Year End 2020 Portfolio Review

What a traumatic and unpredictable year, certainly it has been tragic for those directly impacted by the virus or who have suffered the death of a loved one.  From a pure financial standpoint, I am in a lucky position where I'm able to work from home and didn't need to tap into savings or my brokerage account to make it through the year.  Being in that fortunate position, and also not managing outside capital, allowed me to hold through difficult times and not capitulate.  However, especially after November and December there are now signs of excess everywhere and I'm having a hard time squaring overheated speculation in certain areas with the never ending list of bargains I'm finding.  Confusing times in the market.

I finished the year up 24.34%, which is well shy of some others investors performance this year but still above the S&P's 18.40% -- fully acknowledging that the large cap index is not a good benchmark for my portfolio, on the surface I take more risk, but it's more of an opportunity cost bogey and widely quoted.  My lifetime-to-date IRR of this portfolio is 24.52%.  Positive attribution winners this year included Green Brick Partners (GBRK), Colony Capital (CLNY), Five Star Senior Living (FVE) and Franchise Group (FRG); negative attribution losers were MMA Capital Holdings (MMAC), Liberty Latin America (LILA/K) and some undisclosed special situations (MCK/CHNG splitoff, MGM tender) that went haywire in the spring meltdown.

Thoughts on a few Current Positions

• While not a high conviction idea, I still do like Accel Entertainment (ACEL), the largest distributed gaming provider in Illinois.  The thought here is that slot players are going to go hyper local post-covid, why drive an hour or two to a depressing rundown regional casino when you can drive five minutes to a depressing rundown strip mall?  These VGT locations are essentially mini-casinos first and a bar or restaurant second, the bar/restaurant piece is often regulatory arbitrage to allow for the VGTs and not the other way around.  Regional casinos make the vast majority of their money from slot machines, ACEL is the slot machine revenue without the capex and overhead of actually running a casino.  Currently there are no VGTs in the city of Chicago, but with covid destroying the budget even further, wide spread tax increases seemingly difficult to push through in the current economy, legalizing VGTs within the city limits could be on the table providing an easy growth opportunity for ACEL.
• Despite a good run in 2020, Five Star Senior Living (FVE) is still a cheap stock, with an enterprise value of just $150MM ($96MM of cash, $7MM of debt, and I'm capitalizing an RMR termination payment of 2.875x annual fees) and another $96MM of owned real estate on the balance sheet, against $30-35MM of EBITDA, trading under 4.5x EBITDA for a company that is now mostly an asset-lite management company.  Tucked away inside of FVE is a high growth rehabilitation concept, Ageility, that is growing quickly and only requires $20-30k of upfront start up costs per new location, it could be quick to scale.  What happens to all the cash?  Management clearly has their hands full operating the business this year, but once covid passes, what will be the capital allocation plan?  It hasn't been well articulated at this point.
• My obligatory bullish comments on Howard Hughes Corporation (HHC) -- Their diversified model should help them versus pure play REITs, in the coming years I picture HHC being more focused on residential land development than on office/multi-family new construction they were pre-covid, their big land banks are in Las Vegas and Houston, maybe not as hot as Austin and Miami but they're both low cost-of-living and no state income tax markets that should have the wind at their backs.  While not in the same markets, Green Brick Partners (GBRK) should continue to benefit from similar migration trends to Texas as well as their shift in focus to entry level homes which are benefiting from incredibly low mortgage rates.  Rounding out a real estate discussion, "new" BBX Capital (BBXIA) should still have some upside despite the obvious problems, their assets are primarily cash, a note to a timeshare operator (good reopening/stimulus trade) and Florida real estate which should have continued tailwinds.  It's trading at just 35% of book value, even if the right number is 50% of book value, that represents an additional 42% upside.
• MMA Capital Holdings (MMAC) has been a frustrating hold since they went to an external structure, I won't pretend that I've spent more than a few minutes on Hannon Armstrong Sustainable Infrastructure Capital (HASI), it appears to be a better and more diversified business, but it trades at over 4.75x book value and MMAC trades at 0.65x.  Just reading through the HASI 10-K and investor presentations you get all the good ESG vibes that MMAC should be putting out, but still aren't, maybe with the recent CEO we'll see a change, with all the money flowing into ESG products, MMAC has to take full advantage.  Even from a skeptical external manager point of view, you'd assume Hunt wants a piece of what could be a decade long theme.
• Colony Capital (CLNY) was a significant winner for me this year, thank you to those that encouraged me to take a closer look at the common after my post on the preferred stock near the bottom of the crisis.  I doubt I'll have much to add on CLNY going forward, the business is a bit above my head, but willing to give Ganzi some room and will continue to hold.  I found this write-up well done and helpful in modeling the path forward from here.  Even if you're not sold on CLNY, I think it is worth of monitoring because of the number of transactions that revolve around it (hopefully CLNC), there will opportunities that arise in the next few years.

Previously Unmentioned Positions

• Back in the spring, I puked out of my position in Perspecta (PRSP), a 2018 spinoff of DXC that provides IT services to the government, but since then activist fund JANA Partners has taken a liking to it after PRSP passed its 2 year safe harbor post-spin making it able to be acquired without jeopardizing the tax free spinoff.  In November, Bloomberg reported that PRSP had hired advisors to pursue a sale.  The original thesis was that PRSP could be a replay of CRSA (also a DXC government services spinoff) which was sold for 12x EBITDA to General Dynamics, that thesis might still hold, 12x PRSP's ~$600MM EBITDA would be approximately $30 per share. 
• ECA Marcellus Trust I (ECTM) is a 2010 vintage oil and gas trust that were a popular structure a decade ago, an E&P company would sell producing wells to the trust and the trust in turn sold shares to retail investors promising high dividend payments.  Unsurprisingly, these didn't go quite as promised, ECTM is now a tiny nano-cap that is pushing closer to tripping a clause in its trust indenture that would force a liquidation of the trust, returning any proceeds to unit holders.  ECTM shut off the dividend and if the royalty payments fall below $1.5MM for the trailing twelve months the trust will liquidate, royalty payments were $1.12MM through 9/30 putting it very close to tripping for the year.  Greylock (successor to the original sponsor ECA) projects the royalty to exceed the threshold this upcoming quarter (however that was before natural gas prices started to fall on fears of a warm winter), even if it does, it appears this trust will trip it sometime next year forcing the liquidation.  The trust has 17,605,000 units outstanding, trading at a price of $0.17, for a total market cap of just ~$3MM against a book value of $17MM.  Most of that book value is the estimated fair value of the royalty interests which can be pretty squishy, Greylock has the right of first refusal buying the royalty interests back and there's a bit of uncertainty around if ECTM is entitled to get 100% of that payment or 50% (I read it as the 50% clause applies only on the formal trust termination date of 3/31/30 but I could be wrong).  Either way, pretty attractive upside that should be non-correlated with much of the market, but again, only a small PA type trade.
• I did jump into the SPAC arb trade with Pershing Square Tontine Holdings (PSTH) thanks to a great post by Andrew Walker.  Instead of selling puts, I did a buy-write trade, just fits my eye a little better.  I see the downside as pretty minimal, Bill Ackman is an incredible marketer (I'm generally a fan of him despite his flaws) and if a deal is announced in the next few months that would close before 6/18/21, I have a hard time imaging it would trade significantly below the trust value after it de-SPACs.  Ackman will get on TV, etc., and he'll also be investing a significant sum alongside PSTH in a pre-committed PIPE at $20 further providing support to the transaction value.  Selling pre-deal SPAC call options might be a theme for me next year.

Closed Positions

• On 10/19, Front Yard Residential (RESI) announced that it would be acquired by a consortium of private equity (Ares and Pretium) for $13.50 per share, I sold that day, and then several weeks later on 11/23, the offer was bumped up to $16.25 after a better offer came to light.  This could be the start of similar deals where post-covid the entity will be too subscale (MCC and CLNC are two potential examples) and there is plenty of private equity money out there willing to buy cheap real assets.
• I've mostly reduced my exposure to hospitality plays, Extended Stay America (STAY) has weathered the storm nicely as their rooms feature kitchens (limiting interaction between guests) and acts as temporary residences rather than true leisure travel.  It also drummed up some rumors of PE interest, I sold to put money to work in other places, but it could be worth monitoring as it still is the only remaining major hotel chain that is both the brand manager and the owner of its hotels (plus the weird paired share structure), eventually that will change.  Similar idea with Hilton Grand Vacations (HGV), it probably still gets sold at some point to Apollo (who will pair it with DRII before coming back to the public markets), but I sold to put money to work elsewhere, HGV might be interesting as a re-opening trade.  I could see stimulus checks going towards downpayments on timeshares, people will want to "live a little", prioritize vacations again, plus timeshares are similar to extended stay, often feature a kitchen and more space that might be desireable in a post-covid environment.  Lastly, I have been selling calls over and over on Wyndham Hotels & Resorts (WH), the implied volatility (not that I really know what that means) seems to be too high to me and so I've been rolling covered calls until the day when the shares get called away from me.  WH is almost a pure franchising play on economy and midscale hotels, which have held up better than the upscale business or destination focused hotels, but its trading at a fairly full 12x 2019 EBITDA and who knows when it'll get back to 2019 EBITDA levels?  I like the business, but feels like its been bid up as a reopening play alongside MAR/HLT when it shouldn't necessarily as its business model is significantly different enough.  These three all skew away from the traditional business traveler which will likely be the last to return in full, so all three could be attractive depending on your view of the reopening trade.
• Another one where there is probably a little more upside but I've needed cash for other ideas is Gaming & Leisure Properties (GLPI), their primary tenant is Penn National Gaming (PENN), PENN's stock as 20x since the bottom and presumably has unlimited access to capital right now thanks to Barstool Sports and the online sports gambling theme.  PENN starts to pay cash rent again here next month which should allow GLPI to reinstate a cash dividend (dividends have been a combination of cash and stock this year) and should fully recover to the mid-to-high $40s. 
• I finally let go of Liberty Latin America (LILA/K) this month (at least temporarily), I did fully participate in the recent rights offering and the stock responded well after that, but had a sizeable tax loss that just became too valuable for me this year.
• I sold about 2/3rds of my Avenue Therapeutics (ATXI) position after getting long term capital gains treatment, unfortunately, I should have sold it all as I ended up taking a loss on the remaining 1/3rd when ATXI failed to secured FDA approval for IV tramadol.  Their merger partner has moved to terminate the deal while ATXI is trying to fix their FDA submission, I'm far out of my comfort zone in trying to handicap the situation but could be an interesting idea for others more inclined.
• The Marchex (MCHX) tender offer was bumped up and I exited, haven't followed it much since then but did have several people reach out to me saying their call analytics software is best-in-class so there might be something there to those interested in small cap software businesses.
• Maybe it was a bit of "quarantine brain", but I did a lot of small merger arb or other quirky special situations throughout the year that I didn't get to writing about or didn't have anything more to add to the discussion -- more than I normally would -- these included CETV, SKYS, BREW, DLMV, SPAC warrant exchange offers for BIOX and ATCX.  One positive to the SPAC mania this year is its likely to result in a lot of interesting special situation opportunities in the coming years.  Screw ups included the MCK/CHNG exchange offer where I was unhedged and loss a fair amount of money and to a lesser extent miscues with the MGM and AMCX tender offers.
• Two old CVRs came up empty, INNL and GNVC, BMYRT appears to be the same way, I still want to like these but it is important to be selective, think through the structure of each CVR and the counterparty.  On the positive side I did receive interim distributions from IDSA and MRLB -- although curiously MRLB hasn't paid its final milestone payment despite the sales threshold being met several months ago, if you know the story there, please reach out.

Performance Attribution

Current Portfolio

My leverage is a bit higher than I'm comfortable with right now, but given personal circumstances, didn't want to realize gains in 2020 versus 2021, so I might be trimming early in 2021 (anecdotally I'm not the only one) some winners to make room for new ideas.  As always, thank you for reading and especially to those that I've interacted with either via the comment section or via email/DM, I'm not always quick to respond but I do appreciate the networking and the sharing of ideas has made me a better investor.  Happy New Year and stay safe, there's light at the end of the tunnel.

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

Colony Credit Real Estate: CLNY Moving Quickly, CLNC Sale Next?

Colony Credit Real Estate (CLNC) is a commercial mortgage REIT that is trading at 52% of undepreciated book value (their owned real estate is triple-net), Colony Capital (CLNY) owns 37% of the shares and is the external manager of CLNC.  CLNY is in the midst of a transition to a PE manager focused on digital infrastructures assets (they've hinted that they'll likely convert to a c-corp next year) and is quickly selling off their legacy traditional REIT assets, in recent months announcing the sale of their hospitality portfolio (a bit of a surprise versus handing over the keys) and more recently their remaining industrial assets.  CLNY CEO Marc Ganzi is everywhere, blitzing the virtual conference circuit, multiple TV appearances and selling assets left and right, the CLNY stock price has responded by roughly doubling in the last 5-6 months.  

CLNY has two large assets remaining (lots of smaller ones too), their healthcare real estate portfolio and CLNC, prior to covid they announced intentions to pursue an internalization transaction with CLNC where CLNY would presumably have gotten additional shares in CLNC as compensation for their management contract.  Post-covid, that internalization concept no longer makes sense as the bid-ask spread is too wide since CLNC trades at such a significant discount of book value, it makes it difficult for both sides to come to an agreement, CLNY would have to take a discount or CLNC shareholders would face dilution for an internalization transaction to work at current prices.

What do I think might happen?  Somewhat similar theme to MCC, most commercial REITs are externally managed and thus incentivized to grow/acquire --  I think we could see Ganzi push a sale of CLNC and CLNY's external management agreement to another commercial mREIT.  This would create a win-win for all sides, CLNY would get full immediate value for their external management contract, the buyer would acquire CLNC at a discount which benefits both its shareholders and adds AUM to the buyer's external manager, and CLNC shareholders would get a premium to current price and relieve the overhang of what might happen to CLNY's non-strategic 37% ownership position.  There is some transaction on the horizon, just a matter of the structure, here is Ganzi on the Q3 CLNY earnings call (courtesy of tikr.com):

Jade Rahmani (KBW)

Okay. Well, I applaud the swift actions the management team had taken. Definitely refreshing and very good to see the progress. I wanted to ask you about a particular -- as Tom Barrack might call it a Rubik's Cube, which is CLNC. There's an overhang in the mortgage REIT space because people are looking at commercial real estate as a long cycle to recover and potential impairments, loan losses on the credit front. So that's one thing that they have to address. Secondly, there's the liquidity that go into managing that. And finally, there is some access investment capacity. But when you look at stocks like CLNC and there's many others TRTX, LADR, to name a couple trading at 40% to 50% of book value. It means that investors are also potentially assuming an eventual dilutive capital raise.

So CLNY owns 37% of CLNC. And to me, that bodes for an opportunity, you can have CLNC buyback some of those shares at a premium to where it's trading, yet it still would be wildly accretive to its book value, wildly accretive to its earnings. It would reduce the overhang of CLNY's 37% stake because people do wonder when those shares will be liquidated, and yet it would provide CLNY with fresh capital to accelerate the digital transformation. How do you think about that as a potential option for both CLNY and CLNC to explore?

Marc Ganzi

Well, Jade, it's almost like you bugged our investment committee. So look, seriously, first and foremost, I want to applaud Mike Mazzei, Andy Witt, David Palamé. For those of you that had the chance to hear that earnings presentation, it's also another great story of transformation and execution.

When we brought Mike Mazzei on board to run that business unit, we couldn't have been more clear about what the objectives were: first and foremost, to make sure that we shored up our loans that had any issues with them, hit repo lines on 2 loans, gravitating to liquidity, and Mike's done an amazing job stabilizing that portfolio, returning cash to the balance sheet. And now that business is poised, as you heard yesterday, to play offense and be selective. And they'll play offense inside of their sandbox. And I don't get too involved in what Mike and his team does. I think they're doing a great job of executing and as one of their largest shareholders, we couldn't be happier with the progress that's happening at CLNC.

When you look at its peer group, CLNC got ahead of its issues quickly. Mike addressed those issues. He stabilized the story, he rotated the cash and now we have an enviable position where we can play offense, and we'll continue to recover book value.

You saw the shares perform well after market last night. They performed well today. We have a lot of confidence around that management team's capability. And in the meantime, we keep our options open, Jade. No option is off the table for CLNC. We've made that clear 2 quarters ago. We made it clear a quarter ago. I'll make it clear today. As we rotate to digital, if there's a good opportunity to harvest, the hard work that's been done at CLNC, we have an open ear, and we'll listen to whatever proposal comes across the table.

Seems pretty clear to me that a transaction will happen soon, given the pace of divestitures at CLNY, I would bet on Ganzi surfacing value here.  I doubt that CLNC would buy back CLNY's shares as suggested by the analyst question as it doesn't divest the external management contract, an outright sale of both CLNC and the management contract seems more likely, swift and bold, more in the Ganzi deal mold.

But let's take a look a CLNC a bit closer, I think its reasonably attractive as a standalone entity.  CLNC was created out of the threeway merger of old CLNY/NSAM/NRF, it was previously a non-traded product that was brought public in early 2018 and has since had a rough existence.  As expected with a non-traded REIT, their portfolio resembled an asset gatherer mentality without much of a cohesive strategy.  Here's what the portfolio looks like today, predictably they have a legacy segment ("LNS" = legacy non-strategic) where they house all the iffy stuff like their retail exposure.

The portfolio is a little bit of a grab bag, but back in March, Colony brought Michael Mazzei in to be the CEO of CLNC, Mazzei is an alumni of Ladder Capital (LDR, disclosure: long) where he served as the president until June 2017.  Ladder has a reputation has being a conservative credit shop, I personally like their style, so when Mazzei joined CLNC it was worth monitoring.

I've been surprised along with others, but commercial real estate loans have generally held up better than expected during the pandemic, whether the reason is modifications, interest reserve accounts, or the equity injecting additional cash into the deal -- their CLO for example hasn't experienced any credit events in the portfolio -- with a vaccine on the way, I tend to think all parties involved will continue to work together to salvage value and get to the other side.  Now is the time to get long some of these asset plays with a catalyst, the market exuberance hasn't quite made its way down to publicly traded private credit vehicles with actual real assets, but I think it eventually will.

CLNC has confidence in the future, I like when management at least acknowledges what the market is thinking, this is an external vehicle, so their options aren't ideal, but they've already hinted they'll reinstate their dividend in Q1 2021 and are making new loans today (tikr.com), you don't do that if you're on the ropes:

We also recognize that our current share price is a deep discount to our book value. This discount is also greater than that of our peer group. The current market valuation effectively implies that there are approximately $1.2 billion of future potential losses. We feel the best way to address this disconnect is by shifting the focus and momentum of the CLNC team beyond the challenges of COVID-19 and toward playing offense.

In our effort to close this gap, we are committed to continuing to protect the balance sheet while redeploying capital into new investments, building earnings and reinstituting a quarterly dividend.

In summary, while not fully out of the woods, we have accomplished many of our goals during this challenging time. We are now focused on executing our business plan to grow earnings. We have already begun to originate new loans while continuing to remain vigilant on asset, liability and cash management. The continued risks of COVID-19 can, by no means, be dismissed. However, through the efforts of the CLNC team and the support of our counterparties, CLNC is now in a position to lean forward.

CLNC does have a mix of financing, a CLO, repurchase agreements, they should have decent amount of flexibility to handle any problem loans.  Leaving out a lot here, but at 50-55% of book value, I think the setup is more important than the actual assets -- I trust Ganzi to make something positive happen here both for CLNY and CLNC.

Disclosure: I own shares of CLNC and CLNY

Medley Capital: Internalizing Management, Sale Seems Likely

Apologies for the recent string of relatively small and/or illiquid ideas, here is another one from the trash bin: Medley Capital (MCC) is an orphaned BDC that will likely be sold in the next several months.  The story begins in August 2018, when MCC's external manager, Medley Management (MDLY), orchestrated a three way merger that would combine the manager with its two BDCs, publicly traded MCC and non-traded Sierra Income.  That deal met a lot of resistance from shareholders as it appeared to be a non-arms length way to bailout the overleveraged MDLY at the expense of the BDC shareholders while ensuring underperforming management continued on top.  The deal was in limbo until May of this year, almost a full 2 years after the merger announcement, when the deal was finally put out of its misery and terminated.  I'm skipping a lot of drama in those two years including a proxy fight with the team from NexPoint, but following the termination, MCC continues to retained advisers to pursue strategic alternatives and recently announced that MDLY's management agreement would be allowed to expire at year-end and that MCC will internalize management.

After a 1-for-20 reverse split earlier this year, MCC is trading for ~$26.50 ($71MM market cap) with a 6/30 NAV of $54.83 (MCC's fiscal year end is 9/30, the 10-K should be coming out shortly), meaning MCC is trading at roughly a 50% discount to NAV.  For reference, despite the pandemic, the average BDC trades for 86% of NAV today.

For the uninitiated, BDC is an acronym for business development companies, which typical function as non-bank lenders to leveraged middle market (sub $50MM in EBITDA) companies, often providing financing for private equity buyouts or M&A transactions.  Following the financial crisis, banks can no longer provide these loans on reasonable terms, so non-bank lenders like BDCs of CLOs have filled much of the void.  These loans are all below investment grade and the leverage ratios of the underlying companies is typically 5-7x EBITDA, they can be a bit scummy and certainly shouldn't be pitched as safe dividend payers to retail investors.  There are some 45+ publicly traded BDCs (like REITs, there are also non-traded ones like Sierra Income that are sold through the investment advisor channel), most of them are externally managed, often by household names (at least to anyone reading this) like Ares, KKR, Oaktree, Apollo, BlackRock and others that can essentially use the BDC as a lender for their own PE activity.  If that wasn't enough, they charge hedge fund style fees to the BDC.  These management fee streams are highly valuable as a BDC is technically a closed end fund and the capital inside it is essentially permanent.  So the average BDC trades for 86% of NAV, roughly 10 of the 45 trade above NAV which allows the BDC to issue additional equity, anyone below NAV is generally restricted from issuing shares but they can still grow assets through M&A which has been fairly active in the bottom of the sector.

Given this dynamic of external managers wanting to grow fees and now that MDLY will be out of the way (MCC no longer has to serve two masters in a transaction), the orphaned BDC should make for an easy M&A target, especially considering the wide discount to NAV.  The buyer and MCC can essentially split the discount somehow and both come away happy.  Following the sale of their broadly syndicated loan (larger borrowers, more liquid loans) JV to Golub and paying off one of their two baby bonds, MCC is clearly too subscale (maybe the 40th largest BDC of the 45 by assets) to be internally managed and if the plan was a true go-it-alone strategy, they likely would have refinanced the baby bond versus pay it with cash on the balance sheet.  The new CEO is an activist in MCC, David Lorber of FrontFour Capital, he's also headed up the Special Committee, from the internalization press release they've hired a credit person on what seems like a temporary basis to oversee the remaining portfolio, all sort of signals to me that this is once again for sale.

Of course, everyone has seen the deal, it was shopped previously and the conflicted board (MDLY management on the MCC board) turned down other offers during the go-shop period in order to continue to push the MDLY-MCC-Sierra deal that would have preserved MDLY's management team.  However, now that MDLY is largely out of the way, debt markets are flush with capital (low rates is great for private debt, everyone will be reaching for yield), we're looking at a potential reopening and economic recovery, I'm guessing at least one of those suitors will come back and make a deal for MCC.

Other Thoughts:

• I haven't discussed the portfolio, obviously given the turmoil this company has been through in the last two years as you'd expect, the portfolio is a bit of an unclear mess of assets.  It is more heavy on equities than most peer BDCs, including 764,040 shares of AVTR which is up ~66% since 6/30 or $8MM in NAV ($3ish per share).  On the downside, the JV they did sell to Golub is about -$7MM in the other direction.  The S&P/LSTA Leveraged Loan Index is now trading about 95 cents on the dollar, up significantly from the lows in March and April, and for reference, on 6/30 it was trading at 89.  Even the junkiest of loans, rated CCC, are today trading at 86.  We'll see in a few days where the 9/30 NAV is struck, but I don't think it should be materially below where it was on 6/30, but I'm not a credit analyst and only spent a little time thumbing through their holdings.
• This situation reminds me a little bit of RESI, a broken deal, external management being pushed aside and no reasonable path to becoming an internally managed company for the long term.  That one ended very successfully with a quick deal that was then revised upwards after a competing offer came to light (I unfortunately was out by the time of the revised deal).
• BDCs are no longer included in most indices, MCC doesn't pay a dividend, there really isn't a natural investor base for this and I think that partially explains how its languished here and really doesn't have a future outside of a deal.

Disclosure: I own shares of MCC