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