Thursday, September 9, 2021

Atlas Financial: Senior Bonds Should Reject RSA, Reopening Play

At a certain point, I should probably turn this blog over to a few of my smarter readers, Atlas Financial Holdings (AFHIF) has been mentioned a few times in the comment section by ADL.  Be warned, Atlas has a lot of hair on it, thinly traded and the common stock is a nano-cap (sub $10MM).

Atlas is in the early innings of a business transition, previously they were an insurance company to the niche light commercial auto market (think taxis, limos, shuttle buses, etc.), that wasn't a great segment prior to covid and then really got crushed during the pandemic with rides down 90+%.  Anyone that has tried to get a ride-share or taxi lately knows, there's a massive driver shortage and fares have spiked significantly, eventually this will normalize and drivers will return.  The insurance subsidiaries of Atlas are now in receivership/liquidation, the remaining business and the go-forward strategy is a managing general agent ("MGA") model (d/b/a Anchor Group Management) where Atlas originates and services insurance policies for a fee but the risk is borne by third-party insurance company partners.  In addition, they've developed a mobile app targeted at ride-share drivers that offers micro-duration policies (essentially an hour-to-hour type thing) that would have sounded very SPACable earlier this year, but at the moment is more of a call option and not super material to the business as far as I can tell.

If they can return to writing the same volume as they did in 2018 (~$285MM, approximately 15% market share) under the MGA model (management put this goal out there in their recent investor call), this could be a multiple bagger (they take a 20% commission and guided to 20-30% pre-tax margins), but the path between here and there is highly uncertain and probably not realistic.  To put that goal in context, they currently have only 5% of that in-force, writing a bit more than on a run rate basis as new business is inflecting with the reopening.  To make it even hairier, the company has a quickly approaching $25MM debt maturity in April 2022, that security is a baby bond ($25 par, exchange traded) under the symbol AFHBL.  

The company missed the July payment on these bonds (although you would have no way of knowing unless you owned the bonds) and then last week the company announced it had come to a proposed restructuring support agreement ("RSA") with 48% of the noteholders to exchange the current bonds for a new security with similar terms (same headline 6.625% coupon, but the company has the option to PIK at 7.25% for the first two years) but pushing the maturity out 5 years in an amend and extend.  Troubling, alongside the restructuring of the bonds, Atlas is receiving rescue financing from "certain supporting noteholders" in the form of a 12% $2MM convertible term loan with an additional $1MM delayed draw.   As a "setup fee" the supporting noteholders are also getting a free 2,750,000 shares (and up to 5 million shares if the delayed draw is fully drawn), which is close to $1.4MM at current prices, quite the setup fee for a $2MM loan!  The loan has a conversion price of $0.35, which is in the money at today's $0.50 share price, so if fully drawn and converted, this rescue financing could end up with over 13.5 million shares compared to the current share count of just over 12 million shares.  The convertible loan is also senior secured and senior to the proposed restructured bonds, effectively these "certain supporting noteholders" are extracting value from the rest of the noteholders.  In a normal bankruptcy proceeding, all noteholders would be treated equally and would likely receive a pro-rata combination of new bonds and equity.

The bonds (AFHBL) did trade up on this news to $11-$11.50ish (par value is $25) creating a yield-to-maturity in the mid-to-high 20% range if the proposal is approved.  But I think there is an opportunity for a better, fairer deal for AFHBL noteholders, if you own the bonds feel free to reach out to my email and I can put you in touch with a group that is pushing for a better deal.  I plan on rejecting the RSA.  Either way, seems like an interesting quirky way to play a reopening or normalization of the post-pandemic economy.

Other thoughts:

  • Atlas has its corporate headquarters for sale (953 American Lane, Schaumburg IL) for $13MM, they do have a $6.5MM mortgage on the property that is held by the estate of one of their former insurance companies that are now in receivership.  So there should be some equity in the property, providing meaningful liquidity to a company of this size, potentially negating the whole need for the egregious convertible loan if they could get it sold quickly.
  • Atlas is heavily tied to two insurance providers, so this isn't quite the "originate to distribute" model it sounds like but more of an outsourcing model with two customers, so the customer concentration risk here is quite high.  National Interstate Insurance Company is the partner for shuttle buses and Buckle Corporation is the partner for the taxi and limo business.
  • It appears that Uber and Lyft are being more rationale in their pricing post pandemic, both are public now and no longer have near free cost of capital to sustain negative gross margins, maybe some market share stabilizes or inches back for taxis and limo services where Atlas's business historically focused.
  • The same CEO that drove this into the ground is still the CEO, which gives me some pause on the likelihood that they'll be successful executing the turnaround.
  • This likely isn't a takeout candidate, in the 10-K, they mention that as part of the insurance company liquidations, Atlas agreed that if they choose to sell the MGA operations, the insurance company estates would receive 49% of the proceeds.

Disclosure: I own AFHBL

17 comments:

  1. Are the noteholders who agreed to the exchange the same ones who are funding the rescue financing?

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    1. Yes, "Supporting Noteholders" is defined as the 48% that have agreed to the RSA, and then "certain Supporting Noteholders" are funding the convertible loan, so presumably there's not 100% overlap but a subset of the 48% are the lenders in the rescue financing.

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  2. In bankruptcies it is also not uncommon for one party to extract value from other parties. If they would decide to restructure in chapter 11 you would probably face DIP financing from day 1 that will also have super priority over all existing loans, and it would not be uncommon to see backstop fees and/or oversubscription rights in a capital raise and things like that. Not to mention the massive professional fees involved in the whole process. I'm very skeptical that voting against the RSA is a great plan unless you know exactly what you are doing. If you are successful in blocking the RSA the alternative might be a chapter 11 restructuring...

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    1. To be clear, I don't know what I'm doing and flexible in my thinking here. But yeah, I agree with all that, the current RSA just seems particularly egregious, maybe its the best deal minority noteholders can hope for? Calling giving away 5 million shares a setup fee seems like a slap in the face.

      In chapter 11, you would get the 12% DIP, but potentially it wouldn't need to be funded if they could sell the headquarters. Then the noteholders would receive a pro-rata combination of new notes and equity as a group and the equity would get a little taste, plus some warrants, etc. Here the certain noteholders are getting pretty substantial preferential treatment, their downside is getting protected via the seniority of the convertible loan at 12% and their upside is juiced via getting half the equity if things work out.

      Even if the RSA goes through, the bonds still look interesting to me, just think there could be a more fair solution out there. Maybe I'm just bitter I can't be part of the convertible loan! Little guys have certain advantages, but being a professional has some as well.

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    2. Am of two minds on this because while I agree it's an awful lot to give up, it's not necessarily out of line as a % on nominal enterprise value and in terms of what the market might bear; I suspect shops have an informal dollar minimum, and Atlas is so tiny that any ask is going to be a large chunk of it.

      That said, if I were management/lender, I'd still be open to giving "outside" bondholders a bit more to get it done. Even with ~half signed on, it seems on pretty shaky ground, and this is a good payday with equity upside and, obviously, some costs already expended to get to the current agreement. Aggrieved holders sometimes act less than rationally if a deal is egregious, which this--to my mind--isn't, but it's close. So, again, it's all game theory.

      And I agree with Alpha Vulture that Chapter 15 (Caymans, oof) would be a disaster and almost certainly deplete the estate. Plus they have been trying to sell their HQ for a while; who knows when they'll be successful and the specter of fraudulent conveyance arises if they succeed and still do an in-court restructuring (an HQ sale might obviate the need for that, but...).

      I'm still pretty positive on this getting done and will write one of my useless letters to management. Interesting that the notes look like they may move up again, just based on bid/ask, though who knows with something this illiquid.

      Also, I deny the characterization (if it was made) of me as a "smarter reader"! I'm keenly aware of all the unmentioned dumb trades I make; through great struggle, I'd say I cling to the middle (have had decent returns, but am still trying to figure out what percentage of them--though I know it's high--is due to luck). I'm very grateful for all your work and thought here; obviously there's some benefit to you in terms of structuring your thoughts and obtaining feedback, but still, this blog is generous.

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    3. Couple quick notes on things mentioned before: EPM has increased its dividend again, really underlining their commitment to shareholder return. It will never be an A-grade company because it's oil & gas, but they stick to their knitting and avoid most of the financial chicanery and sidetracks that bedevil their peers, so I am comfortable with them as a long term holding. All else equal (which it never is in hydrocarbon land), I imagine they will increase their dividend to 10 cents/quarter sometime in the next year.

      I think I mentioned PNNT briefly. They are a BDC trading under 70% of NAV, with a very large portion of their portfolio in equity. This has led to both lumpy results and relatively low yield to assets, but now they are harvesting some of their largest positions and putting the proceeds back into yield assets (not that that's easy) and continuing their very small but potentially-very-lucrative equity coinvestment program. After suffering through the asset-value decay many BDCs have had over the past few years, their NAV is now at the highest point in ~5 years. Their dividend is still down almost 60% over that period, and I expect it to start growing as they redeploy.

      I believe the remaining lockup on CANO (one of their larger equity holdings, and a company on which I am quite positive) expires in early December, and the redeployment of proceeds from that monetization alone (though I'm a little unclear on whether the 20% promote they have to pay is included in their valuation) could add ~1.5 cents per share in quarterly distributable income. CANO's appreciation since the 6/30 measurement adds more than a dime to NAV.

      If you assume normalish market conditions and give management the benefit of the doubt (which isn't necessarily easy, though I do rate them pretty highly given how they've navigated the past decade) and assume they can and will do what they say they're going to, then this will be a stock with an NAV of around $10 with a quarterly dividend of 15+ cents in the next 6 months; if it normalizes to an "OK BDC" multiple of 80-85% NAV, you'd see price +20-30%, though dividend would probably have to return to 72+ cents/yr to really support that.

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    4. Oh, and ADES, which I also mentioned, continues its relentless slide. Given that they will have $90+ million in net cash by year's end (some restricted) on a ~$120 million company, their remaining operating business may have finally turned the corner, shareholders are clearly fatigued after years of promise not crystalizing, and they are undergoing a review of their alternatives, this strikes me as a good risk/reward that improves as the price declines--though there's always the chance that the price is right and signaling: stay away!

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    5. EPM has had me worried for the last month or so because I had no idea if they were hedging natural gas prices. Luckily per conference call no they have not and probably won't hedge unless they take on debt for another acquisition (thank god since last hedging experiment was a disaster). JCS has so far worked out as planned. I have traded it in an out since the original announcement. I'm hoping when this dividend news dies down so will the price (like what happened after original announcement) but you never know. I looked at ADES last year or so and couldn't quite understand the carbon credit stuff with the accounting so I walked away. Mistake of course. LGL is not trading even close to where I was hoping since IRNT is sticking around $20. These meme stocks don't drop quickly like in the old days... See GME and AMC still up there months after initial insanity

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    6. Yeah, I think the general EPM playbook is to not hedge, and last year's hedging was just to preserve their treasury in case there was a protracted swoon. It obviously didn't work out well but I understand the desire to hold onto their cash for a potential distressed purchase they weren't quite able to pull off. In general, I like their low-complexity approach, though obviously the multiasset/multibasin base they've bought into changes that somewhat.

      JCS good/great/bananas; I sold out 40% of my remaining today after hours because I'm happy with $10+.

      I think the sunsetting of the 45 credits is a good thing for ADES, because now it can be analyzed as a proper operating company. I don't have a ton of conviction in them, because the promised turnaround in the carbon factory has been "close" for years, but their cash buys them some goodwill.

      Oh, man, I forgot that LGL is the IRNT sponsor!

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    7. Agreed on ADES. Net cash (adjusted for RC cash flow and some corporate overhead) is about $75m at year end, so EV is about $40m - $45m.

      They bought the AC plant for $65m + 10m in lease commitments and did some CapEx subsequently. The Cabot deal should be a positive. Plant is likely worth more now.

      Also, if you take historical EBITDA and adjust that for the announced price increases and Cabot revenue increase I can see this plant generating $17m - $24 in EBITDA. They bought the plant at ~4x EBITDA, which also suggests that the market valuation is too low.

      If the strategic review ends in a sale shareholders will likely do well. Seems to me that this plant easily could be worth $70m - $100m (or even more if you are optimistic) rather than the ~$45m implied by the market.

      And with only one plant left and a couple of strong-ish large shareholders I think going private is the logical conclusion of the strategic review.

      Of course one of the key risks is that they decide to go at it again with a nice acquisition or whatever. Also, I know nothing about activated carbon whatsoever, so who am I to value this plant at a gazillion dollars ..

      Anyway, not the highest conviction pick but I like and own it. I'm a sucker for cash on the balance sheet.

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    8. Same. Going back again to names I mentioned, basket of small medical device companies not looking great with NUWE doing a steeply-discounted capital raise. Still think there is good hunting in the field, which is eternally-consolidating, but I might have basketed the wrong names.

      Am adding to (unmentioned) EOLS, which I think trades too cheaply given that its legal and liquidity issues are in the rear-view. It's an aesthetics company growing rapidly, and I pencil in cashflow breakeven by the end of next year.

      Also adding to BDSI, where I believe management is actually focused on adding value.

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  3. Sure, and pushing back on some terms might not hurt. In the end the chapter 11 route is presumably also a massive value destruction event for the supporting noteholders, so in theory all parties should have an incentive to avoid that. But if you compare this out of court restructuring with what I think is the alternative it might already be a pretty good deal for everyone.

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  4. Can "certain supporting noteholders" be those two insurance carriers (National Interstate and Buckle)? Sounds likely as they would become controlling shareholders after full conversion. If RSA fails they may just walk away and kill the business

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    1. Unlikely that they own the bonds, but I guess its a possibility

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  5. How do you get a position on when it trades 500 shares a week?

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    1. Maybe I just got lucky, but I didn't have any trouble picking up a position (~2000 shares)

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  6. Where did you shake out on BSIG?

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