Tuesday, November 30, 2021

Altisource Asset Management: Preferred Overhang, Cash Shell w/ Optionality

Many readers will know this situation, Altisource Asset Management (AAMC) is a cash shell with approximately $80MM in the bank after their only asset management client, Front Yard Residential (RESI), terminated their external management agreement with AAMC resulting in RESI being internalized (AAMC was a 2012 spin, was trendy at the time to spin the management company).  Front Yard later sold itself to private equity (Ares and Pretium) which likely will turn out to be a great deal (even after they hiked the offer) for the buyers given how single family rentals have traded since.  Friend of the blog, Andrew Walker did an excellent podcast (and even answered one of my questions on it) with Thomas Braziel and Jeff Moore pitching AAMC.  They go into some of the background, particularly on the controversial Bill Erbey, who was formerly an executive (back in the early-to-mid 2010s, Erbey ran Ocwen and a few satellite entities like AAMC), but now is *just* a 39% shareholder in AAMC after legal trouble forced him out of the day-to-day operations.

Long story short, Altisource has a large preferred overhang (originally $250MM, currently $150MM after two exchanges), the stock previously traded north of $1000/share (now for $17.90) and issued a zero coupon convertible preferred stock with a strike price of $1250.  The cash from the convertible preferred was used to buyback shares, presumably to boost the shares above the strike price making everyone happy, but instead the stock collapsed.  Now that piece of paper is hopelessly out of the money, it is basically a zero coupon bond with a mandatory redemption date of 3/15/44.  However starting in March 2020, every five years the preferred holders can request a full redemption:

(b)    Each holder, at its option, shall have the right, in its sole discretion, to require the Corporation to redeem all of its outstanding Series A Preferred Shares by providing written notice to the Corporation within fifteen (15) Business Days (but not more than thirty (30) Business Days) prior to a Redemption Date of its intent to cause the Corporation to redeem such holder’s Series A Preferred Shares on such Redemption Date (each, a “Holder Redemption Notice”) which will specify (i) the name of the holder delivering such Holder Redemption Notice and (ii) that such holder is exercising its option, pursuant to this Section 5, to require the Corporation to redeem shares of Series A Preferred Shares held by such holder. The Corporation shall, within fifteen (15) Business Days of receipt of such Holder Redemption Notice, deliver to the holder exercising its rights to require redemption of the Series A Preferred Shares a notice specifying the date set for such redemption, which date shall be no more than thirty (30) Business Days after the Holder Redemption Notice (the "Holder Redemption Date"). The Corporation shall redeem for cash on the Holder Redemption Date, out of funds legally available therefor, all, but not less than all, of the outstanding Series A Preferred Shares held by such holder at an amount equal to the Redemption Price.

The larger holders did indeed request redemption last year.  But the trick is AAMC has to redeem the entire class at once, and obviously they can't redeem the $150MM outstanding with only $80MM in net cash.  The preferred stock is closely held, two holders (Putnam and Wellington) have settled with AAMC and exchanged for either a combination of cash and stock in the case of Putnam or just cash in the case of Wellington.  Both worked out to approximately 11-12 cents on the dollar.   The remaining significant holdout is Luxor Capital which is pursuing litigation against AAMC.

I have never subscribed to the "preferred stock has no teeth" thesis, here is where my views differ (again, I'm often totally wrong):

  • Luxor is not anchored in any way to the previous two settlements, they're the largest holder (basically the only remaining holder) of the preferred stock and still have leverage.  I'm a structured finance guy, they're almost the "controlling class" in this situation, without them the overhang isn't resolved.  Additionally, Putnam included a "most favored nation" clause in their settlement which effectively hitches their settlement to Luxor, it gets Putnam out of the lawsuit but also allows them to retain the optionality of a better deal.
  • Altisource won't risk consummating a new business combination/merger before the preferred stock overhang is resolved.  If the deal is successful, then AAMC could potentially be on the hook for the full $150MM down the road or at a minimum increases the recovery rate for Luxor.  I don't see anything happening until Luxor settles, maybe there's a settlement and merger simultaneously but it feels highly unlikely that the preferred can just sit out there until 2044 (for either side).  So this is a game of chicken until then, and those situations can last longer than people want to believe (I would have thought RHE would have settled by now).
But the price has fallen considerably in the last several weeks to $17.90 today, at this price the thesis seems more interesting (basically back to where it was before Wellington settled) and allows some margin of safety in the circumstance that Luxor strikes a significantly better deal than either Putnam or Wellington did.

Here's the current situation, obviously the capital structure is upside down at full face for the preferred, I'm discounting the net cash for two quarters of cash burn, dealers choice there.

How I'm thinking about a post-settlement proforma: I'm assuming that the Putnam settlement is the best case.  Putnam held $81.8MM of the preferred stock and received 288,283 shares of stock and $2.863MM in cash (split in two payments), if we applied that ratio to the remaining $150MM outstanding, I get about a $25 NAV.

But if Luxor was going to settle for the Putnam deal, they would have already, so applying a multiple to that, let's say they negotiate a 25% or 50% better deal than Putnam, I get an NAV of $23.28 and $21.50 respectively.  Against a $17.90 stock, that seems like a reasonable discount, if you did a goal seek on the multiplier to get to the current price, Luxor would need to strike a deal more than 100% better than Putnam (also includes the incremental benefit to Putnam for MFN clause) to get to the current share price.

I'm not going to speculate on a deal target, the podcast interview I referenced does a bit of that if you're interested, but AAMC included in the below in their Q3 earnings release:
Mr. Thomas K. McCarthy, Interim Chief Executive Officer, stated, “The Company’s attention and focus continues to be the evaluation and pursuit of certain business opportunities and acquisition targets in which to focus the Company’s resources and enhance shareholder value. The Company has liquidated its equity holdings and is now in an all-cash position in preparation of an acquisition event.

During the third quarter, the Company also engaged the services of both an investment bank, Cowen and Company, LLC, and the law firm, Norton Rose Fulbright, LLP, to assist us in identifying and reviewing potential acquisition and merger opportunities. While no final decision has been made, the Company is in discussions with several potential acquisition or merger targets including cryptocurrency and brokerage related businesses”.

The company is probably mid-process, I'm guessing that a settlement with Luxor is announced at the same time (if they take shares, they could participate in the upside, removing the litigation overhang will likely cause the stock to bounce significantly), plus there are some "meme able" buzzwords in there and a relatively low float, I agree that something crazy could happen with this one and at today's price you're not paying much, if anything, for that optionality.  But there are hundreds of SPACs also competing for similar buzzy deals, so who knows, could be challenging to get a deal done and there could be a frustratingly long stretch with no news.

Disclosure: I own shares of AAMC 

Wednesday, November 24, 2021

Sonida Senior Living: Out of Court Restructuring, fka Capital Senior Living

Sonida Senior Living (SNDA, fka Capital Senior Living under the old symbol CSU) recently completed an out of court restructuring led by Conversant Capital, the same investor that has been instrumental in institutionalizing and providing growth capital to INDUS Realty Trust (INDT).  While clearly different, the industrial/logistics asset class has covid tailwinds versus senior housing having covid headwinds, the results could rhyme with each other longer term as this micro cap "grows up" (to steal a tweet from "Sterling Capital" @jay_21_, also h/t for the idea). Sonida is now positioned to use their reset balance sheet to take advantage of a fragmented senior housing market with plenty of distress (looking over at our friend RHE), but also with long anticipated demographic tailwinds finally being realized with an increasingly large population aging into senior housing.

Below is the standard investor relations overview slide.  Unlike some others in senior housing, SNDA is not a REIT (more similar to BKD), but owns and operates the vast majority of their facilities as they exited locations the company formerly leased from others (VTR, WELL, PEAK etc) in recent years.  There's embedded real estate value at SNDA as a result, which may someday lend itself to some kind of REIT transaction.  They also have a small management business that resembles Five Star's (FVE) business model (got there in a similar way too when SNDA restructured their leased properties) that helps offsets some G&A in the meantime.

The restructuring agreement took a few twists and turns, including heavy opposition from 12+% shareholder Ortelius Advisors, but was eventually approved by shareholders in October and closed earlier in November.

A total of $154.8MM (net $140.8MM) was raised through a combination of:
  • $41.25MM in convertible preferred stock (11%, conversion price of $40) to Conversant plus an additional $25MM accordion to the convertible preferred stock if needed for growth capital 
  • $41.25MM in common stock at $25/share to Conversant, plus warrants to purchased an additional 1 million shares at $40/share
  • $72.3MM through a rights offering at $30/share to all company shareholders
  • Conversant previously provided a $16MM rescue bridge loan to the company, it was repaid in full upon closing of the transaction on 11/3/21.
Most of the capital is going to be used to stabilize the company's balance sheet and take care of some deferred maintenance capex the company likely punted on the last two years.  The capital basically allows the company to recover and get back to some kind of normalized operating environment.  Senior housing has had the unfortunate position of getting hit by covid from both the revenue and expense side.  It's not fun to mention but obviously covid caused a lot of deaths in this age group and likely prevented a lot of move ins as family members stayed home and turned into caregivers to avoid subjecting love ones to senior housing during a pandemic.  On the expense side, first they had PPE expense and now a tight labor market which is squeezing their margins.

But attempting to look through to what their results could look like in a year or two as the world normalizes, the key numbers to run a scenario analysis are the occupancy and NOI margin (I'm going back to YE 2017, no good reason just seemed "normal", for their owned properties they did 88% and 38% respectively):
To be clear, they're a ways away from normal, as of their last earnings report, occupancy was 82.3% and NOI margin was 21%.

For the cap rate, it's a bit tricky too, senior living is similar to hotels where if you're the owner operator it's less of a real estate business and more of a service business.  But Ventas (VTR) recently purchased Fortress controlled New Senior Investment Group (SNR) for $2.3B:
"The transaction valuation is expected to represent approximately a 6% capitalization rate on expected New Senior Net Operating Income ("NOI").. the acquisition price implies a 20% to 30% discount to estimated replacement cost on a per unit basis.. the transaction price represents a multiple of <12 times estimated 2022 New Senior normalized FFO per share including full synergies."  
It's not an apples-to-apples comparable, New Senior didn't operate their properties, just leased them out which is arguably less risky (although a lot of senior housing REITs have had to take back properties) but at least allowed them to be a REIT and lower their cost of capital.

The proforma debt and share count is a little messy, I've probably made some errors here, so those who know better, please feel free to correct me.
That compares favorably to today's share price of ~$32 per share, but that's an asset/takeout value (doesn't include corporate overhead, etc.) and assumes a full recovery.  But also doesn't include any additional growth or deal making which will likely come in the future, based on who they've brought in, the re-branding, it all signals that this is going to be more of a growth platform (similar to the GRIF to INDT rebrand).  
On sort of a going concern basis, using normalized numbers, including the convert but excluding the effects of the warrants, I have it trading at 12.5x normalized EBITDA (below where other senior housing companies trade, but to be fair, they'd trade lower on a normalized number too).  Not screaming cheap on an absolute standalone basis, they probably need additional scale to create some operating leverage on the G&A and corporate expenses.

Other thoughts:

  • I don't have the stats to back it up at my finger tips, but the dynamics in senior housing appear to be similar to those in single family residential.  There was significant overbuilding of senior housing in the middle of the last decade, then it dropped off a cliff, now we're finally seeing the long promised demographic wave moving into the 80+ cohort which could cause supply to tighten and rent/occupancy to rise.
  • I like the new board of directors.  The new Chairman is Dave Johnson, he was previously the President of Wyndham Hotels (WH) and is a board member of Hilton Grand Vacations (HGV), two companies I've followed/respected for several years.  Then to repeat the tie in with INDT, Conversant is bringing in Ben Harris as a board member, formerly the president of Gramercy Properties Trust (fka GPT) which was a blog favorite, most of the other key members of that team are at INDT now.
  • While not as great of an inflation hedge as multi-family due to the greater percentage of variable/labor costs in senior housing, inflation should be able to be mostly passed onto to the residents.  SNDA disclosed in a recent call that they were increasing rents by 5+% next year, VTR is targeting 8% in their owned properties, etc.
  • Sonida has a fairly high concentration in Texas, Wisconsin, Indiana and Ohio.  Their facilities tend to be smallish and on the older side, about an average age of 23+ years.
  • The company recently announced they'd be managing an additional 3 properties for Ventas starting 12/1, while not material yet, perhaps the managed segment could be a growth business for Sonida.  It's a fee business, not exposed to lease expense or capex of an operator, etc.
  • The company is going to restart giving guidance for 2022, presumably with Q1 earnings, which could give some needed visibility to investors as I fully admit my back of the envelope math is mostly a guess at this point.

Disclosure: I own shares of SNDA (plus INDT and RHE-A still too)

HMG/Courtland Properties: Microcap REIT Liquidation

*Disclaimer: Please note that is this a $18MM market cap that is closely held and illiquid*

HMG/Courtland Properties (HMG) is a tiny REIT that recently announced intentions to hold a vote early next year to approve a plan of dissolution and liquidate.  HMG was founded in 1974 by Maurice Wiener, he is 80 and is still the CEO of the company (technically this is an externally managed REIT, but there is no incentive fee), he controls 56% of the shares through various entities leaving little doubt the liquidation proposal will be adopted.  

The company's assets are a bit of mess (this liquidation will probably take several years), but the largest asset is a 25% equity ownership in a newly constructed Class A multi-family apartment building ("Murano at Three Oaks") in Fort Myers, FL.  Construction began in 2019, the building was completed in March and is already 97% leased as of the recently released 9/30 10-Q.  With inflation running hot and migration to the sun belt, cap rates on multi-family assets like this one are being quoted below 4%.  This is a hidden play on the craziness in multi-family M&A.  

Disclosure on the property is limited.  But checking the building's listing on apartments.com, it appears the going rate for their units is around $25 annually per square foot, there are 318 units and 312,000 square feet of rentable space.  Let's round down a bit for some vacancy to $7.5MM top line revenue, again back of the envelope, let's use 40% of gross rent goes to some combination of property management, operating expenses and taxes (I spot checked a few multi-family REITs for this, could be off!), that gets you an NOI of $4.5MM on the property.  

I'm sure I'll get the comment that this asset would go for less than a 4 cap but let's use that for now too, since it just started leasing this year, guessing there's not a lot of rents that need be reset to market as leases rollover like other properties.  There's a $39.5MM construction loan on the property, so the net value to the equity under my math is ~$73MM with HMG's share of that being $18.25MM, or roughly the market cap of the company.  Their equity investment in the apartment joint venture is held on the balance sheet at $3.3MM (HMG put in $3.6MM into the project, but due to equity method of accounting, HMG recognizes the proportional losses of the project has experienced since it has been in lease up mode).  Again, sounds a bit crazy, the asset was built for $54.1MM and now seemingly worth double that or more.  Given the debt here is a construction loan and the asset is freshly stabilized, even if the equity group doesn't sell it outright, they'll likely refinance and pull a decent amount of cash out that could be used for an initial liquidation dividend.

The rest of the REIT sort of looks like someone's personal portfolio/family office, in this case the CEO's:

  • The external advisor's "Executive Offices" at 1870 South Bayshore Dr in Coconut Grove, FL.  This appears to be a single-family home (unclear if the CEO uses it as his primary residence) that has a Zestimate of $2.5MM, it has a tax assessment of $1.5MM and a book value of $590k (it was purchased in the 90s).  There's no debt on the property, let's call it $2MM net to HMG or roughly another $2/share in value.
  • 28% interest in a 260 River Street in Montpelier, VT, carrying value of $870k.  Tricky to tell what this really is but they had some environmental abatement issues that are seemingly behind them, a new tenant took possession of the property in March.
  • About $4MM in net cash (after subtracting out ~$800k of current liabilities)
  • $2.8MM of marketable securities, much of which is equities and preferred stock in undisclosed large cap REITs
Then it gets a little strange (if it hasn't already), there's $4.85MM (as of 9/30) in carrying value in 46 individual private investments, it appears like most of these are real estate related (including some multi-family which could have embedded gains) but also includes non-real estate related stuff like technology and there's an energy investment hidden in here somewhere too.  Below is the breakout from the last 10-K, the carrying values have moved around a bit but gives you a sense of the asset classes.  

These investments are carried the lower of cost or fair value, there could be some diamonds in the rough, a few excerpts from recent monetization events: 
"During the nine months ended September 30, 2021, we received cash distributions from other investments of approximately $1.03 million. This included distributions of approximately $584,000 from our investment in a multi-family residential property located in Orlando, Florida which was sold during this quarter. We recognized a gain of $315,000 from this investment." 

And this one: 

In August 2021, one of our other investments in a private bank located in Palm Beach, Florida merged with a publicly traded bank, and we exchanged our original shares for shares in the publicly traded bank. Accordingly, we have reclassified this investment as marketable securities, and as of September 30, 2021 this investment with historical cost basis of $35,000 has an unrealized gain of approximately $128,000.
But also this one:
The other OTTI adjustment in 2020 was for $175,000 for an investment in a $2 billion global fund which invests in oil exploration and production which we committed $500,000 (plus recallable distributions) in September 2015. To date we have funded $658,000 and have received $206,000 in distributions from this investment. The write down was based on net asset value reported by the sponsor and takes into consideration the current disruptions in the oil markets because of the economic fall out of the pandemic.
Even stranger there are some ~$1.5MM in loans they've made, apparently mostly all to the same person.

On the minus side of the ledger, there's about a $1MM in annual expenses between the management fee and G&A, we should probably capitalize that for at least 4 years given it's going to take time to unwind all the mess here and I get approximately ~$30/share in value and it trades for about ~$17.25/share today.  

The key with any liquidation is the timing of the cash flows.  Here it could be a reasonably attractive IRR since the largest asset just stabilized and it would make sense to either sell or refinance cash out of it in the near term.  Once most of your basis is out of the stock, it's easier to be patient on later monetization events.

Disclosure: I own shares of HMG

Sunday, November 7, 2021

Advanced Emissions Solutions: Another Informal Liquidation

We're at the end of earnings season for small caps, this could be stale in under a week (ADES reports 11/10), Advanced Emissions Solutions (ADES) is a $130MM market cap with no debt and by year-end should have ~$90MM in net cash as one of their two business segments is running off due to the expiration of a tax credit.  The company announced strategic alternatives in May, likely intending to sell the remaining business segment and effectively liquidate the company.  Similar to other informal liquidation ideas lately (LAUR, PFSW, RVI, JCS, BSIG, etc), the downside is protected by the cash generated from monetizing one business segment that could be returned to shareholders either by a tender offer or a special dividend, with upside coming from an M&A event for the remaining segment.

This is an unoriginal idea, it appeared in the comment section of my Laureate Education post (might have appeared earlier but I can't find it) and other investors have shared their views with me given the similarity to others I've written up, there is also an excellent VIC long thesis on the situation.  If you've read it, you can probably stop here.

In 2011, the U.S. government implemented a 10-year tax incentive program (IRS Section 45 Tax Credit) to motivate electric utilities to use cleaner burning coal and reduce emissions.  That tax credit is expiring at the end of 2021.  Within ADES's refined coal segment, they own a 42.5% interest in Tinuum Group, which is basically a royalty business on the tax credits power plants receive utilizing their services.  In their Q2 press release, ADES is projecting $30-$40MM after-tax to be distributed to ADES from this runoff segment by year end.  Add that to the $57.3MM of cash on the balance sheet as of 6/30, and the cash balance should be roughly $90MM.  There are 18.85 million shares outstanding, that's $4.75/share in net cash on a ~$7.00 stock.

The remaining segment is an activated carbon business, Advanced Purification Technologies ("APT").  Out of their Red River Plant in Louisiana, APT produces chemical products primarily used to purify coal fired power plants (reduces mercury emissions) but they've also made efforts to diversify into other end markets like industrials and water treatment plants that aren't in secular decline.  APT was acquired by ADES in late 2018 for $75MM from Energy Capital Partners who had originally built the Red River plant for $380+MM (*correction, ADES originally built it, see first comment*).  Coal usage has declined faster than was underwritten a decade ago when the plant was built; the original greenfield investment wasn't money well spent.  Although, with natural gas prices moving up significantly this year, maybe the coal-to-gas fired plant conversion theme will slow?  As part of the acquisition, ADES also acquired the on-site lignite coal mine (Five Forks) that is used as an input to produce activated carbon, interestingly the mine operations are subcontracted out to old friend of the blog NACCO Industries (NC).

The APT business continued to struggle after ADES acquired it, covid didn't help either, but back in September 2020, ADES entered into a 15 year supply agreement with competitor Cabot (CBT) to supply activated carbon in North America that results in two important things: 1) diversifies the APT business away from coal into other end markets (also provides some revenue certainty to a buyer); 2) rationalized the competitive market by facilitating Cabot's exit from the industry.  Earlier this year, they entered into a second supply agreement with Cabot to supply international markets for 5 years.  On the negative side, Cabot had ADES take ownership of their Marshall Mine (on-site lignite mine of Cabot's plant) and immediately shutter it, reclamations efforts have begun (again, being performed by NACCO), but importantly for Cabot, the asset retirement obligation moved from its balance sheet to ADES.  The remaining ARO is about $12MM to ADES (there is a cost sharing agreement between ADES and CBT), 70% of the work/cost is to be completed in the first two years, but it could have a long tail and make a sale of APT more challenging.

Currently the APT segment is roughly breakeven, but appears to be inflecting, per the press release describing the Cabot supply agreement inked in Q4 2020:

We expect our production to ramp up incrementally during a 4-5 quarter transition period, which when complete is expected to yield the following net impacts to our current operations:
Incremental annual revenue growth of 30% - 40%;
Incremental annual EBITDA growth of $10 million to $15 million; and
Diversified end markets will reduce our power generation exposure to less than 50% of product portfolio.

Presumably ADES should start to see some improvements in Q3 results given that 4-5 quarter timing (the backdrop for their remaining coal exposure seems positive as well) and hopefully hear some hints the Red River plant's utilization rate is ramping, this is a high fixed cost business so the operating leverage can be pretty huge.  ADES bought the business for 4.2x EBITDA back in 2018, implying $17-18MM in EBITDA, it doesn't seem unreasonable that the post-covid run rate (including the CBT supply agreement) is above that number.  Conservatively assuming that the APT segment is worth what ADES paid in 2018, $75MM, netting out the $12MM in ARO, gives a $63MM "remainco" valuation or $3.35/share.  Add that to the net cash and its at least an $8.10/share stock, that's probably conservative on both sides, coal is surprisingly hot (meaning the remaining royalty could be closer to $40MM) and APT should be worth more than $75MM post CBT deal.  But I'm not an engineer, only have a loose idea of what activated carbon is based on YouTube, this is clearly more a situation I like (rhymes with others that have done well with recently) more than the business itself.

Other thoughts/notes:

  • ADES has $93.8MM of federal NOLs, in order to protect against a change of ownership that would eliminate the NOL, the company put in a plan in place effectively prohibiting anyone from acquiring more than 4.99% stake in the company.  Given the small market cap, the plan limits the potential pool of investors.  Also leads itself to a liquidation mindset as the NOL should provide a tax shield.
  • In March, ADES felt confident enough in the trajectory of the business to institute a price increase.
  • The Red River plant is a low-cost (reportedly the lowest-cost AC producer), underutilized asset, that thesis alone could appeal to PE buyers.

Disclosure: I own shares of ADES