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 (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 (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