate in Illinois, where my family and I reside.  Distributed gaming is where a bar or a truck stop (technically anyone with a liquor license) contracts with a company like Accel to place video gaming terminals ("VGTs" but kind way of saying slot machines) in their establishment with a revenue share agreement between the two parties.  Accel owns and operates the machines, but in an asset-lite fashion as the local business owner has all the real estate, operating risk and expense of running a bar/restaurant/truck stop.  You can think of distributed gaming as an operating casino but without the capital intensity of owning the real estate or the capitalized lease of operating a large casino.  Here's the basic business model:
Illinois is a fiscally challenged state that has gone all-in on gambling as a tax revenue source, recently approving 5 additional casinos plus 1 mega-casino within the Chicago city limits (where there currently are no casinos or VGTs in bars/restaurants), a 60% increase from the 10 commercial casinos that have been in operation historically.  As part of this gambling expansion, lawmakers also increased the maximum bet size from $2 to $4 and increased the number of VGTs a liquor license holder can have from 5 to 6 machines.  While the legislation was passed in July, neither the increase in the number of machines nor the increase in hold percentage has been meaningfully rolled out yet.  Each municipality in Illinois is additionally strained for tax revenue and competition among bars is intense, thus it's increasingly becoming necessary for a local dive bar to have gaming terminals on their premise.  If your town doesn't allow VGTs, chances are the town over does and customers may follow (alongside the food/beverage sales tax that local governments survive on).  The state needs revenue, local bar and restaurant owners need new sources of revenue especially with rising labor prices, all setting up a nice tailwind for continued distributed gaming growth in Illinois that was only legalized in 2012.

Distributed gaming is disrupting regional casinos, it is more convenient for gamblers to drive to a local bar they might already frequent than to drive an hour to one of the first generation riverboat style casinos that doesn't provide much more in terms of experience than a typical bar.  Gaming tax revenue via VGT surpassed that of the casinos in Illinois for the first time last year, giving them a possible lobbying advantage for continued expansion in the future.  The big wildcard is Chicago, which currently does not allow VGTs within the city limits, given Chicago's fiscal situation (it's not good) that will likely change in the future as well which would provide a massive boost to the distributed gaming industry.  VGTs, like the lotto, are an easy short term fix for politicians looking to avoid raising property taxes.

The new gaming law isn't all positive for operators, the Illinois tax rate on VGTs is increasing from 30% to 34% in 2020, the VGT operator (Accel) and the business owner by law must split the revenue 50/50, essentially the government (mix of state and local) gets 1/3rd, VGT operator gets 1/3rd and the business owner gets 1/3rd.  Since VGT operators can't compete on price in Illinois, it means they must compete on service, machine quality, and other areas where scale will give Accel an advantage over smaller competitors that can't spread those costs over a larger base, have buying power with suppliers or don't have the accumulate data that Accel has built up to help improve operations.  Fixing the pricing also creates sort of a unnatural oligopoly structure to the industry in Illinois (this is not the case in other markets like NV or MT), there won't be pressure to reduce their split or lose a contract and the gambling customer base isn't price sensitive (the hold rate on Accel's machines is about 8%, meaning it'll pay back about $0.92 of every dollar played) creating a pretty durable margin.

Scale matters, this is a fragmented industry with a lot of potential to roll-up the smaller players in the state and enter into new jurisdictions as more states legalize distributed gaming as a way to increase their tax revenues.  Accel has been a serial acquirer of smaller Illinois competitors, they've completed 9 deals since distributed gaming was legalized in 2012, and now that they have a public stock as currency, I would anticipate them doing more in the future.  Smaller operators in Illinois or elsewhere in the country might find it attractive to sell to Accel yet retain some equity upside in a liquid public stock.  Rolling up an industry like this seems less risky as the end product and pricing is generally the same, its a fairly standardized product and since pricing is fixed, you're not expected to share any synergies with the customer.  Accel also has a conditional license to operate in Pennsylvania, where lawmakers recently approved VGTs located in truck stops, a potential first step before a broader roll out to other liquor license holders, it will be a small market initially, but like Illinois, Pennsylvania has really pushed gaming as a tax revenue source.

Accel is projecting about $115MM in EBITDA for 2020, after their most recently closed acquisition, they have over 10,000 VGTs and representing about 1/3rd of the Illinois market.  Maintenance capital expenditures are pretty limited, mostly just servicing existing machines occasionally, creating a pretty attractive free cash flow conversion rate.  Using management estimates (its a SPAC, these could be wildly ambitious and include a lot of assumptions from the new gaming expansion and recent acquisitions), I'm coming up with ACEL trading around 9.2x EBITDA or a just sub 10% free cash flow yield (pre-growth capex).
There aren't any great public peers (seems to be the case with all SPACs, that way they can always comp themselves against inappropriate peers) but on an absolute basis that doesn't seem particularly expensive for what should be a pretty durable, growing and recurring revenue stream.  Boyd Gaming (BYD) did buy a Illinois distributed gaming peer for 8x EBITDA in 2018 and Golden Entertainment (GDEN) which is a mix of Las Vegas local casinos and distributed gaming trades quite a bit cheaper but also has significant debt and is more capital intensive.  I would imagine Accel performing better through a recession than casino peers as gamblers choose the hyper-local option over making a day out of traveling to a regional casino.  That along with their asset-lite model, lower leverage, and growth profile means Accel should trade for a decent premium over gaming peers.

I bought a small toehold position, could be a mistake as the SPAC aspect makes me nervous, but I like the business.

Other Thoughts:
  • There's some poor counterparty credit risk aspect to their business model, they partner with small local mom and pop type operators, you're not likely to see VGTs at a Buffalo Wild Wings for example, but you will in the beat up corner bar.  Bars and restaurants go out of business regularly and their 7 year contracts aren't enforceable if the business in question closes down.
  • No one is going to include Accel in an ESG portfolio, it's about the opposite of ESG, VGTs are an eye sore (often they're in a separate room with a seedy looking saloon door entrance), encourages addictive gambling and just not a great productive use of time/money for society, truly a tax on the addicted and often poor.  But it's a proven business model and the hold percentage is much better to players than say the state lotto industry.
  • Accel currently doesn't have a players rewards program that many gaming companies utilize to market to and retain customers.  Given distributed gaming is a natural competitor to the regional casinos, could it make sense for someone like PENN to acquire Accel, roll out their rewards program and link the two customer bases together to drive people to the regional casinos?  It's unclear if current regulations would allow Accel to have a rewards program, but an eventual combination with a regional casino player could make sense.
  • Accel also does similar arrangements with other bar equipment like pool tables, darts, jukeboxes, sort of an open a bar out of the box type arrangement, but the non-gaming side is just sub-5% of total revenues.
  • Like every other SPAC, Accel does have warrants that will dilute equity at $11.50 and above, the capital structure is a bit confusing but that's par for the course for a SPAC, I imagine they'll attempt to buyback some of the warrants.
  • They pitched themselves as a "gaming-as-a-service" company in the SPAC investor decks, thankfully that's been removed in the latest post-merger presentation on their website, seemed a little scuzzy even for a distributed gaming SPAC.
  • Every SPAC needs a story on why it went the SPAC route versus the traditional IPO route -- Clairvest is a Canadian PE firm with a solid track record in gaming (they own a chunk of the highly successful Rivers Casino just outside O'Hare Airport) that owns a piece of Accel, they had some board and governance rights if the company went IPO but not if the company merged with a SPAC.  Clairvest ultimately sued and recently the two sides came to an agreement with Clairvest remaining equity owners in Accel and getting a board seat.  Unclear to me what the dispute was between Clairvest and Accel that started the SPAC route, but in the end its been resolved somewhat amicably, make with that story what you will.
Disclosure: I own shares of ACEL

Friday, November 15, 2019

Hilton Grand Vacations: In Play, Speculating on a Deal

Another idea I'm returning to after it has received some takeover speculation is Hilton Grand Vacations (HGV), as a quick recap, HGV is Hilton Worldwide's (HLT) timeshare business that was spun (alongside Park Hotels & Resorts) from Hilton at the end of 2016.  I won't go through the timeshare business (I've done that a few times previously) but of the other two larger timeshare rivals (VAC and WYND), HGV is a pure play on one brand without an exchange or rental business, making it a simpler candidate for consolidation.

HGV ran into some accounting noise and operational/timing issues with their inventory strategy that caused a selloff in their shares opening the door for an activist or an unsolicited bid.  In August, the NY Post reported that private equity behemoth Apollo Global (APO) was interested in making a bid for HGV.  Apollo previously took unbranded (and somewhat controversial) timeshare operator Diamond Resorts International (DRII) private in 2016, and tried to re-list shortly after in 2018 but pulled the IPO.  Apollo clearly got feedback that the public markets weren't interested in an as-is Diamond Resorts (they've recently dropped the "International" from their name) at an acceptable valuation to Apollo, so they need a plan B.  It appears plan B could be to take HGV private and merge it with Diamond, re-brand the HoldCo and bring it back public without the same Diamond brand stench.  Some point to the risk that Hilton needs to consent to a merger, this is true, but it seems contemplated that HGV would be acquired or operate non-Hilton branded timeshare properties with the caveat that it would be operated separately from Hilton branded properties and without access to the loyalty program, from the 10-K:
We are able to operate vacation ownership properties under other brands (with no royalty due to Hilton) if we do so without using any Hilton IP or Hilton Data and they are otherwise separate operations from the Licensed Business.
And they would likely lose the Hilton Grand Vacations name per the licensing agreement since Diamond has more units than HGV, again from the 10-K:
Under the license agreement, our right to use the Hilton Marks as a trade, corporate, d/b/a or similar name will automatically terminate if (i) the aggregate number of units of accommodation in our Licensed Business falls below two-thirds of the total number of units of accommodation in our entire vacation ownership business; (ii) we merge with or acquire control of the assets of Marriott International, Inc., Marriott Vacations Worldwide Corporation, Hyatt Hotels Corporation, Wyndham Destinations and Interval Leisure Group, Inc.  or their respective affiliates and we or they use their brands in any business after such acquisition; or (iii) we become an affiliate of another Hilton competitor.
It wouldn't be the first time potentially competing (is Diamond technically a Hilton competitor?) hotel brand flags were housed under the same corporate timeshare entity, ILG had the Hyatt brand and first merged with Vistana which housed Starwood's timeshare business before being brought back into the Marriott/Starwood fold when it was purchased by Marriott Vacations Worldwide (VAC).  But the Hyatt timeshare properties remain at VAC, although they represent a much smaller percentage than Diamond's properties would be under a proposed HGV/Diamond merger.  Why might Hilton consent?  HGV pays a 5% royalty on all timeshare sales, this amounted to $100MM in 2018 (and essentially falls straight to HLT's bottom line), a well capitalized and scaled HGV is to their advantage, I'm sure the team at Apollo can come with a few slides showing how this revenue stream could grow in the coming years with Diamond cash flow being used to fund HGV inventory and growth.

The other buyer being mentioned is Blackstone (BX), they took Hilton private in 2008 but no longer have a significant investment in HGV having divested their stake in 2017.  They're familiar with the business, but they'd be strictly a financial buyer and seem less likely to be the winner.  Worth noting that Blackstone's president, Jonathan Gray, is also the chairman of Hilton, unclear if that matters but seems noteworthy.  Additionally, I wouldn't count out Wyndham Destinations (WYND) being involved in the bidding process either (although their stock trades well below that of HGV), there are lot of potential synergies and HGV is part of the WYND's RCI exchange network, plus it could move WYND slightly up market and bring down Wyndham's persistently high loan loss reserve averages.

HGV's management at least acknowledges the benefits of industry consolidation, essentially confirming the rumors, from the most recent earnings call:
Stephen Grambling: Great, and I appreciate you can't comment on the reports out there on M&A, takeover stuff specifically, but how do you generically think about the positive and negatives of consolidation in the space, and perhaps tying in anything that’s specific to HGV?
Mark Wang: Yes, Stephen, it's Mark. I think we recognize the value proposition of consolidation in our industry and other industries. I think, from our perspective, some of the key reasons for consolidation is you want to improve your asset base, you want to strengthen your brand, and in this industry's case, you want to have the access to a pipeline of incremental new customers. So, I'd say, look, we've got a great set of assets and we have this great brand and relationship with Hilton, and we've talked about the tour pipeline that they provide us, and we've had a long and strong history of execution and growth. So, look, I think consolidation has been positive in the industry and we understand the rationale behind it.
Clearly he's speaking from HGV's attractiveness as an asset and not how an acquirer might help HGV, but I think his comments could apply to either Apollo/Diamond or Wyndham quite nicely, primarily access to Hilton's growing hotel and customer base needed to source additional timeshare owners.

In the latest round of bidding, Bloomberg reported Apollo's bid is $40 and the stock currently trades for $35+ showing some skeptism that the deal will be consumated.  From a valuation perspective, HGV sits essentially in-line with VAC on 2020 estimates:
In 2018, VAC purchased ILG for a total enterprise value of approximately $4.7B on $365MM of EBITDA plus $75MM of synergies, for a fully synergized multiple of ~10.5x EBITDA.  ILG had an exchange business that while low/no growth is a free cash flow machine and likely pushed the overall multiple up some.  But let's say the number needed to finalize an HGV deal is $42, with no synergies that would be 10x multiple and using a $50MM synergy number gets it back down to just under 9x, quite attractive for control over a timeshare business with a quickly growing hotel chain like Hilton.

Other Thoughts:
  • Elliott Management was rumored to be involved in HGV, but it doesn't show up in their recent 13F, probably doesn't mean anything - maybe they never owned it, but worth closing that loop.
  • HGV offers a fixed/week interval product while Diamond Resorts uses a points based product, maybe a little additional culture clash to be concerned about, or Apollo could see an opportunity to modernize HGV's product into a points based system (one benefit of the points based system for the timeshare operator is its easier to sell upgrades to existing owners)
In summary, we have several buyers, both strategic and financial, circling HGV, I'm surprised that shares are trading well below the $40 reported first bid even if HLT needs to provide its approval.

Disclosure: I own HGV calls (also remain long WYND)

Franchise Group: fka Liberty Tax, Franchise Rollup

Franchise Group (FRG) is the result of the odd conglomeration of: 1) Liberty Tax (old TAXA); 2) Buddy's, a franchised chain of rent-to-own electronics and furniture stores; 3) Sears Outlet business; and soon to be 4) Vitamin Shoppe (VSI); that is being orchestrated by Vintage Capital's Brian Kahn who was recently named the CEO of the newly launched platform company.  Andrew Walker posted two excellent write-ups (here and here) on the situation a couple months ago, I won't do it the same justice, but I'll run through my thoughts anyway as I took a position in it.

Liberty Tax is the third largest tax preparer, well behind both H&R Block and Jackson Hewitt, the tax preparer market is a highly fragmented business with a lot of mom and pops.  It is the type of franchise business where you effectively own your job and you outsource the marketing and back-office infrastructure to the franchiser.  Liberty's business model is mostly targeted at lower income taxpayers who are unlikely to purchase TurboTax or do-it-yourself type software, they want someone else to do it quickly for them and assist in getting their refund as fast as possible, it's a decent business that should be relatively stable.  However, in 2018 Liberty Tax's founder and CEO was forced out after a sex scandal was uncovered and his shares where sold to Vintage Capital that July.  The company understandably struggled through this upheaval and EBITDA dropped 17% from 2017 levels to $35MM (9/30 fiscal year end).  Then in November 2018, TAXA received an acquisition proposal for $13 per share from a private equity buyer that ended up going no where.

Concurrently with all that, Vintage Capital was wrapped up in a bizarre failed merger with Rent-a-Center (RCII) which competes in the same rent-to-own market as Vintage's Buddy's chain with Vintage forgetting to execute a routine extension to the merger agreement that allowed Rent-a-Center to break the deal and force Vintage to pay a substantial break up fee.  Presumably Vintage was going to merge Buddy's with Rent-a-Center and continue to pursue a franchise model.  With that deal off, Vintage moved to Liberty Tax where they already had a substantial holding and offered to recapitalize the company and give existing shareholders an option to tender their shares at $12, a substantial premium to where the shares had fallen after the $13 buyer had backed away.  As part of the transaction, Liberty Tax bought Vintage's Buddy's chain of stores and created "Franchise Group" to pursue a rollup strategy of franchised or "franchisable" businesses.

Since the creation of Franchise Group, Vintage isn't wasting time buying additional struggling businesses, since the merger with Buddy's, they've entered into two transactions but while both Liberty Tax and Buddy's are primarily franchised, the next two fall into the franchisable category.  The first announced was with Vitamin Shoppe (VSI), a struggling vitamin and nutrition retailer that is being disrupted by internet shopping.  The second transaction announced, which just recently closed, is with Sears Hometown and Outlet for the Sears Outlet business and the 8 Buddy's stores that SHOS operated.  My guess is overtime these Sears Outlet stores more or less end up looking like or being re-branded to Buddy's stores as they sell similar household durable type items to the lower income segment.

There's a lot going on here, its a complex situation that I'd guess very few people are looking closely at, volume has been minimal and it just today uplisted back to the NASDAQ under the FRG symbol.  I'm sure there are quite a few mistakes with the below, so do your own homework as well, but I tried to come up with a proforma look at what the combined company might look like once the dust settles.
Most of these numbers are pulled from the recently completed tender offer and the VSI proxy statement.  Alongside the closing of the Sears Outlet transaction, they went ahead and franchised 5 stores to "A-Team" for $15MM (they have 120 more stores).  The tender offer closed this week with just under 4 million shares participating at $12.  Throwing it all together on an admittedly back of the envelope fashion, I come up with the proforma company trading at roughly 5x EBITDA.  Franchise businesses trade all over the map, but generally well above 5x -- a rent-to-own comp like RCII for example trades over 7x EBITDA and they are still mostly company operated stores.  It's hard to put an exact value on FRG, but I'm guessing there are a lot of value levers to pull here and if it works out (and the economy doesn't rollover) could be a multi-bagger.

Disclosure: I own shares of FRG

Ben Franklin Financial: Tiny Bank Merger and Liquidation

Ben Franklin Financial (BFFI) is a tiny (sub $10MM market cap) two branch community bank located in the northwest Chicago suburb of Arlington Heights that completed its second step mutual-to-stock conversion in 2015.  Ben Franklin Financial is a pretty straight forward community bank, it takes in deposits from a small local radius and primarily turns around and makes a mix of residential mortgages and commercial loans.  At just under $100 million in assets, Ben Franklin Financial is sub-scale, poorly managed and as a result loss making bank (to pile on, BFFI was also operating under an OCC consent order until this past February) that caught the attention of community bank activist Joseph Stilwell who encouraged the company to pursue shareholder friendly actions like repurchasing shares or pursuing a sale.  In July, the company announced a unique sale transaction with Illinois based Corporate America Family Credit Union ("CAFCU") for between $10.33 and $10.70 for shareholders, the stock bounces between $9.60 and $9.80 today.  Why sell to a credit union?  Since a credit union is technically non-profit, they might be willing to pay more for a struggling operation like BFFI since they just need to cover their operating costs.  The credit union buying a bank thing is a recent trend but this is a first of its kind transaction where the credit union is purchasing a bank that converted from a mutual holding company.  The catch being there is some uncertainty as to how depositors who did not participate in the mutual conversion process will be treated in the liquidation and other uncertainties like terminating employee benefit plans.  Not only is the amount uncertain, but the timing is as well, the transaction with CAFCU is expected to close in early 2020 with the distribution to shareholders occurring "within several months", thus this is more of a two step process, an asset sale and then a liquidation rather than a clean merger.

Assuming a 5/15/2020 payment date (call it 4 months after an early 2020 transaction settlement) and I get an IRR of between 12% and 20% off of the last trade at $9.75 or gross returns between 6% and 10%.
Maybe I'm underestimating the possibility of the deal breaking but I think you're getting paid for the illiquidity of a nano cap and the uncertainty of both the ultimate payout and timing, both risks that a small personal account like mine is well suited to take.

Disclosure: I own shares of BFFI

Asta Funding: Going Private Offer

Asta Funding (ASFI) is an old familiar name in the value investing community (I owned it for a stretch), it was once primarily a buyer of defaulted consumer debt for pennies on the dollar that would then go out and sue debtors in order to garnish their wages and recoup their investment, fun stuff.  Following the financial crisis, Asta took a writedown of most of the value in one of their large consumer receivables portfolios but it ended up still cash flowing and looked cheap with this potentially large zero basis asset.  They used those cash flows to diversify into similarly unsavory financial services businesses without much logic such as social security disability advocacy, personal injury claims and structured settlements.  This is a family controlled business and they have treated it that way in the past, they had a dust-up with Mangrove Partners which Asta ultimately ended up paying what looked like greenmail with a large tender offer, followed by a special dividend for most of the market capitalization pushing it further into microcap terriority, then had to restate years of financials, all of which led the shares to be completely ignored by the market.  For a while there it was trading below cash, a clear error of omission on my part not jumping on it then as I've always kept ASFI on my watchlist.

But on November 1, Gary Stern, Asta's Chairman and CEO offered to purchase the remaining outstanding public float (the Stern family owns ~60% of the company) for $10.75 per share conditioned upon acceptance by a special committee of independent directors and a majority of the minority shareholders vote for its approval.  Given the premium to where shares had been trading, I would expect both to be relatively easy to obtain.  Book value is about $13.50 with more than half that being cash, maybe there's a tiny chance of a bump.  But the board is only 5 members, one of which is Gary Stern, two of them have been on the board since the mid-2000s and have let this situation play out to-date, the other two are relatively new but likely friendly with the Stern family given the controlled status.  Even without a bump, financing should be a breeze considering the Sterns can dividend out the cash to themselves when in full control making this a low risk idea.

It's about a 6% gross spread, not fantastic, but I'm familiar with the company and its management, I see this as their opportunity to return to a family company and operating in the dark without pesky minority shareholders or exchange listing requirements (about half their press releases in recent years are NASDAQ de-listing notices).  Plus I have some dry powder and have been stashing cash in more small special situations like this until I find more mainstream ideas.

Disclosure: I own shares of ASFI

Thursday, September 12, 2019

Syncora Holdings: Operating Business Sold, Cash and NOL Stub

Syncora Holdings (SYCRF), through its subsidiary Syncora Guarantee ("SGI"), is a provider of bond insurance that ran into a whole bunch of trouble following the financial crisis.  Like the other bond insurers, Syncora branched out beyond municipal insurance (to be fair, they did also suffer with Detroit and Puerto Rico) to subprime RMBS, CDOs and other toxic securitizations of the pre-crisis era.  During and following the recession, many of the supposedly AAA structured securities were impaired and Syncora was called upon to make good on their guarantee which forced the insurer to the brink of insolvency.

In the decade since, Syncora has been in constant litigation (they scored several huge settlements with banks that issued subprime RMBS) and restructuring mode.  Previously a bit of a black box, Syncora last month sold SGI to an affiliate of credit manager Golden Tree Asset Management for $392.5MM with a go-shop period through September 13th.  It then re-struct the sale price higher with Golden Tree this past week to $429MM plus the assumption of some preferred share pass-thru securities that wasn't originally included in the deal after receiving an unnamed unsolicited offer (the go-shop was also cancelled).  Once the transaction with Golden Tree closes in Q4/Q1, Syncora plans to distribute the sale proceeds to shareholders, all that will remain is $30+MM of cash and miscellaneous assets (valued at $45-60MM total including the cash) plus around $300MM of net operating losses.

Syncora has 87 million shares outstanding, assuming about $20MM in leakage and other deal related expenses, the company will likely distribute cash back to shareholders roughly equaling today's $4.70 share price.
Assumes no value attributed to the NOL
What is the company going to do with the stub after the SGI deal closes?  Anyone's guess, it will be a tiny shell with a few random assets (waterfront raw land in Detroit, 80% of Swap Financial), management claims to be in active conversations with their advisers on a transaction, but the NOL monetization dream is elusive for many if not nearly all similar NOL shell stories.  So maybe the 30% discount to NAV needs to be a touch higher, at a 50% discount I come up with a 16% IRR, still an attractive situation.

Disclosure: I own shares of SYCRF

Wednesday, August 21, 2019

Avenue Therapeutics: Two-Step Merger with Cipla, CVR

Avenue Therapeutics (ATXI) is a one product development stage biotech with a binary investment outcome (let's be honest, most small biotechs are binary, this one just more explicitly so) related to their Stock Purchase and Merger Agreement with a subsidiary of Cipla, an India based global generic pharmaceutical company.  On 11/12/18 (closed in February), Cipla (via their U.S. subsidiary InvaGen) announced the purchase of 33.3% of Avenue for $35MM or $6/share (where it trades today) and agreed to purchase the remaining shares for $180MM or $13.94/share conditional on the FDA approval of IV Tramadol as a Schedule IV drug for post-surgery pain relief.

Tramadol is a fairly common pain reliever (~40th most prescribed medication in the U.S.), it has been around for decades internationally and was first approved in pill form in the U.S. in 1995.  Tramadol is an opiod, but it's considered a weak or a non-conventional opiod, most of the conventional opiods are classified as Schedule II controlled substances by the DEA, which essentially means they're highly susceptible to misuse and abuse, Tramadol contrastingly is Schedule IV (DEA's schedule is a I-V ranking, I being the most dangerous/no medical use).  Given the growing awareness of the opiod epidemic in this country, there's an opportunity for a painkiller that sits somewhere between Schedule II opiods like morphine or Vicodin and over-the-counter drugs like Tylenol and Advil.

Tramadol is currently only approved in oral/pill form in the U.S., Avenue (via their controlling shareholder Fortress Biotech - FBIO) owns the exclusive license to develop and commercialize an intravenous ("IV") version of Tramadol, IV Tramadol is widely approved and used (~10% of IV painkiller market share in Europe) internationally but hasn't been approved for use in the United States.  Avenue has already completed two Phase 3 studies of IV Tramadol with positive results, for moderate to moderately severe pain IV Tramadol has generally performed as well as morphine (don't need something as strong as morphine if you're only in moderate pain, something weaker does the job just as well).  Currently the company is putting together their new drug application ("NDA") to submit to the FDA for approval.

The conditions of the merger specify:
  1. Final FDA approval of the Product on or before December 1, 2020, if as of such date there are no pending queries from the FDA with respect to such Product approval, but if there are such pending queries from the FDA as of such date, then such FDA approval shall have been obtained on or before April 30, 2021;
  2. Labelling for the Product containing an indication as moderate to moderately severe (post-operative) pain, not restricted to any specific type of surgery; and
  3. Classification of the Product by the U.S. Drug Enforcement Agency (“DEA”) as a Schedule IV Drug under applicable Legal Requirements; 
The timeline for FDA approval is typically about a year, 2 months of a preliminary review that justifies a full 10 month review of an NDA.  If Avenue is able (the company says they're on track) to complete and submit the NDA by the end of November, the 12/1/2020 deadline shouldn't be an issue.  By doing two Phase 3 studies (one for tummy tucks and one for bunion surgery) Avenue is going for the broad label and given IV Tramadol's widespread use, should have a good case for it.  The wildcard might be the Schedule IV classification, we are entering into an election season and opiod litigation is heavily in the news, if the DEA changes Tramadol to a Schedule II drug alongside the conventional opiods, that could blow a hole in the merger agreement.

If the merger is completed following FDA approval, Avenue shareholders will get an additional kicker in the form of a CVR tied to the sales of IV Tramadol with a $325MM annual revenue threshold with a favorable graduated tier scale above that.  One similar example to look at is IV acetaminophen (Tylenol), it is both a success story we can point to where it was approved in oral form for many years and then was only recently (well, 9 years ago) approved in IV form, but a quick Google and there's a lot of dispute whether the IV form is any different from than oral, especially hard to justify given that Mallinckrodt has done a series of price increases.  In 2017, IV acetaminophen did $300MM in sales, still below the CVR threshold for Tramadol many years after IV acetaminophen was commercialized.  But again, Tramadol might have a better chance of filling that pain gap than acetaminophen considering it's a weak opiod, either way, the CVR's value is likely many years off and not worth underwriting.

Avenue is an interesting binary outcome, the market is pricing in a less than 50% of chance of the merger with Cipla being completed, despite what appears to be a mostly straight forward FDA approval process (at least to this clueless retail investor) considering the drug is already approved in a different form in the U.S. and in the same form in many other developed markets.  Why is it mispriced?  Management answered this question by pointing to the lack of investor relations and promotion, they don't need additional financing after the deal with Cipla to complete the FDA approval process, so no need to promote the stock.  Makes some sense to me along with the relatively low float given the large stakes owned by FBIO and Cipla.  Additionally, I think people don't like such explicitly binary outcomes and general loss aversion keeps people away despite the seemingly favorable odds.  Thanks to "Ben's Jamin" who mentioned Avenue in a comment section a while back.

Disclosure: I own shares of ATXI

Industrial Services of America: Tiny Liquidation, Assets Sold to Nucor Sub

Another small personal account type idea:

Industrial Services of America (IDSA) is a nanocap ($9MM market cap but trades on the NASDAQ) metal recycling and auto salvage business headquartered in Louisville, KY doing business as ISA Recycling.  On August 19, the company announced the sale of substantially all of their assets to River Metals Recycling, a subsidiary of the large steel producer Nucor Corporation (NUE), for $23.3MM and following the sale, the dissolution of the company with proceeds being distributed to shareholders.  IDSA's balance sheet is a bit of a mess and the company was facing de-listing, but following the liquidation, IDSA expects to distribute $1.15-$1.35 per share, with the stock trading at ~$1.10 that's an attractive 13.5% spread to the mid-point.

The sale is expected to close late 4th quarter or early 1st quarter 2020, IDSA will likely need to reserve some cash following the sale to handle any final wind down expenses and other contingencies but I would expect the bulk of the distribution to happen alongside the asset sale with River Metals.  River Metals is a subsidiary of The David J Joseph Company which is Nucor's scrap metal recycling business, they're in the same business as IDSA so this deal makes plenty of strategic sense, clean tuck-in transaction.  IDSA is heavily owned by insiders including over 20% of the shares owned by the former CEO's family trust, perhaps the family was disinterested and wanted to cash out?  IDSA shareholders will need to approve, but again, it is a fairly tightly controlled company.  It's worth mentioning there is also a closing contingency around a storm-water drain, hard to handicap that.  Anyway, seems like an attractive situation, any thoughts welcome.

Disclosure: I own shares of IDSA

Wednesday, August 7, 2019

Extended Stay America: Rejects Split-Up, Underlying Value Here

Extended Stay America (STAY) is the last remaining public company of size that is an integrated hotel operator and owner of their real estate in the United States (other than Hyatt which is family controlled).  As their name suggests, they compete and are the largest player within the extended stay lodging segment where the average guest stays anywhere from a week to several months.  Demand for the extended stay segment is typically not leisure driven, but rather temporary business assignments, training, relocation bridge housing, medical, or other needs that could span a few weeks.  Extended Stay America has a unique corporate structure where the publicly traded STAY is a "paired" stock, underlying STAY is a hotel management company ("Extended Stay America Inc") and a REIT ("ESH Hospitality Inc"), this structure provides most of the tax benefits of a REIT without the conflicts that can arise between OpCo and PropCo.  ESH Hospitality is 43% owned directly by shareholders via the paired stock structure and 57% owned by Extended Stay America Inc which pays corporate taxes on the dividends received from the REIT.  In the summer of 2018, the company announced it was exploring strategic alternatives with most assuming either a true spinoff or a sale of the management company to one of the hotel brand aggregators with a simultaneous spin of ESH Hospitality (similar to LQ/CPLG/WH last year).  Today, along with earnings, the company announced that it had concluded its strategic review and was going to maintain the status quo, the stock fell 5-10% on the news.

It had been over a year now since that strategic alternatives announcement, the first quarter conference call got a little chippy and some fatigue had built up in the investor base.  Given the relative size of the franchising business and where multiples in the sector are today (especially on the REIT side), I think the company made the right move and event driven sellers (along with the general slide in the market) are providing an opportunity to pick up shares of STAY at a discounted price.

Most of the value is in the real estate and not the management company (unfortunately), as of 6/30, the REIT owned 554 hotels with 61,500 rooms, the management company managed an additional 73 hotels for third parties with 55 more in various stages in the pipeline.  By maintaining the status quo, it allows the franchise side of the business to build up with new construction or conversions, plus ESH plans more asset sales to third parties.   But eventually, the company will succumb to pressure and split the company somehow.  How might that look?

Just to give an idea how STAY is valued today, it essentially trades at the bottom end of the limited service lodging REITs group despite not having to pay a third party management company for its owned properties and having a small franchising business.  Sure there is some tax leakage with the pair structure compared with a pure REIT, but the optionality (it's going to happen someday) on the sale of the management business should make it more valuable than REIT peers, not less.
The extended stay business model is fairly high margin (no frills, rooms cleaned once a week) and STAY generates a decent amount of free cash, roughly $325MM on their current asset base using a maintenance capex of 7% of revenues.  At today's prices, that's a 12% free cash flow yield to the equity.  Looking at it another way, using $80MM of maintenance capex on $564 in EBITDA, STAY is trading at 10x UFCF when they've been selling hotels at ~17x that metric over the past few years.  Management did caution today not to assume that 17x multiple on future asset sales, the next round will be their lower performing hotels, but it's still a useful read through to the disconnect between private and public multiples in real estate today.

Back to what a split might look like: ESH Hospitality would be another economy-midscale REIT similar to CorePoint Lodging (CPLG), it would have the most keys of any lodging REIT but a relatively small market valuation.  If we assume that STAY puts a similarly egregious management and franchise contract on ESH Hospitality as Wyndham/LQ did to CorePoint (I don't think this will be the case since most of the value is in the REIT) with a 5% management fee and a 5% franchise fee, I come up with the following back-of-the-envelope breakout between the two:
Sticking with the LQ/WYN comparisons, if we value the management company similarly to Wyndham Hotels (WH) at 12x and the REIT at 9x similarly to CorePoint Lodging (CPLG), STAY would equate to a combined value of $17+/share versus $14.50 today.  Again, I think this is the worst case split scenario as hopefully management has learned a lesson from CPLG and wouldn't put that management contract on the larger piece of the business.  If the market slowdown passes without a recession we could additionally see multiple expansion back to where lodging REITs traded in 2017-2018.  If the management company were sold versus split off, there would be additional upside as the G&A would essentially be wiped out, perhaps $20+ per share in total under that scenario using today's multiples.  To be clear, this split isn't happening in the near term, but it shows the underlying value in their operations and I believe it's only a matter of time before the market really forces management's hands.

Other thoughts:
  • Just one example of the benefit to STAY's management company being part of a larger brand, as a one-brand entity, Extended Stay's loyalty program is small (under 3 million members), plugging the brand into a larger rewards program could prove valuable to people who are on a temporary work assignment and can use their points on a resort vacation versus another sterile Extended Stay property off the side of the interstate.
  • Labor costs are really squeezing hotel operators at this point in the cycle, unemployment rates are so low that they're having a hard time recruiting labor and are mostly unable to pass that additional cost onto customers.
  • STAY increased their buyback authorization, they have $263MM remaining which is roughly 10% of share outstanding, on the conference call they made it clear they intend exhaust the authorization this year.  Alongside a ~6% dividend yield and that's a compelling total "shareholder yield".
  • Their numbers can look a little messy on a year-over-year basis as they've been selling hotels to third parties, to normalize the 2019 EBITDA vs 2018, you would need to add $21MM for the sold hotels.
  • Management also talked about what a recession might do to their results, anywhere from a $50MM hit to EBITDA in a mild downturn to $100MM hit in a more severe recession, taking those haircuts off of current EBITDA means it would be trading at 9.5-10.5x, certainly not a high valuation considering lodging REITs were trading for 11-12x not too long ago.
Disclosure: I own shares of STAY (continue to own CPLG and WH too)

Empire Resorts: Going Private Offer, Possible Bump?

Empire Resorts (NYNY) is a one property newly built casino resort ("Resorts World Catskills") located about 90 miles from Manhattan in the Catskills region of New York.  The Resorts World branded casino cost ~$1B to build and opened in 2018, it has struggled to ramp up in the year or so that it's been open.  Empire Resorts is 86% owned and controlled by Malaysian billionaire KT Lim, chairman of the Genting Group, via a family trust ("Kien Huat").  On August 5th, Kien Huat made an offer of $9.74 in cash per share for the remaining 14% it doesn't already own, shares are trading for ~$9.25 today (shares are pretty illiquid).  While that's not a tremendous return -- a 5.3% spread (but still good enough) -- this has the possibility of following the path of similar controlled buyouts I've written about in TRK and VLTC where to placate the independent directors (and perhaps save them from shareholder lawsuits) the controlling shareholder bumped up the bid once or twice before entering into a definitive agreement.  From a 10,000 foot view, this feels a bit opportunistic, the resort just opened, casinos often take a little time to season and develop a loyal clientele, sports betting is being rolled out in New York state, and the corporate structure is a little strange as it probably makes sense for this property to be wholly controlled under the Genting umbrella.  Just all feels a bit opportunistic and maybe leads to a small bump.

Disclosure: I own shares of NYNY

Thursday, July 25, 2019

Gannett: Rumored Deal with New Media

Gannett (GCI) is the publisher of the USA Today and about one hundred other midsized and smaller daily publications, newspapers are clearly in secular decline and have been for some time.  Newspaper publishing is an industry that went through a period several years back when there was a trend of spinning off the newspaper business from TV broadcasting or other media businesses (current GCI was a spinoff of the original Gannett that was renamed TEGNA).  I participated in several of those breakups and was lucky to make a little bit of money despite the backdrop of the industry, so why not give it another try with two companies I've written about previously potentially merging.

Last week, the Wall Street Journal reported that New Media Investment Corp (NEWM) was in talks to purchase Gannett in a cash-and-stock deal.  New Media is similar to Gannett, just without the USA Today, they own a bunch of small town newspapers and a couple midsized ones.  New Media is externally managed by Fortress Investment Group (now owned by Softbank), NEWM is one of the few operating businesses (non-REIT/BDCs) I know of that is externally managed, it was a spinoff of Newcastle (now Drive Shack) originating as the result of Fortress buying the debt of local newspaper publisher GateHouse Media (the entity WSJ references as the buyer) within Newcastle and later taking control of the post-reorg GateHouse.  Fortress has since used New Media as a vehicle to roll-up the distressed local newspaper industry at low single digit EBITDA multiples and then pay an out sized dividend to attract retail investors (standard externally managed playbook type stuff).

This deal has a hint of HPT buying SMTA's master trust to it, Fortress gets paid a management fee of 1.5% off of New Media's equity, Gannett is a low-quality asset but represents a way for Fortress to roughly double their management fee with one of the last large willing sellers (the other publishers are mostly controlled/family owned) at a price that both could claim victory with given the synergies at stake.  As an asset gatherer, New Media will be aggressive in pursuing Gannett and will likely get a deal done.

As a little recent background on Gannett, earlier this year they fended off a hostile takeover and later a proxy fight from PE owned MNG Enterprises (dba "Digital First Media"), the owner of the Denver Post and the San Jose Mercury News among other publications.  MNG Enterprises offered $12 per share for GCI (currently trades at ~$9.60) but the hostile bid and lack of committed financing led Gannett management to dig in their heels and resist the effort.  While this was happening, Gannett's CEO stepped down in May and the company has been without a named successor since.

How could this be a win for all three parties (Fortress, New Media, Gannett)?  The Wall Street Journal references $200MM of potential synergies being discussed in the deal, which sounds like a lot compared to Gannett's $290MM EBITDA guidance for 2019, and it is, but there is a lot of overlap between the two's footprint and $200MM is roughly 25% of Gannett's run rate G&A expenses, I think there is some reasonableness to the synergy number that a PE manager could extract from the operations.  New Media's stated acquisition criteria is to buy publishing assets at 3.5x-4.5x EBITDA, GCI trades for 5.6x standalone EBITDA of $290MM (mid-point of 2019 management guidance).
New Media can buy Gannett for "4x EBITDA" using a post-synergy number of $490MM and all three parties can claim victory: 
  1. Fortress gets to roughly double their management fee; 
  2. New Media gets a large acquisition within their stated price target to bleed for continued dividend yield, and given NEWM trades at a premium to the industry (due to the high dividend yield) it would be accretive to shareholders; 
  3. Gannett gets a higher price with credible financing than what they turned down earlier this year justifying their actions
Speaking of financing, New Media's debt is primarily a term loan that is owned by CLOs.  The leveraged loan industry is under a microscope at the moment, primary issuance is down considerably year-over-year as investors prepare for lower interest rates (loans are floating rate products) and loan mutual funds have seen 30+ months of outflows.  However the demand for CLOs has kept a strong bid under loans and have essentially created forced buying of risky debt.  New Media is already a familiar name and present in dozens of CLOs, they could presumably finance a bid for Gannett through this channel.  Fortress is a strong PE sponsor and an active CLO manager in their own right.

So how might a cash-and-stock deal look like?  New Media has conventional debt of $450MM against a $180MM LTM EBITDA, or 2.5x levered, if they added the $490MM (let's save EBITDA addback math for another time) and kept leverage roughly the same they could raise enough financing to pay $6-7/share in cash and then issue the rest in NEWM stock.  I'm also including Gannett's pension shortfall in EV, NEWM likes to exclude their capital leases and pension liability from their leverage numbers so maybe they could justify paying on the higher side of my back-of-the-envelope estimates.  Anyway, I think this deal crosses the finish line as Gannett is floundering and doesn't have a controlling shareholder, New Media wants to gather additional assets for its external manager, it's a win-win for a dying industry.

Disclosure: I own shares GCI (and a few calls as well)

Friday, June 28, 2019

Mid Year 2019 Portfolio Review

The calendar can sometimes play tricks on the way returns look, now in hindsight 12/31/18 was a tough determination date skewing my 2018 results to the downside and now is skewing my 2019 results to the upside.  Through the end of the second quarter my blog portfolio is up 58.3% versus 17.9% for the S&P 500, the big first half has pulled up my lifetime-to-date IRR to 22.5%.  Outsized winners this period included KAR and SMTA due to sizable call option positions and then to a slightly lesser extent big wins in CZR, HHC and MMAC.
Often when I post an idea it's sort of an initial indication of interest, usually starting with a 3-5% position for me, and then in the comments section I get more bullish or bearish on an idea.  KAR Auction Services (KAR) was one of these, I liked the idea and the spinoff of IAA in January, posted on it, received some feedback so when the company conducted an odd conference call in February and the stock subsequently sold off, I was ready to act.  Ended up buying a large (for me at least) position in call options that paid off handsomely, although I sold too soon (last week) given the price movements today on the first day of regular way trading.  IAA looks fully priced to me.  KAR looks potentially cheap depending on how you value TradeRev and RemainCo's closest public peer, BCA Marketplace in the UK, was sold this week to private equity for 12x EBITDA.

Other Closed Positions:
  • Caesars Entertainment (CZR):  Eldorado Resorts (ERI) and Caesars inked their cash and stock deal earlier this week with a headline price of $12.75 per share, with much of the cash coming from VICI Properties (VICI) via the sale leaseback of three casinos.  The deal price isn't too far off of what I paid in 2017 for my initial position in CZR through CACQ, but it is a big move from the 4Q lows when the world was potentially falling apart, what a difference 6 months can make in the markets.  Now seems like a good time to back away from the gaming sector, I'm interested to see how the industry does through the next recession, especially with the PropCo/OpCo model that's all but rolled out across the entire group.  I suspect we'll see some opportunities and dislocations there in the future, but for now I'm going to wait on the sidelines. 
  • Spirit Realty Capital (SRC): When the news broke that SMTA had sold the assets in their master trust to HPT, I took the opportunity to exit SRC and roll some of that into SMTA.  SRC will be a vanilla net-lease REIT by the end of the year and it'll probably trade up a bit higher from here as the multiple plays catch-up, but an acquisition by one of the larger net-lease names is likely off the table.  There are enough net-lease properties in private hands that there's no reason for someone like Realty Income (O) to buy SRC, they could issue their expensive shares in a secondary and buy cheap assets directly without the headache and expense of a merger.
  • Mitek Systems (MITK): Mitek Systems ended up dropping their strategic process, they have new management that presumably wants to create value independently (and not lose their jobs), the company has a strong niche, but investing in a small software growth stock wasn't my initial thesis so I sold it for a small gain.
  • Hamilton Beach Brands (HBB):  I was still holding onto a stub position in HBB as a result of its 2017 spinoff from NACCO Industries (NC), ended up selling it as I just didn't have conviction enough in the company meeting its long term revenue goals in the face of increasing pressure from Amazon.  Amazon's advertising model to get into the top of the search results is going to pressure margins going forward.
  • OncoMed Pharma (OMED):  Mereo Biopharma has been a disaster since the reverse merger with OncoMed, it's notably tied up in the Woodford Patient Capital Trust mess and likely has an overhang as a result.  Celgene also decided not to exercise their option on a drug that was 2 of the 3 CVRs in this transaction, chalk this one up as a loss.
  • Voltari Corp (VLTC):  This tiny NOL shell ended up being a home run for those small enough to get into it, the final price was $0.86/share versus the initial $0.58/share offer Icahn made to start things off.
Portfolio as of 6/30/2019:
Disclosure: Table above is my blog/hobby portfolio, I don't manage outside money, it's a taxable account and a only portion of my overall assets.  The use of margin debt, options, concentration doesn't fully represent my risk tolerance.

Speedway Motorsports: Going Private Offer, Bump Coming?

Speedway Motorsports (TRK) is the owner of 8 racetracks around the United States, they primarily host NASCAR events and other smaller motorsports promotion races.  The company is 71% owned by founder Bruton Smith and his family, earlier this year a entity controlled by the Smith family (Sonic Financial) offered to buyout the minority shareholders for $18 per share.  This follows a similar path as TRK's larger peer, International Speedway (ISCA) which has agreed to be taken private by the controlling France family (who also own NASCAR).

Similar to other sports, TV broadcasting rights are a major source of revenue for NASCAR, they entered into a 10 year deal with Fox and NBC that runs through 2024.  NASCAR's structure is a little different than others, the governing body is privately owned and receives approximately 10% of the TV revenue, the racetracks themselves are owned by three publicly trades companies (ISCA, TRK, and smaller DVD) which receive approximately 65% of the TV revenue, with the remaining 25% going to the drivers and their teams.  The France family will be merging NASCAR and International Speedway once the deal closes.

NASCAR has struggled since peaking in the early 2000s, television ratings and attendance have fallen through the floor, with many people point to changing the car to make it safer (but leads to dull racing) or to the general decline in interest in cars.  But it still garners media attention, like all sports programming it is something that needs to be watched live and has a niche loyal following that would complain if it was suddenly dropped from cable television packages.  Interestingly, the most recent television contracts were struck in 2012 and 2013 with a 30% increase from the previous deals despite clear evidence that NASCAR was already in decline.  Maybe the Smith family has an inside track on what the next deal might look like?  If so, now is an opportunistic time to take it private, retool the sport and industry structure outside of public shareholder view, with the 5 years left on the current TV contract providing much of the cash to fund the take-private deal.

I can't find any historical news on it, but Chuck Akre mentions in the podcast Invest Like the Best a history with Bruton Smith (well not by name) indicating that several decades ago when Smith took Charlotte Motor Speedway (predecessor to TRK) private and that he had his hand in public shareholders pockets, Akre vowed never to invest with him again.  But since returning to public markets, it appears TRK has acted reasonably with minority shareholders, the Smith family have maintained their ~70% ownership throughout the current iteration's history.  But there is some history here of minority shareholder abuse.

This situation likely follows that of International Speedway ($42 bid in November, followed by a $45 accepted offer in May) and there's a 5-10% bump from the $18 offer price, the market is certainly anticipating one with the stock trading around $18.50 per share.

Disclosure: I own shares of TRK

Friday, June 21, 2019

Command Center: Reverse Merger with Hire Quest, Tender Offer

Command Center (CCNI) is an illiquid micro-cap staffing company providing temporary semi-skilled and unskilled labor to light-industrial, hospitality, transportation and retail customers.  Through a network of 67 branches in 22 states they deployed over 32,000 employees to 3600 customers last year, a sizable operation given their $25MM market cap.  The company has historically struggled with mediocre management, exposure to oil and gas markets and a lack of scale, all of which led to activist investors pressuring the company to explore strategic alternatives in 2018.

On 4/7/19, the company announced a merger with privately held Hire Quest Holdings, effectively structured as a reverse merger where Hire Quest management will run the combined company and Hire Quest shareholders will own 68% (76% after the tender) of the proforma company's stock.  Temporary staffing is a fragmented industry with several large players and then many "mom and pop" type operators. Hire Quest's business is structured as a franchiser, they provide the back office support and negotiating scale on workers compensation insurance (a significant expense for this industry) to its franchisees under the brand names Trojan Labor and Acrux Staffing.  After the merger with Command Center is complete, the company plans on franchising the 67 Command Center branches to mirror the Hire Quest business model.  Interestingly, Command Center previously operated under the franchise model but bought out their franchisees in 2006.

In tandem with the reverse merger, the combined company will be conducting a tender offer of up to 1,500,000 shares at a price of $6 (versus a price of $5.45 today), in the proforma financials provided in the proxy, it shows the current cash on CCNI's balance sheet of $7.5MM being withheld for the tender offer.  They're a little short of the $9MM necessary for the tender, but given the cash build since the Q1 financials came out, I'm going to assume the company is essentially both cash and debt free.  Additionally, since the company will be franchising the current 67 Command Center locations, they should see some cash inflow from those sales.  The 2006 acquisition of 69 franchised stores which formed Command Center was done for 13.2 million shares which traded at roughly $1 at the time of the announcement (data is a bit hit and miss, this was an even tinier OTC stock at the time so my figures could be off), or we'll call it $180k per location which sounds reasonable as the buyers are going to be the store manager or someone looking to own their own job.  If correct, that's another $12MM in additional cash that could be used for buybacks/tender offer or expansion.

In the press release announcing the reverse merger, management provided the following pro-forma commentary:
"If Hire Quest revenue were determined on a similar revenue for the year ended December 31, 2018 would have been approximately $189 million.  Based on our current projections, after some period of integration and normalization, we believe the combined entities will produce annual EBITDA in excess of $15 million, exclusive of growth opportunities."
Following the tender offer, the company will have 12,968,678 shares on a diluted basis, at today's share price of $5.45 (and the assumption of zero net cash/debt, no value to the franchising), the enterprise value for the proforma company is approximately ~$70.5MM.  Against a post deal (could be messy the first year or so) estimated EBITDA of $15MM, the new Hire Quest is trading for roughly 4.7x EBITDA, well below the large publicly traded staffing companies.
Clearly some of these companies have higher quality businesses than that of a sub-scale CCNI, but with a new owner-operator management team in place, a differentiated franchise business model, post deal closing Hire Quest could have a more attractive story to tell investors narrowing some of that valuation gap.  At 7.0x EBITDA, still a discount to the group, shares would be worth $8.10 per share, or nearly 50% higher than today's trading price.  If we want to get a little crazy and use my $12MM cash number from the sale of franchises, that's just under another $1 per share, call it $9 per share total. Originally the deal was targeted to close in the second quarter, but that time frame has slipped a bit, the company is holding the shareholder vote alongside their annual meeting on 7/10/19 with the merger likely to close sometime shortly after it's approved.

Disclosure: I own shares of CCNI

Craft Brew Alliance: Speculating on ABI Qualified Offer

Craft Brew Alliance (BREW) is a collection of craft beer brands formed with the merger of Redhook Ale and Widmer Brothers in 2008, but it is best known for its fast growing Kona Brewing brand of beer.  Originally a Hawaiian craft beer, Kona is now positioned as a beach inspired mass marketed lifestyle beer.  If you're unfamiliar with Kona, they recently did a big media buy during the 2019 NCAA basketball tournament, here a link to one of their commercials espousing the island lifestyle.  CBA is ~31% owned by brewing giant AB InBev ("ABI"), in August 2016 ABI entered into a distribution agreement with CBA that laid out a path for ABI to purchase the remaining ~69% they don't already own.  The agreement has a graduated payout schedule based on the date of an announced acquisition, the first two dates have passed and the last deadline for ABI to make a "qualified offer" for CBA is 8/23/2019, the qualified offer has a minimum of $24.50 per share.

Craft Brew Alliance is an unfortunate name, it's now widely agreed the craft beer segment is over-saturated with thousands of breweries, it's difficult for the mid-sized independent brewers to survive as most craft drinkers have migrated to the ultra-local inside your own zip code breweries.  It's much more fun to show up to a party with a growler of IPA from down the street than a 6 pack from a super-regional brand you can get at any Walgreens.  The original version 1.0 craft brands like CBA's stale Redhook or Widmer brands are in free fall and pioneering brands like Boston Beer (SAM) have pivoted to so called "alcopop" and spiked seltzers.  Similarly, Kona has morphed into a mass-marketed lifestyle brand, their two flagship beers (Blue Wave and Longboard) are relatively easy drinking and light.  A small anecdote reflecting that shift, my old college bar now has "$3 Big Wave Thursdays" as the weekly special, it's no longer "craft brew" if 19 year olds are playing beer pong with it.

AB InBev is viewed as over-leveraged after the acquisition of SABMiller, they also cut the dividend in half last October sending their shares to multi-year lows as they deal with declining beer volumes, but since the dividend cut shares have recovered nicely this year.   Acquiring CBA would be a relatively small check (~$325MM) for ABI to write and would fill a hole in their U.S. portfolio where they don't have the rights to the similarly positioned Corona brand.  Additionally, if ABI passes on making a qualified offer, they would owe CBA a $20MM fee and potentially open themselves up to another brewer making an attempt to purchase CBA, how would ABI feel about a competitor (Constellation Brands?) getting a free ride on their distribution system for the next several years?

But the market clearly doesn't believe it will happen, today shares trade for $13.60, the minimum qualified offer price of $24.50 would represent an 80% premium.  The downside is probably in the $8-9 range if there's no offer, so by triangulating the implied odds the market is telling you there's about a 4-1 or 3-1 chance of the deal being completed.  Let's just assume that's right, an interesting way to speculate on the deal getting done is through August $20 call options which are trading for ~$0.20 per contract.  If the deals consummates, it's likely to be all cash and at the minimum price, so we know the timing and we know the price, assuming a small spread, the calls would move up to ~$4.00 or so on a deal announcement, or a 20-1 payout structure.  I'd love to be able to invest in 30 similar trades to spread out the dispersion, but even on its own its a compelling proposition and I have made it about a 1% cost basis position in the calls.

Disclosure: I own BREW August $20 calls

Monday, June 3, 2019

Spirit MTA REIT: Sells MTA Assets to HPT, Remains Compelling

[Apologies for another SMTA update, I'm still active, but I haven't really bought much new lately.]

Spirit MTA (SMTA) this morning announced the sale of the assets contained within the Master Trust to Hospitality Properties Trust (HPT) for ~$2.4B, after redeeming the Trust's debt and other transaction expenses will net SMTA approximately $450MM (I was hoping for more like $500MM, but this is a reasonable outcome).  HPT shareholders (bagholders?) might be asking why a hotel REIT is buying net leased retail assets, but it is good news for SMTA shareholders as the transaction is for cash that has committed financing from an investment grade borrower and doesn't require an HPT shareholder vote.  HPT is externally managed -- abused -- by RMR Group (RMR), they're interested in increasing AUM and resulting management fees, closing is targeted for the end of Q3.

Updating my NAV for the $450MM sale:
With no value to the remaining NAV pieces that are in question, the value to SMTA shareholders is approximately $7.90, so at today's price of $8.30 (and assuming the deal closes), you can buy the remaining assets for $0.40 with upside of potentially up to ~$2.50-3.00 of value on the workout and other assets.

Old news to those deep in the comment section of my earlier SMTA post this year, but here are additional thoughts on the remaining NAV components/risks:

As part of the spinoff, SRC via SMTA loaned Shopko $35MM via a term loan to receive access to ShopKo's periodic financials.  When Shopko filed for bankruptcy in January, SMTA wrote off the term loan and as a result, it doesn't appear in their NAV table, however, per the liquidation waterfall in the almost wrapped up Shopko bankruptcy, the term loan should be paid in full.
The low end estimate also shows essentially a full recovery, that's approximately $0.75/share, already well ahead on the $0.40 investment in the other assets above the MTA and cash.

The Academy Sports + Outdoors distribution center in Katy, TX is another big component to the other asset category, it is Academy's largest warehouse and home to their headquarters.  Like many other retailers, the company is struggling, it's owned by KKR and has significant debt that trades at a discount.  But if they were to restructure, I'm guessing they'd keep this warehouse as again, it's their headquarters, and it serves their largest/original market in Texas.  Katy, TX is outside of Houston, home to many large warehouses including Amazon.  Industrial real estate is hot right now, just this weekend Blackstone announced another deal (they've done several including GPT and FRPH).  As part of the CMBS financing transaction, the property was appraised at $144MM in 2018, and Academy's distress was very apparent at the time of this appraisal, below is the chart of the Academy term loan going back to issuance.  It trades for 75 today, down from early 2018 levels, but was still in distressed territory back then, it's not a new story.
In my NAV, I'm putting a 8.5% cap rate on the $9.5MM NOI, call it a 20-25% haircut from the appraised value done before the spinoff.

On the workout portfolio, many want to write these off completely, much of these are actively leased, just don't fit the portfolio profile of a publicly traded REIT but still of institutional type asset quality.  From the Q1 recorded conference call:
"Starting with portfolio activity, we continued to actively manage the portfolio during the first quarter, selling three properties for $5.4 million in gross proceeds. We also executed a lease with 7-Eleven on a former non-core vacant asset which we will look to dispose of at a far improved price above its previous start value.
In addition, the leases for two non-core assets formerly leased to Neighbors Health System have recently been assumed by new operators. We plan on contributing those two assets into the Master Trust, which allows us to deploy restrictive release account cash before that cash is swept to repay ABS notes with corresponding make whole penalties. In turn, these contributions will enhance our unrestricted cash position outside of the Master Trust."
The new tenant is Diagnostic Health and according to the servicer report, entered the trust with a collateral value of $8.41MM at a cap rate of 13.6%, assuming the same cap rate across the rest of the workout portfolio plus the book value of the vacant properties nets out a $57MM value.  This number likely has the widest range of outcomes, much of the value is a multi-tenant office building leased to PwC in Columbia, SC, hard to get a read on how much that asset is worth, open to others thoughts.

Another risk people site is the Shopko CMBS lender coming back to SMTA, but it appears the CMBS lender has moved on, as mentioned in the SITE Centers (SITC) Q1 call:
"First, we signed a management agreement with Credit Suisse, providing them advisory and operational services for 83 assets leased to Shopko on which they have recently foreclosed. Importantly, the agreement came with rights of first refusal for 10 assets in the portfolio and allowed us to leverage our existing operating platform to generate nearly 100% margin on any fees we received. Credit Suisse's needs were ultimately short-lived, but we nonetheless earned the $1 million in the process which was a contributor to our strong quarterly results."
Later in the Q&A, they clarified it was a short lived asset management agreement because their client sold the portfolio quickly.

Putting it all together, I think it's pretty reasonable to come up with $10.70 NAV with some range of outcomes around that value primarily dependent on the Academy distribution center and other workout assets being sold for reasonable valuations.  The main risk from here is the timing, HPT didn't buy the SMTA holding company, so there will likely need to be a small holdback amount to address any clean up and other shut down expenses.  Maybe its $10 by the end of Q3 with the remainder sometime down the road after that?  The other concern might be the HPT deal requires a shareholder vote at SMTA, SRC is waiving their promote/incentive fee surprisingly, maybe to get in the good graces of a couple activist shareholders in Indaba and Mangrove, but surprising nonetheless for Jackson Hsieh to leave money on the table.  I find the valuation compelling today and added more, it's my largest position by a decent margin at this point.

Disclosure: I own shares of SMTA and Oct $7.17 Calls