Friday, April 2, 2021

Updates: MMAC, PFX, LUB & Others

This a liquidation value themed post, feel free to ignore if that's not your thing, but I wanted to put some updated thoughts on paper for a few small cap asset plays that are either trading well below liquidation value, should be liquidated, or are in the process of liquidating.  All in my assessment will result in attractive uncorrelated returns from current prices in this arguably frothy market.

MMA Capital Holdings
Readers are probably sick of my rantings on MMA Capital Holdings (MMAC), but the company has run into trouble, part self inflicted, part act of god, and the situation is quite different than it has been in recent history.  Approximately three years ago, MMAC sold their asset management business along with some other businesses to Hunt in a transaction that turned MMAC into an externally managed company primarily focused on loans to utility scale solar energy projects.  Some investors were smart enough to sell after that transaction, there's an excellent podcast "In the Market Trenches" where the hosts discuss MMAC prior to the Hunt transaction and why they decided to sell after the event, in hindsight that was the correct decision.  I should have as well.

The credit lending niche MMAC plays in is construction and development loans, permanent long-term financing on utility scale solar projects is a fairly competitive space, there are plenty of institutional investors and/or yieldco's willing to provide financing to solar projects with in-place long-term agreements to investment grade electric utilities.  

The average life of MMAC's loans is fairly short-term, so according to the company, it was slightly a timing coincidence that their portfolio was highly correlated (50+% of asset) to a single sponsor and a single energy market in ERCOT.  Reasonable risk management would suggest otherwise, but that was the situation the company found itself in going into covid where post project completion takeout financing (where MMAC's loan would get paid off) started to become scarce and then February's Texas winter storm hit and knocked out much of state's energy production causing the spot pricing of electricity to soar.  In one of MMAC's problem loans, "ERCOT Project 1" in their 10-K, the company reduced their gross dollar exposure before the February storm but increased their risk position by providing an equity sponsor loan to the developer in order for their original construction/development loan to attract take-out financing.  When February's storm hit, ERCOT Project 1 was impacted/damaged to the point where it could not meet its power obligations to its customer, forcing the equity (and thus MMAC as a lender directly to the equity) to purchase electricity in the spot market (at crazy high prices) for their end utility customer in order to meet the contracted amount.  Covering those losses along with other problem ERCOT loans ("Project 2" and "Project 3" in the 10-K) are estimated at "up to $4 per share" according the company. From the 10-K:

The ERCOT market remains volatile and uncertain primarily stemming from the February 2021 weather event and resulting energy crisis. There is litigation among various market participants and potential legislative reform is being considered, all of which remain uncertain. Assuming that the Company was unable to recover any of the additional advances made to ERCOT Project 1 (as outlined above), the Company’s allocable share of losses in the first quarter would, when taken together with loan-related interest income that is not expected to be accrued and other impacts stemming from the aforementioned actions taken to maximize the recovery of loans made to ERCOT Project 2, be $23.3 million, or approximately $4.00 per share (such loss would be recognized by the Company as a reduction in equity in income of the Solar Ventures). However, it is difficult to estimate first quarter impacts related to these exposures in absence of, among other things, the completion of fair value measurements of loans outstanding at the Solar Ventures at March 31, 2021, which require various valuation inputs that were not available as of the filing date of this Report. Further, additional events may occur that could cause this estimate to change by amounts that could be material.

Good time to mention that MMAC invests in solar loans alongside a "capital partner" as the company describes, that capital partner I believe is Fundamental.  The "Solar Ventures" started out as a 50/50 partnership where capital calls were contributed equally and investment decisions were shared amongst the two partners.  But in the last year or so, MMAC has been unable or unwilling to make their pro-rata contributions while their partner has continued to fund their own contributions as well as MMAC's to the point that MMAC is now a materially junior partner in the Solar Ventures (MMAC has a bit above a 1/3 stake in the larger 2 JVs, "Solar Development Lending" and "Solar Construction Lending").  

The split in the Solar Permanent Lending ("SPL") joint venture is 45% MMAC, 55% Fundamental, this is a less used JV as its not the construction/development lending focus, but the ERCOT Project 1 sponsor equity loan was basically transferred to this joint venture, the sponsor of Project 1 was only able to put $3MM to buy the shortfall amount of spot-rate electricity mentioned earlier, MMAC/Fundamental were on the hook for the additional $22.5MM, at a 45% pro-rata, MMAC is out $10+MM on ERCOT project 1.  This leaves about $13.3MM in additional losses the company has forecasted for Q1, which hopefully should be reasonably close given they released their 10-K at the last possible moment, 3/31/21, on quarter-end.

At year-end the company has an adjusted book value (only adjustment is removing the deferred tax asset) of $39.66/share before the estimated $4/share in ERCOT related losses, so the pro-forma book value is approximate $35.66 per share today versus a closing share price of $20.23 on Thursday before the Good Friday holiday.  If you believe the February storm is a one-time event and that the covid-reopening will loosen up the takeout financing channel, shares could be cheap.

I did make my debut appearance on a corporate earnings call with MMAC on Friday, excuse the number of times I say "I guess", but my underlying point I was trying to make is the Hunt transaction has been a failure and it might be time to either sell or liquidate the company.  Courtesy of tikr.com (an excellent resources BTW that I highly recommend), the whole Q&A was pretty good, but here's my part:

         Unknown Attendee

I saw in the 10-K that MMA ceded control of the workout process to the capital partner. Remind us how -- like new origination portfolio management decisions are handled at the Solar Ventures now that MMA is kind of certainly the minority partner in those ventures. And if the capital partner has made more pro rata contributions, I guess, in addition to you, does it become even more minority partners since the February storm?

Gary Mentesana

Sure. So I guess, a couple of different things on that, Matt. So the investor member partner and MMA jointly approved new investments, and the new investments do not find their way into the Solar Ventures, unless both partners approved. So that has been the case from the beginning of time. And I think that there's only been one instance where there was not a consensus to approve a loan. And in that instance, MMA approved it, and they made did the whole loan, MMA got repaid substantially as underwritten.

And I think I just want to kind of point that out that we generally view things very similarly through kind of a credit lens. You're correct that when MMA became a minority investor in the Solar Ventures, that decision control over workouts was ceded to that investor member. But I think it's also important to note that kind of Hunt has the expertise relative to this business, right?

The loans that got originated and asset managed are all done by Hunt on behalf of the Solar Ventures. And while decision control for workout has been ceded to the investor member, the investor member to date has kind of generally followed the lead of Hunt. And I think that we probably would have kind of made the same decisions if we were kind of co-decision makers throughout the process since we have been a minority investor.

With respect to your question as to where the investment ratio is since the February storm, there have been additional investments, and I'm working for it in the K, from the investor member disproportionately to MMA. And you can see it on Page 5 of our filing, we've noted that the MMA's investment interest -- economic investment interest in SCL and SDL has fallen to about 38% as of March 24.

Unknown Attendee

And did that happen since the February storm or before? I guess, my question is more, is your capital partner like still fully committed kind of after these events, I mean, if they're still inserting new capital into the Solar Ventures?

Gary Mentesana

Yes. They are.

Unknown Attendee

Okay. And then you kind of touched on this before, but kind of the risk management and guidelines and constraints that resulted in over half of the UPB being with a single sponsor in a single market. I guess, are there any changes that have happened to those 2? I guess, the portfolio management guidelines to kind of reduce this -- the chance of something like this happening in the future.

And then kind of alongside of that, is there any risk to the revolving credit facility going into the fall as a result of these 3, I guess, projects potentially being in workout status and no longer being eligible for the revolving credit facility kind of borrowing base?

Gary Mentesana

Sure. So I'll take the first part and maybe ask Megan to kind of fill in some of the color on the second.

So there are a variety of lessons learned. One is market based, right, with ERCOT kind of -- or cuts a little different than kind of the rest of the markets that facilitate solar projects that we lend to throughout the country. And we're currently not looking to originate any future investments in ERCOT until kind of we can get greater insight on potential legislative reform and also taking into account all sorts of litigation that is kind of active in that market right now.

I think the other thing that we've kind of learned from this process is that focused -- focusing on large projects at an early stage as we did in this kind of late-stage development loan for each of these projects carries risk relative to -- if there is not an ability to flip the project as was originally anticipated.

The sponsor, and not uniquely, but the sponsor had a business model where they basically gathered all of the puzzle pieces, so that kind of the puzzle, the final project could be put together, that they basically were looking to flip the project at NTP, notice to proceed, for construction. And they had been very successful and, as I said, successful with the first loan that we did with them.

But the lesson learned is that you may need to commit additional capital to keep the project on schedule if there isn't an ability to flip NTP and cause construction financing to kind of repay the late-stage development loan. There are other lessons learned, but that's probably the most significant, both with respect to the market and the product type.

With respect to the revolver, we're constantly kind of in discussions with the lenders in that credit facility to make sure that it works as we hope it would. Megan can kind of speak to the details relative to the impact of these loans to that facility, but I don't think you should necessarily be troubled at all by kind of that -- the standing of that facility. Megan?

Megan Sophocles

Yes, Thanks, Gary. I guess, generally, we're in compliance with all of our kind of debt covenants and managing the revolving credit facility and the borrowing base to appropriately capture the troubled status of the loan. And you're correct that we are not getting borrowing based credit for the loans, but can remain in compliance kind of with the borrowing base requirements and the facility in general. So it's actively being managed.

Unknown Attendee

Okay. And then I guess just one kind of broader question. So I've been an investor for 7 or 8 years at MMAC. And kind of since the Hunt transaction, I think that was done like $33.5. And now we're -- I guess, now we're pro forma $36.5 or a little less than that, $35.5 after the $4 potential hit.

And we've tried a persistent discount that kind of time. We haven't had any real benefit from the Hunt platform in terms of new investment verticals. We can't seem to market the stock to ESG investors, despite the incredible tailwinds in that theme.

There's about a $90 million gap now between kind of what I would call pro forma book value and where the market cap is. The termination fee at Hunt is about $25 million. I guess, what kind of strategic -- like what's the strategic plan? I mean, it almost looks like it makes sense to me that we could put this company into -- fully in the runoffs and make a considerable investment kind of from where the current share price is.

Gary Mentesana

So great question, Matt. I think that it's safe to say that the Board is constantly looking at opportunities to enhance shareholder value and is very focused on the gap between share price and kind of the value of the company, however you define that, whether that's adjusted book value per share or some other metric, right?

In the past, we had been thinking about kind of return of capital policy that has not been put in place at the moment, but the Board is looking at kind of -- all kind of avenues to enhance value and including raising the stock price. We're -- it's difficult in that the company is small, and it doesn't have a formal following among an analyst pool, and that has been a problem for quite some time.

With respect to the fact that we're not doing equity offerings, Hunt would very much -- just like the shareholders, would like to get the stock price up, so that additional equity could be offered in an accretive way since Hunt is compensated based upon a management fee on the adjusted book value.

But it's difficult, right? There are certain constraints relative to the NOLs as to trying to preserve that value, so that we don't have to pay tax liability in the near term, but it is difficult. And I think that the ESG tailwinds have been there for a bit. I think that they've probably gotten stronger since the new administration came in with respect to solar. But obviously, we have not been able to get traction on that, and kind of the events in February kind of make that somewhat difficult at the moment.

I hope there were a few bugs in the transcript software otherwise the few people that have asked me on podcasts hopefully understand why I'm probably better at writing than public speaking.  But either way, in the three years since the Hunt transaction, proforma book value has gone from $33.50/share to $35.66/share, a rather pathetic CAGR.  If you do the math, Hunt has earned management fees of $22.4MM (not including expense reimbursement) from 2018-2020, not a fair comparison since an internalized entity would still incur fees that Hunt is absorbing, but that's $3.90/share versus the $2.16/share shareholders have gained in book value (certainly not market value) in those three years.

Hunt's termination fee is 3x the average management fee of the last two years plus one year of average expense reimbursement, by my math that's roughly $25MM or $4.32/share.  Taking the $35.66/share proforma adjusted book value, subtracting the $4.32/share termination fee, gets you $31.34/share in liquidation value (let's pretend that ongoing net interest income cancels out liquidation expenses) which is 55% higher than the current stock price.

A straight liquidation might be unlikely to happen, this is an externally managed vehicle now after all, but the current structure doesn't appear to be work.  The company clearly doesn't have enough liquidity to continue with the Solar Ventures in its current construction, their revolver is being penalized due to the non-performing loans, and as confirmed by my question regarding their capital partner's eagerness to continue to invest post-February storm, it seems to me that a logical out would be to sell the Solar Ventures to Fundamental and then put the remaining legacy assets into a liquidating trust.

Other reasons why this makes sense:
  • The Hunt platform has added no value to MMAC, the Solar Ventures all precede the Hunt transaction in 2018, no new investment verticals have been added that you could attribute to MMAC being apart of a larger investment platform.
  • Former CEO Michael Falcone resigned unexpectedly, likely this was just a botched retirement, but given that there was no new blood at the Hunt level able or willing to come in and take leadership of entity (Falcone was months later named Chairman), might signal Hunt's wavering commitment to MMAC.
  • The company has failed miserably at capturing the ESG trend.
  • Due to the structure of the Solar Ventures and MMAC's minority interest now, their capital partner has the right to receive any distributions from the JV disproportionately until we're back to 50/50, which means that not only does MMAC not have cash flow to either pay a dividend and attract the yieldco crowd or repurchase stock like the good old days, but potentially as good loans roll off their capital partner could receive the full proceeds until the partnership is 50/50 leaving MMAC with more exposure to problem loans than they already have today.
Even if it doesn't voluntarily liquidate or pursue strategic alternatives, MMAC is fairly cheaper here.

PhenixFIN (f/k/a Medley Capital)
This is the old Medley Capital, PhenixFIN (PFX) is a BDC that internalized management as of the beginning of 2021.  Somewhat similar to ACRES Commercial Realty (ACR), this is a forgotten private credit lender that changed names and might not be on investors radar.  Book value as of year end was $52.94 versus a current share price of $33.15, or said another way, its trading at just 63% of book value.  No one would argue that PFX's assets are pristine, but the leveraged loan market (the asset class BDCs primarily own) has recovered substantially during covid, in fact, the riskiest of leveraged loans, those near default, rated CCC are currently trading at an average price of 91.4 cents on the dollar, a significant disconnect from where PFX's shares are trading.

But that analysis is a little too simple, PFX is basically running a shoe string operation right now, the CEO is a hedge fund manager without leveraged loan experience, they have indicated that PFX has hired an advisor to token oversee the portfolio without really naming a portfolio manager.  They don't appear to be originating new loans, I believe this portfolio is essentially in run off.  The balance sheet is atypical for a going concern BDC, at year-end they only had $14.8MM of net debt versus an investment portfolio of $160MM, making it if not the least levered BDC, close to it.  Just to emphasize the point, PFX has virtual no leverage and trades at nearly the biggest discount in the sector (and BDCs are supposed to mark-to-market their assets, but clearly these aren't Level 1 assets).

The company is buying back stock and recently entered into a 10b5-1 plan, presumably because they're not able to repurchase enough shares otherwise given the liquidity.  While not huge upside (my target is like ~80-85% of book, 25+% from here), PhenixFIN remains one of my higher conviction ideas, with limited downside and should either be formally put into liquidation or sold this year.  I've added shares in the first quarter.

Luby's
Luby's (LUB) is a restauranteur that is officially in liquidation now, LUB released its first filing under the liquidation method of accounting.  By making a few reasonable adjustments you can come up with a liquidation value higher than the stated $3.82/share versus the market price of $3.32/share today.

Liquidation accounting is nice because its simple, the company is tasked with valuing their net asset value assuming realized market value for the assets and subtracting their liabilities and any expenses they expect to incur during the liquidation.

The first obvious adjustment would be the PPP loan which LUB is considering a debt in the liquidation accounting, while they are under a current audit by the Small Business Administration, most believe that nearly all PPP loans made in good faith will be forgiven by the U.S. Government.  Forgiveness of the PPP loan is worth an additional $0.32 (or +9.6%) to the net assets in liquidation.

The other obviously conservative treatment is around the operating lease liabilities:
Under the going concern basis of accounting, we accounted for our operating leases as described below. Under the liquidation basis of accounting, we value the operating lease right-of-use assets at zero, since we do not expect to receive cash proceeds or other consideration for the right-of-use assets.
While they fully account for the operating lease liabilities at 100 cents on the dollar despite:

In fiscal year 2020, we terminated and settled our remaining lease obligation for 16 closed restaurant properties and negotiated an early termination date and reduced lease payment at one operating restaurant property. In the first quarter of fiscal year 2021, we terminated and settled our remaining lease obligation at seven closed restaurant properties. Subsequent to the first quarter of fiscal year 2021, we settled one addition lease obligation for a closed restaurant property. While the amounts paid to settle our lease liabilities varied, in the aggregate, we have settled these 24 leases for approximately 25% of the total undiscounted base rent payments that would otherwise have been due under the leases through their original contractual termination date. Although we can offer no assurances that we will continue to settle any lease obligation for less than its recorded values, any future settlements at less than the recorded value of the related lease obligation would increase our reported net assets in liquidation.
Per the company, all the restaurant and real estate assets are likely to be sold by the end of the fiscal year which is in August, with a final liquidation happening sometime in the early-to-mid 2022, my guess is the total distribution comes in at $4.25-$4.50 which is an attractive return from current prices.

ECA Marcellus Trust I & Sandridge Mississippian Trust I
Lastly, these are tiny nano-cap OTC oil and gas trusts, please be careful and do your own research before investing in either.  But I mentioned ECA Marcellus Trust I (ECTM) in my Year End 2020 post as a potential liquidation scenario, while the latest 10-K indicated that ECTM had not triggered the threshold for a liquidation as of year end, I still anticipate the trust doing so in the next several quarters, its current "NAV" is $0.97/unit versus a current price of $0.29/unit, leaving plenty of room for either bloated expenses or shenanigan's related to a liquidation auction.

Another similar vintage oil & gas trust is Sandridge Mississippian Trust I (SDTTU) which has already tripped its liquidation test threshold and is in the process of selling its assets and distributing the proceeds to unitholders.  As of 12/31/20, the trustee reported a net asset value of $0.31/unit versus a current price of approximate $0.22/unit.  $0.12 of that is cash, the rest is the remaining value of the oil & gas royalty, which the filings describe the valuation process as:
For December 31, 2020 as the Trust assets now meet the criteria for Held for Sale, the impairment was determined by taking the estimated fair value less the estimated cost to sell the assets. Fair value was derived from relevant market pricing related to the sale of a similar asset that was sold recently pursuant to a sale process conducted by a third-party advisor. 
So presumably the asset value is somewhat reasonably correlated to current market value, and then in terms of timing, it appears the trust should wrap up fairly quickly by the end of 2021:
The Trustee expects to complete the sale of the Trust’s assets by the end of the third quarter of 2021 and to distribute the net proceeds of the sale to the Trust unitholders on the following quarterly payment date. The Trust units are expected to be canceled shortly thereafter.
If all works perfectly, it likely won't, we're looking at a 40% upside from current prices.

Disclosure: I own shares of MMAC, PFX, LUB, ECTM and SDTTU

Thursday, March 4, 2021

INDUS Realty Trust: GPT 2.0

I'm about a year late on this post, thank you to Sterling Capital (@jay_21_) -- one of the best follows on Twitter -- for pointing me back to the idea.  Also deserves a belated hat tip for collaborating on the ACR idea.  

One of my early successes was Gramercy Property Trust (GPT), originally a busted up commercial mREIT (favorite theme of mine) which following the financial crisis transformed itself into an industrial triple net lease REIT before eventually selling itself to Blackstone in 2018.  The architect of that transformation and value creation story was Gordon DuGan, one of the few CEOs I've kept a Google alert to keep tabs on where they go next.  Last March, DuGan popped back up as the new Chairman of Griffin Industrial Realty (GRIF is the old symbol), Griffin was an accidental real estate company, a 1997 spinoff from an operating company, Griffin spent the following two plus decades operating in the relative shadows slowly building out an industrial portfolio -- first in Hartford on historical land holdings and later expanding to PA, Charlotte and Orlando.  Bringing in DuGan signaled a transition for the company, late last year Griffin announced they would be rebranding as INDUS Realty Trust (INDT) and converting to a REIT.  On the investor day last fall, DuGan admitted to have never heard of the company prior to meeting the CEO at a REIT conference, but today I think the company is interesting (more of longer term value investment than event-driven) because:

  • This is a jockey play, Gordon DuGan is a proven capital allocator, he did this once before, I have confidence he can do it again.  This is a somewhat similar playbook to GPT, take a small-cap industrial REIT (~$450MM) that is small enough to do one-off deals, institutionalize it, in the process the valuation re-rates up to the more liquid large-cap peers.
  • Industrial REITs are richly valued, they trade for ~4-5% cap rates and have been major covid beneficiaries as ecommerce "last-mile" logistics and inventory management have become more critical.  INDT's growth is not in acquiring assets, but rather acting as a developer, industrial/logistics buildings are relatively cheap and quick to build, the arbitrage between yield on development costs and market cap rates is wide at this time.
  • INDT raised a significant amount of equity this week in a secondary offering at $60, possibly weighting on the trading dynamics in the short term and creating a buying opportunity.  The equity raise is accretive to the long term value as that capital is put to work into new projects at attractive yields and it also helps improve the liquidity of the shares.

The current industrial portfolio is heavily skewed to the Hartford market where INDT had much of its undeveloped land, purchased long ago and some of that land is still held on its balance sheet at historical cost.  The company's strategy to diversify away from Hartford, instead focusing on their other markets of Lehigh Valley (PA), Charlotte and Orlando.

They point to the age and size of their assets as a differentiator, their buildings are newer and focused on the mid-sized market which provides them a lot of flexibility in the types of tenants they can attract while still being economical from a cost perspective.  I don't have a lot to add to their current portfolio, seems reasonably high quality with a diverse tenant mix.

Why INDT is unique is their ability to grow through development versus needing to rely on making sizable portfolio acquisitions to move the needle.  I'm generally a sucker for real estate development companies, my view is the market has a hard time valuing development assets correctly as they're non cash generating and thus not great for the REIT structure or investor base.  The problem with development companies is typically the long construction cycle, if for instance you're HHC, its 2018 and makes perfect sense to build a beautiful high rise office building on the Chicago River, by the time its complete in 2020, there's a pandemic and people are questioning if they'll ever go back into the office again.  A lot can happen in those two years before construction is complete and even longer to bring it to stabilization.  With industrial warehouse type properties, the construction is pretty quick and simple, 9-12 months, the product type is pretty homogeneous, you don't need a fancy architect to attract top tenants.  The timeframe from shovels in the ground to stabilization is shorter and the certainty of projected cash yield is firmer on construction costs.  This is a less risky form of development with much of the same upside.

INDT has historically been able to earn 7.7%-8.1% cash yields on their development costs, their current projects are estimated more in the 6.0%-6.5% range (guessing the difference is land cost, historical cost versus current market in their new developments), but with stabilized assets trading in the 4%-5.5% range, there's a lot of margin available to INDT's development platform to create shareholder value.

This week, the company issued equity at $60 per share giving them ample capital to pursue additional development opportunities later this year.  To illustrate what I think the company could be worth once this capital is put to work, I created the below back of envelope math.

The company still has a fair amount of non-core assets to be sold, so I assume those are sold at the price they're currently contracted at or book value which might be conservative, especially for the land holdings.  As part of their recent REIT conversion, they'll have a purging dividend that will be paid in part cash and part shares.  Then I also assume they'll sell the additional greenshoe shares, but maybe that's not a guarantee if the market's slide continues.  But then all that cash, plus incremental debt gets pushed into development projects at a 6.5% yield on cost, revalued by the market at a 5% cap rate.  The end result is roughly $82 per share, think of that as a target price a year out.  Probably a few mistakes in there, feel free to point them out.  One thing I am ignoring for now is the warrants that were issued last year as part of a private placement, those have a strike price of $60 which would raise additional capital as well.

My estimate is highly dependent on the market cap rate for industrial properties and their yield on cost for development, I ran a quick scenario analysis that shows what the math looks like at various assumptions.  Across the top is the development yield and down the left side is the market cap rate.

As you can see, the market is roughly valuing INDT at a 6% cap rate with little value being given to their development pipeline.  The math could really go in INDT's favor if they're able to issues shares closer to NAV or even above (many industrial REITs trade at a premium to NAV) creating that virtuous cycle that all REITs strive to get.  In summary, you have a proven capital allocator in a subsegment of the real estate market that should have continued tailwinds post-covid with a decently long but safe development pipeline to create significant value. 

Disclosure: I own shares of INDT

Wednesday, February 24, 2021

Technip Energies: FTI Spinoff, Forced Selling, Asset-Lite Business

Technip Energies (THNPY, ADR in the U.S.) is a recent spinoff of TechnipFMC (FTI). Technip Energies is an engineering firm that specializes in large downstream energy infrastructure project management, think multi-billion dollar LNG facilities in remote areas, floating LNG megaships and refinery buildouts. This is far from my area of expertise (if I really have any), I've had a few missteps in energy related spins before, but I think it presents an interesting special situation opportunity because:

  • Forced selling by both index funds (FTI was dropped from the S&P 500 index earlier in February ahead of the spinoff) and U.S. domestic oriented managers that can't hold the Paris listed/headquartered Technip Energies.  One data point around forced selling, the shares closed today at €11.26 in Paris, but $12.01 in the U.S. ADR.
  • Complicated percentage of completion accounting that makes the business difficult to analyze that may lead to some valuation errors, or obscure the attractive economics of the business.
  • Technip Energies is a surprisingly asset-lite "people business" despite the cyclicality of mega projects, their backlog (€13B) for the next several years is in place, they're guiding to mid-single revenue digit growth over the medium term and thus have no immediate concerns about growth trailing off, yet it trades for a ~15+% FCFE yield with what's essentially a zero net debt balance sheet.
Pre-spin TechnipFMC was the result of a merger between U.S. based FMC Technologies (original FTI) and French based Technip in 2017, primarily done to formally combine the two's subsea business that they had previously tied together in joint venture. That subsea business is now the parent, TechnipFMC, which retains the name and FTI symbol, along with the dual listing between the U.S. and Paris. The spinoff, Technip Energies, is almost entirely a legacy Technip business and will be headquartered and primarily traded in Paris. Originally, the spin was only going to trade overseas, but in the end the company decided to also include a sponsored ADR that would be distributed to U.S. holders of FTI. But the ADR shares will trade over-the-counter and generally won't be eligible for U.S. based indices. I've covered some merger-spin combination in the past, they tend to be interesting, might be worthwhile to frame this in a similar way even though the spin was 4 years after, but strategically its similar.

Following the spinoff, TechnipFMC retained 49.9% of the ownership of Technip Energies with the intention to monetize that stake over the next 18 months to reduce debt and shore up the parent's balance sheet. While there will be some short term overhang, it also highlights that the parent didn't want to saddle the spin with debt as is typical lately in order to pay a dividend back to the parent -- FTI wants the spin to trade well to maximize the eventual sale proceeds.

To give some scale to the types of projects Technip Energies works on, here's their flagship Yamal LNG, one of the largest construction projects ever in the Artic. It was built to transport LNG from a remote Siberian peninsula, which didn't previously have road or sea access, to China.

Another is the Shell Prelude, a mega floating LNG facility that is longer than the Freedom Tower is tall, WSJ had an article about it last summer highlighting some of the difficulties of operating something the size of a mini-floating city during a pandemic.

With multi-year projects of this size comes some complicated accounting, Technip Energies operates with a large (~$3B) negative net working capital position.  Their clients pay them partially upfront but mostly along the way as milestones are met, but each periodic milestone payment is always ahead of work to be completed.  As a result, the company has a large "net contract liability" line item on the balance sheet that makes it difficult to analyze the company, one could take a view that as long as the company is growing that the NCL should be semi-permanent and give the company credit for much of the cash on the balance sheet.  I'm guessing some data sites and screeners will take this approach when coming up with an enterprise value for Technip Energies.
But for simplicity and conservatism, I'm going to say the balance sheet is basically in a zero net debt position, now if they stopped accepting new business tomorrow and put the business in run off that would be a bit too aggressive, but at the same time it is probably too conservative of a stance given their backlog and projected growth.

To put a valuation around the company, I took a free cash flow to the equity (FCFE) approach to neutralize the cash vs NCL:

15+% FCFE yield for a near zero net debt company with a strong backlog seems too high, I haven't spent a ton of time on comparables, but I think for an asset lite business like this it should be more around 10% FCFE yield, which works out to a $18+ stock price (for the ADR in USD).

Risks/Other Thoughts:
  • Building mega projects is an inherently difficult business, the work is often performed in remote areas, takes many years to complete and your clients tend to be politically exposed state run entities.
  • Some of their contracts are fixed price, which means Technip Energies takes a significant amount of risk in the projects coming in under budget and on time.
  • Client concentration is also high as you'd expect with projects of this size, 5 clients make up 73% of their backlog.
  • With TechnipFMC retaining a significant ownership position in Technip Energies, there could be a share overhang, so we might be only be partially through two of the three forced selling events.  First was the S&P 500 deletion pre-spin, then the ADR selling off from spin dynamics and U.S. mandate deletion, third will be when TechnipFMC fully exits their stake.  TechnipFMC has pre-sold €200MM worth of Technip Energy shares to BPI based on an initial VWAP, an investor in the business already.
Disclosure: I own shares of THNPY

Thursday, February 18, 2021

Acres Commercial Realty: Yet Another Name Change, fka XAN, fka RSO

Acres Commercial Realty (ACR) is the new name for Exantas Capital (XAN) which was previously the new name for Resource Capital (RSO), which I wrote up back in 2016. The situation is somewhat similar to back then, while not a home run, there's a fairly clear path to a 20-30% near term return. Acres is similar to other commercial mortgage REITs, they provide transitional CRE loans so that borrowers can reposition a property (the risk is somewhere between a stabilized loan and a construction loan), traditional banks have largely been pushed out of this market.

Back in 2016, C-III Capital took over RSO and rebranded it Exantas, C-III cleaned up much of the messier non-CRE assets that were in RSO back then and for a while the company was a clean transitional CRE lender that used the securitization market via CRE CLOs to finance their loans on a non mark-to-market basis. Later, C-III then expanded into CMBS (transitional loans are typically shorter term, CMBS usually has stabilized loans underneath and adds some duration to the portfolio) which they financed through daily mark-to-market lending facilities, unfortunately the CMBS market saw a steep market value drop in March/April 2020 as liquidity dried up. Like many other mREITs, Exantas faced margin calls and was forced to liquidate much of that portfolio at a significant loss. While not the intended strategy, after the CMBS portfolio was largely liquidated, the company is back to a straight forward transitional CRE lender.

Oaktree and Mass Mutual came to the company's aid in July, provided rescue financing via 12% 7 year senior notes that also came with common stock warrants for a penny. At the same time C-III exited stage left and sold the management contract to ACRES Capital (Oaktree owns a stake in ACRES) who took over as the external manager. The ACRES team is mostly former Arbor Realty talent, Arbor primarily focuses on multi-family lending, which I anticipate being the primary focus going forward for ACR, the portfolio is already roughly 50+% multi-family so it shouldn't be a significant transition for the portfolio.

Earlier this week, the company completed the rebranding process to Acres Commercial Realty and simultaneously executed on a 3-for-1 reverse split. Oddly, the rebranding, corresponding reverse-split and ticker change to ACR, appears to have triggered a bit of a selloff in the company's shares for no apparent reason other than maybe market participants didn't follow the change from XAN to ACR. The new ticker doesn't show up in some of the more popular free data sites, while it sounds odd, the shares have dropped from above $13 to below $11 (~16%) in the couple days when the rest of commercial mREITs have been essentially flat.

The capital structure is very levered, most of the debt is CRE CLO financing, the first two CLOs have an attractive weighted average interest rate of about 1.50%, the one they did last September is at 3.28% when issuance was just restarting in the securitization market. Spreads have improved since then, whenever they do their next deal, I expect it to come in significantly.  The company did pause their preferred dividend for a couple quarters, but are now current again.
How the business model works on the debt side, Acres will originate new CRE loans utilizing the secured financing facility (5.75% interest rate, roughly what they earn on their assets) and once they build up a large enough portfolio, they'll obtain term financing via the CRE CLO market at significantly better terms. Now that Mass Mutual (financing lender) is also a shareholder via the warrants, makes sense that the new origination channel will open and available to Acres to continue new loan production and grow the business again. Back of the envelope, I have the earnings power at about ~$1.50/year to the common, and since the company has stopped paying the common dividend, book value should have built since 9/30.

Additionally, the company put in place a $20MM share repurchase program (roughly 15% of the market cap) that will be put to use quickly:
On November 2, 2020, the board of directors (the “Board”) authorized and approved the continued use of the Company’s existing share repurchase program in order to repurchase up to $20 million of the currently outstanding shares of the Company’s common stock over the next two quarters. Under the share repurchase program, the Company intends to repurchase shares through open market purchases, privately-negotiated transactions, block purchases or otherwise in accordance with applicable federal securities laws, including Rule 10b-18 of the Securities Exchange Act of 1934 (the “Exchange Act”).

Putting it together, book value has likely come up since 9/30 via earnings power and share repurchases, debt markets should be wide open to them as the new issuance CRE CLO market is surprisingly strong, especially to multi-family heavy portfolios.  I'm viewing this as more of a few month swing trade as the market "finds" ACR and their story, to potentially a bit longer if I want to stick around for a dividend reinstatement.  I'd put a target price at around $14-14.50, roughly 80-85% of where book value is likely to settle out.

Disclosure: I own shares of ACR

Tuesday, February 9, 2021

Aptevo Therapeutics: Positive Trial Results, Tang Capital Offer, Proxy Fight

This write-up is incomplete, it is a strange situation I don't fully understand but figured it was worth sharing in case any readers have a better idea of what's going on here, please comment.

Aptevo Therapeutics (APVO) is an early clinical stage biotechnology company (~$165MM market cap) that was originally a spinoff of Emergent Biosolutions (EBS) in 2016, which is how it came on my watchlist.  Aptevo was spun with a few commercial assets that were designed to provide a source of funding to pursue their primary platform, called ADAPTIR, I won't pretend to know much about it, but Aptevo has since mostly monetized any legacy assets and focused on developing cancer treatments utilizing their ADAPTIR technology.

An interesting series of events happened in a two week timeframe back in November for Aptevo:

  • On 11/3/20, Aptevo announced positive news on their primary asset's (APVO436) ongoing phase 1 clinical trial, a patient went into complete remission.
  • On the same day, 11/3/20, Tang Capital Partners started from zero and began buying stock indiscrimately at prices from $9.65 to $23.87, not stopping until they had purchased 42.5% the company in the span of 4 trading days.
  • On 11/8/20, Aptevo adopted a poison pill plan (too late!).
  • On 11/9/20, Aptevo announced a second complete remission in the same APVO436 phase 1 trial.
  • Then on 11/18/20, Tang Capital Partners offers $50/share for the remainder of the company they hadn't bought up the previous week, wild stuff.  Aptevo acknowledged the offer but has been mostly silent since then.
  • In December, they did update their shelf registration that includes an at-the-money issuance program, the stock took that news negatively as a sign management might pursue a go-it-alone strategy, or it could be negotiating tactics.
Tang Capital and their founder Kevin Tang are life-science focused investors, Kevin Tang is the CEO of Odonate Therapeutics (ODT) and chairman of La Jolla Pharamceuticals (LJPC), and those are only a couple of his current roles, he's had a long history of investing in, building, and running biotech companies both publicly and privately.  Clearly he has some expertise in the field and thought enough of Aptevo's positive clinical news to rush in and swoop it up (again, on the same day results were announced).

Today (2/9/21), news came out that Tang Capital is going to run a proxy contest to add Kevin Tang and one of his lieutenants to the board of directors and get the company to run a sales process.  

TCP is seeking to: (i) nominate, and hereby nominates, each of Kevin Tang and Thomas Wei (together, the “Nominees”) as directors for election at the 2021 annual meeting of stockholders of Aptevo, and at any other meeting of stockholders held in lieu thereof, and at any adjournments, postponements, reschedulings or continuations thereof (the “Annual Meeting”); and (ii) put forward the following advisory proposal for stockholder approval at the Annual Meeting (the “Sale Process Proposal”):

 

RESOLVED, that Stockholders of Aptevo Therapeutics Inc. (“Aptevo”) request that, in light of the pending offer to acquire the outstanding stock of Aptevo for $50 per share, the Aptevo Board of Directors immediately commence a process to sell Aptevo to the highest bidder, consistent with its fiduciary duty to maximize stockholder value.

Management owns about 5% of the company, they did re-strike their options earlier in 2020 and $50 would put all of those in the money.  Clearly, Tang thinks it is worth more than $50, I doubt he could get out of the position without crushing the stock and thus his investment, pot committed at this point and isn't going away.  There's a lot of execution and financing risk if management tries to go it alone, but I can see the view that if you've spent the last 4+ years getting to this point, you want to see it through on your own terms.  But then again, you're a public company and have a fiduciary duty to your shareholders.  This one is worth following, it's highly speculative with considerable downside, but I started a small position in it recently.

**2/10/20 Edit
I asked for some feedback and got it (thank you!), couple things I missed in the write-up as I thought they weren't material but potentially are very material to the APVO story:
  • Aptevo has a 7-year 2.5% royalty on the Pfizer's sales of Ruxience (in the US, Europe and Japan), a biosimilar drug of Roche's cancer drug Rituxan (top 10 selling drug of all time), sales just begun in Q2 2020, and have the potential to be quite significant.  Some light Googling and some expect peak sales of Ruxience to hit $1B by 2026 (towards the end of Aptevo's royalty agreement), depending how you think of the ramp to that point (or if that's realistic at all) the NPV of that royalty stream could be substantial.
  • Aptevo also has a 15-year royalty on the Medexus Pharmaceuticals' sales of IXINITY, a hemophilia treatment, in the United States and Canada.  The company received $30MM upfront and estimates the total proceeds (inclusive of the $30MM) will be $100MM.  Again, depending how you run a scenario analysis on the NPV of those milestones/royalty fee streams, could be quite significant to a company the size of Aptevo.
  • Aptevo has 436,844 remaining warrants with a strike price of $18.20, which if exercised would raise the ~$8MM in cash, and put the share count at ~4.8 million shares assuming the company hasn't raised additional capital through their ATM.  Tang's ownership percentage would then be approximately 37%.
Disclosure: I own shares of APVO

Friday, January 22, 2021

CIM Commercial Trust: Proxy Fight, Possible Liquidation or Sale

CIM Commercial Trust (CMCT) is another small illiquid idea (~$240MM market cap), CMCT owns about ten office properties in LA, Oakland and Austin, plus the Sheraton Grand Hotel in Sacramento.  When thinking about asset types and locations where covid has been the most impactful -- office, CBD hotel, Bay Area migration, LA lockdown -- CMCT checks a lot of those problem boxes.  CMCT is an externally managed REIT, the manager is CIM Group, a fairly large and well respected real estate firm based out of Los Angeles.  The shares trade at a discount to the company's own estimated NAV (which is very stale, pre-covid), two different activists have put forward a slate of new directors  (here and here) with the intention to liquidate the portfolio.  I believe there's a decent chance management caves here and either commences a liquidation on their own or kicks off a strategic alternatives process aimed at selling the company to one of the other west coast focused office REITs.  The upside is a bit unclear to me (open to hearing from people with a stronger view), so possibly this is more of a watchlist idea, but I opened up a starter position at just under $14/share.  It popped unexpectedly today, apologies that this is not as timely or actionable, it could give it all back, but just for context purposes my cost basis is a bit lower than where it is trading today.

CMCT has a strange origin story for a public REIT, it began life in 2005 as a private equity real estate fund diversified across office, multi-family and hotel.  In 2014, as the fund's maturity was coming up, it was reverse merged into a small mREIT ("PMC Commercial Trust") that made SBA loans (CMCT oddly still makes SBA loans in this legacy segment), with the PE fund owning well over 90% of the proforma entity, but only the non-PE investor shares traded publicly creating this odd stub.  Cynically, CIM took a limited life fee stream and turned it into a permanent one at the detriment of their investors as the shares have failed to trade close to NAV since the reverse merger.  In the meantime, CIM has sold the majority of assets within CMCT in a few different slugs and then returned capital to investors either through a buyback or a big special dividend that was issued in 2019.  Notably, those asset sales were done near their published NAVs at the time.  So here we are now, a subscale externally managed REIT with long suffering shareholders that has limited options to raise capital to grow, sort of stuck in no man's land heading into a post-covid world.

Here are the real estate assets today:

Again, the portfolio is heavy on Oakland and LA.  In Oakland, they own the Ordway Building (1 Kaiser Plaza) which is primarily leased by Kaiser (30% of CMCT's overall rent roll).  Kaiser previously announced they would build a new headquarters in Oakland and consolidate their real estate foot print (presumably exiting CMCT's asset) but recently they cancelled those plans in light of the pandemic, so potentially Kaiser could extend their lease.  If not, market rents pre-pandemic were a decent bit higher than in place rents, we'll see how things shake out in the Bay Area, but Oakland could cool off significantly as San Francisco office becomes cheaper and reduces the spill over into the more affordable Oakland market.  Additionally, they do own a parking lot next door, which they've been marketing as a build-to-suit, but presumably new office development is off the table for several years, my guess is it remains a surface lot for the foreseeable future.

The other chunky asset of concern is the Sheraton Grand Hotel in downtown Sacramento.  CIM acquired the hotel in 2009, it sits next to the convention center in Sacramento which is finishing up a renovation and expansion project, the convention center is scheduled to open in February.  Pre-covid, CMCT was planning to invest $26MM to renovate the hotel, but those plans have been put on hold.  CMCT also owns another parking lot across the street that they suggest is an additional development site for either a hotel or multi-family tower.  Located in a state capital and positioned next to the convention center, I can see a path where this hotel fully recovers.  Downtown Sacramento has seen a considerable amount of development recently and there are a number of hotels that are in the pipeline, one is even considering breaking ground soon, signaling demand or at least the expectation of a recovery in the market.  The hotel is still cash flow negative, in October (last data point) it only averaged a 29% occupancy rate, and isn't expected to cross the break even line during the first half of 2021.

In LA they own several clusters of assets, LA is CIM Group's backyard.  I don't have much to add here, the one asset that is only 21% occupied was previously earmarked for a significant repositioning, but that's been put on hold as well.  The below slide management puts out also shows all of the properties CIM has exited over the years, clearly you can see that they're one of the major players in the LA market providing some comfort around this piece of the portfolio.

The other assets include an office complex in Austin that was just leased up and a small loft style office property in San Francisco.  And as mentioned earlier, they oddly still operate the SBA lender business which is a legacy from the reverse merger.  Making SBA 7(a) loans is a fairly good business, a portion of the loan is guaranteed by the government, SBA loan originators are able to sell that guaranteed portion into the secondary market and since it is guaranteed by the U.S. government, originators are able to sell those portions at a premium.  They're then left with servicing rights and the unguaranteed portion of the loan, which most lenders retain.  The one red flag with CMCT's SBA business, the portfolio is basically a pure player lender to franchisees of economy and midscale franchised hotels (think brands under the WH or CHH flags).  They also have PPP loans they've extended to their borrowers that will likely be fully forgiven and paid by the SBA to CMCT.  I tend to think the economy hotels make it through covid, but its worth flagging that there is risk in this asset. 

So those are the assets, the capital structure is a bit odd here, it's heavy on preferred shares, which about half of which are continuously offered through their RIA channel and are not publicly traded.  I took the 2019 proforma NOI from the Lionbridge letter and backed into what cap rate the market is putting on their assets, approximately 6.7% which feels high to me.

CIM Group does put out an annual NAV estimate, the current one is stale from pre-covid, year-end 2019.  The NAV is a little disingenuous as it also uses the old capital structure, the company has issued additional preferred stock since YE 2019.

We'll probably find out in the next month or two what the new NAV estimate is, it will certainly be lower, my back of the envelope guess is somewhere in the $20-22 range, which would be a 6.0-6.2% cap rate on 2019 NOI.

Will CIM Group cave to activist pressure? 

CIM Group was co-founded by Richard Ressler (Chairman of CMCT, also Chairman and former CEO of JCOM), Avi Shemesh and Shaul Kuba in 1994.  Today they manage just under $30B in assets, about $1B of which is CMCT (at their stale valuation) and they also have a significant non-publicly traded REIT business after their purchase of Cole Capital in 2018.  I bring that up because they recently merged a few of their private REITs, potentially in preparation to list them publicly, might be stretch but that vehicle is much larger than CMCT and they wouldn't want to damage their reputation and limit that REIT's growth in future (assuming CIM agrees that CMCT failed in becoming a growth platform).

The management agreement at CMCT is a bit non-standard for an external REIT, it was rolled over from the original PE fund and wasn't revised in the merger:

  • The management fee is tiered with breaks as CMCT gets larger, but instead of getting bigger, it has only gotten smaller as a public entity, and more problematically the fee is based off of the asset value in the NAV calculation.  The stock has never traded anywhere near NAV and clearly NAV is subjective and manipulatable in their favor.  Additionally they have typical expense reimbursement provisions, read through the activist letters for more detail. 
  • It is a perpetual term contract, "and shall remain in full force and effect until the Partnership is dissolved, this Agreement is required to be (or is automatically) terminated pursuant to the terms of the Partnership Agreement or the Partnership and the Adviser otherwise mutually agree" -- I'm guessing this is the angle of the activists, take over the board and then "dissolve" the partnership entity through a liquidation. But not entirely sure a proxy win for the activists is needed here.
  • One benefit of rolling over the original management contract, it doesn't appear to have a termination fee which most externally managed REITs include, making it more attractive for activists to get in here and attempt to remove the manager.
CMCT is a Maryland corporation which does make it difficult to unseat an external manager, CIM insiders own roughly 20% of the company, so it's an uphill battle.  But again, this is a small piece of CIM, why ruin your reputation over a relatively small management fee stream?  And most importantly, CIM has relented to shareholder pressure before, here Lionbridge describes the events leading up to previous asset sales:

What transpired over the next few years bore little resemblance to CIM’s originally stated growth objectives for CMCT. In 2017, CMCT sold over $1 billion in assets and repurchased a similar amount of CMCT stock owned by the private fund. In its public communications, CMCT depicted these corporate actions as the result of a regular evaluation of its business and prudent management. Based on our firsthand discussions with CIM Urban REIT investors, however, we believe these sales were the result of extreme pressure from its fund investors, who were voicing displeasure for the public vehicle. In other words, only when it was clear that the REIT strategy had flopped, and under intense pressure from its pension-fund clients, did CMCT begin selling property and returning capital to investors.

 

Rather than rightfully completing the sale of its portfolio once and for all and returning the remaining value to its investors in cash dividends, CIM dug in its heels. In 2018, the company announced a "Program to Unlock Embedded Value in Our Portfolio and Improve Trading Liquidity in our Common Stock.” At the time, CMCT was trading at a nearly 40% discount to NAV. This program contemplated another $1 billion in asset sales, or roughly half of the remaining portfolio at the time. The net proceeds were distributed to shareholders, but again, instead of completing a cash liquidation, the private comingled fund was dissolved via a distribution of CMCT shares to its partners. The result was a more structurally flawed company with even less scale. Upon the distribution of CMCT shares, the partners would own over 95% of this deeply flawed and obscure REIT’s shares.

In its public messaging CMCT portrays its asset-sale programs as discretionary capital allocation moves made in response to strong markets and emblematic of CIM’s willingness to return capital to shareholders. Again, based on firsthand accounts from CIM’s partners, we believe that assertion is misleading. We understand the asset sales and return of capital were being demanded by the partners, according to some accounts, under threat of litigation and were not what CIM Group was otherwise inclined to do.

Contrary to what CIM representatives portrayed to prospective investors, what awaited the market after executing the plan to “unlock value” and “increase liquidity” was an ownership base comprising almost entirely legacy fund investors whose moods we understand generally ranged from frustrated to incensed at CIM’s refusal to completely liquidate the company for cash. In the aftermath of the distribution, the shares were soon trading at a nearly 50% discount to published NAV, wider than when the “Program to Unlock Embedded Value” was announced. They would remain in that vicinity for months before they further collapsed in the COVID-related market sell-off.

CIM Group has caved twice to CMCT investors, starkly clear this isn't a growth vehicle for them, my thesis is they'll do the right thing and either liquidate or sell the company, keep their public reputation in place for where there is actual growth (like their private net lease REIT) and brush this entity under the rug.

Another interesting way to play this idea is the Series L preferred shares (CMCTP), I tried for a couple weeks to buy shares but didn't have any luck, it is very illiquid but strangely the class has a liquidation preference of $28.37 versus the usual $25, and its redeemable next year at shareholders option, the company has the option to play stock or cash, but either way it seems like a pretty attractive high teens, low twenties IRR if you're able to get shares at $22-$23.

Disclosure: I own shares of CMCT