Friday, September 16, 2022

Digital Media Solutions: Broken deSPAC, MBO Offer

Another quick idea -- hat tip to Writser again for pointing me in this direction -- Digital Media Solutions (DMS) ($135MM market cap) is a "technology-enabled digital performance advertising solutions" company that came public in July 2020 through a SPAC, Leo Holdings Corp (LHC).  From what I can gather, DMS gets allocated marketing spend from their clients, runs a digital campaign and then delivers warm leads or actual customers to their client depending on the arrangement.  DMS gets paid a percentage of that customer's lifetime value ("LTV") based on the advertising client's models.  While this isn't a great business, DMS is cyclical based on marketing spend (having a down year in 2022), it doesn't seem to be a scam or puffed up science fair project like other deSPACs of recent vintage, DMS is more a marginal-to-average business with potential long-term tailwinds.

Like just about every other deSPAC, DMS came to the market with inflated expectations, they originally guided to $78MM EBITDA in 2021, but only delivered $58MM.  DMS started 2022 with flat guidance of $55-60MM EBITDA, but now only expect $30-35MM due to wage inflation hitting their cost structure (500+ employees), marketing budgets getting slashed and LTV models being adjusted down in their core auto insurance market (Allstate and State Farm are two of their largest customers).  Management expects to return to growth in 2023.

DMS is founder led, the company was started in 2012, the three co-founders are still in the c-suite today and own 35.8% of DMS through their "Prism Data LLC" investment vehicle. In 2016, DMS took on a PE investment from Clairvest, who still owns 27.5% of DMS, and rounding out the top 3 holders is Lion Capital at 11.6% ownership, Lion was the sponsor of the SPAC.  In total, these three firms own 75% of DMS, the remaining 25% has very little institutional ownership and is likely held by retail holders who were caught up in the SPAC mania.
Essentially no difference between A and B shares
On Monday 9/8, via Prism Data, management made a non-binding offer to acquire all of the publicly traded Class A shares for $2.50/share, a 121% premium from where the stock closed the previous Friday.  In their letter, they indicate that Clairvest and Lion "are likely to agree to participate" alongside Prism, leaving only 25% of shares needing to be purchased, or about $40MM.  The offer is not subject to a financing condition (important in today's market), but DMS does have $26MM cash on its balance sheet and Prism has $50MM in pre-committed financing from B. Riley (RILY) to complete the transaction.  

The offer values the minority interest at somewhere around ~10x potentially trough EBITDA, again management expects to return to growth in 2023 (they're the best positioned to know if there is indeed an inflection) so this could be an opportune time for them to take it private again.  In August 2021, the company announced they were exploring strategic alternatives, on the last two conference calls, CEO Joe Marinucci (the signatory on the Prism offer letter), has stated they were "hoping to have an update today" regarding strategic alternatives, this offer is likely the end result.  Marinucci would know where third parties offers were for the business before offering $2.50 to the board, this is likely the best offer and the independent board members will take it given there are no vocal or significant minority shareholders.

Shares closed today at $1.94/share, a 28% spread to the Prism offer.  Yes, there is significant downside given where DMS traded before the offer, but there are no shareholders to put up a fight and likely this is the best offer after the company ran a process.  Otherwise, I think the spread is wide because it is a low float former SPAC.  I bought a smallish position.  Given the number of deSPACs, I anticipate this being a similar fruitful hunting ground as the "broken/busted biotechs", please send me any others that sound or feel like this one.

Disclosure: I own shares of DMS

Wednesday, September 7, 2022

IMARA: Asset Sale, Below NCAV, Potential Liquidation

Since all my speculative M&A ideas seem to be falling flat on their face in the current market environment, it is time to go back to a broken biotech that appears set to liquidate.  IMARA Inc (IMRA) ($43MM market cap) is a clinical stage biopharmaceutical company that announced back in April their decision to discontinue further development of their sickle sell disease treatment (IMR-687) and initiate a process to evaluate strategic options.  The stock then crashed and traded at about half net current asset value.  In 2022, that's nothing exciting on its face, there are lots of broken biotech stocks trading well below cash that it is difficult to parse between them for actionable ideas other than taking a basket approach.  

But IMARA is interesting because today they announced via an 8-K (no press release) that they've sold IMR-687 to Cardurion Pharmaceuticals for $35MM, plus some contingent payments if things go well.  Excluded from the asset sale is IMARA's cash pile:  

Excluded Assets. Notwithstanding the provisions of Section 2.1, no right, title or interest is being sold, assigned, transferred, conveyed or delivered to Cardurion in or to (a) any property and assets of Imara that are not Purchased Assets (including any and all amounts of cash and cash equivalents of Imara), (b) any rights or claims of Imara under this Agreement or any of the Ancillary Agreements, (c) all assets of Imara exclusively related to IMR-261 and (d) all assets of any Third Party with whom Imara enters into a transaction on or after the Execution Date pursuant to which it becomes (or will become) an Affiliate of such Third Party (collectively, the “Excluded Assets”).

Prior to this surprise asset sale (I normally assume a broken biotech's IP is worthless), IMARA had a net current asset value at 6/30 of ~$60MM and 26.3 million shares outstanding, or $2.30/share in net cash.  After the asset sale closes, that number jumps up to $3.65/share (pre-cash/expense burn), yet the shares only trade for $1.67 today.  Hidden in the 8-K, the company mentions the below:

In connection with stockholder approval of the Asset Sale and the plan of liquidation, the Company intends to file a proxy statement and other materials with the SEC. Stockholders of the Company are advised to read the proxy statement and any other relevant documents filed with the SEC when they become available because those documents will contain important information about the Asset Sale and the plan of liquidation.

They did a few other things that hint this it for the company, they amended their retention plans to pay 50% out now on the execution of the asset sale and 50% on the closing of the asset sale, versus paying out on any subsequent reverse merger or other action.  And it appears their advisors are done too.  The current price seems far too cheap if the company is going to return their cash to shareholders, I bought some shares today.

Disclosure: I own shares of IMRA

Tuesday, August 9, 2022

LMP Automotive: Quick Update, Liquidation

A quick update on one of the few ideas that worked for me this year, LMP Automotive (LMPX) ($80MM market cap) announced on Monday that they have sold most of their dealerships and will be asking shareholders to approve a plan of liquidation.  In the press release (oddly, no 8-K was filed), management put out an estimate of $115-$126MM, which on ~11 million shares outstanding equates to $10.49-$11.49 per share in distributions (liquidation estimates are typically conservative).  The asset sale is scheduled to close in October, yet as of today shares trade for just $7.50/share.  Following the asset sale, by my count, LMPX will have only one new car dealership (Bachman-Benard Chevrolet-Buick-GMC-Cadillac in TN, LMPX paid $7.5MM for it in 2021) plus less than a handful of unbranded used car dealerships remaining to sell, which should be a small part of the total enterprise value.  If approved, I'm guessing a large distribution could be made before year end that would return most if not all the current share price, leaving a stub that may take time to wind down.

There are still a number of red flags around LMPX, the company is restating earnings and behind on their financials, they recently fired their CFO, and they seem to have limited oversight (whether it be truly independent board members or strong shareholders) of CEO Sam Tawfik (who is also now the interim CFO).  On the other hand, Tawfik does own 35% of the shares and has been repeatedly emphasizing via business update press releases (here and also here) that the share price doesn't reflect the private market value of the company's assets.  Getting approval for the liquidation shouldn't be an issue, since Tawfik owns 35%, getting over the 50% mark shouldn't be a problem even with a largely retail shareholder base.  The major remaining risk is the asset sale closing, we don't have much disclosure about the buyer at this point, but going back to the original thesis, car dealerships are rather fungible and if the buyer falls through, I'm sure there's one behind them willing to transact at near similar terms.

Disclosure: I own shares of LMPX

Friday, July 15, 2022

WideOpenWest: Cable Overbuilder Rumored for Sale

Quick one today that I mentioned briefly in my Mid-Year post as a watchlist idea.

WideOpenWest (WOW) ($1.6B market cap) is a cable/broadband overbuilder primarily focused on secondary and tertiary markets in the southeast that trades for 7.5x EBITDA, while it sold assets last year for 10-11x EBITDA (here and here).  WOW is rumored to be in a late stage process to sell itself with both Morgan Stanley Infrastructure Partners and Global Infrastructure Partners reported as interested bidders (worth noting that the two asset sales were to strategic buyers, both of these firms would be financial buyers).  Fully acknowledge that we're not in the same 2021 M&A environment, but the PE bid and financing are still there for digital infrastructure like businesses.  Even a takeout at a 9.5x EBITDA multiple would equate to $24.30/share or 35% higher than today's $18.00/share price.  After the asset sales, WOW is currently under levered at 1.9x net debt/EBITDA (a PE buyer would likely lever a cable company up to 5-6x); taking WOW out at a cheapish price with a relatively small equity check due to the ability to lever it up further, this deal would likely be a home run for the buyer.

A bit more about the business, as an overbuilder, WOW is the "challenger" cable provider that enters established markets which typically already included either Comcast's (CMCSA) Xfinity brand or Charter's (CHTR) Spectrum brand (which I'm long via LBRDK).  In order to convince customers to switch from an incumbent provider, WOW has to offer some combination of faster speeds, lower prices and better customer service.  Additionally, WOW lacks the scale and purchasing power of a Comcast or Charter when it comes to negotiating with content providers, further squeezing margins in the already declining video business.  All adding up to an overbuilder like WOW having lower penetration rates (28% of homes passed), thus lower margins and generally viewed as an unfavorable business model compared to the incumbents.

However, times are changing, as more people cut the cord and move away from the broadband/video cable bundle to just seeking out a broadband internet provider, WOW's value oriented proposition starts to look pretty good, offering similar speeds at a lower price.  With a recession potentially on the horizon, WOW might also benefit from the cord cutting trend accelerating and their position as a value offering as consumers look to cut costs.  To provide some perspective, 90% of WOW's new customers are only buying broadband.  Cable valuations have come down recently, partially due to rising competition, new competition is less likely to join the fray into WOW's already competitive markets, rather fiber-to-the-home overbuilders are more likely to focus on markets where the incumbents are vulnerable to new competition.

On the downside, WOW is currently trading at only a slight discount to Charter and the struggling Altice USA (ATUS), where CHTR/ATUS have better business models as a incumbent cable providers.  So there is some deal premium baked into WOW, maybe a turn worth.  I pulled the above public comparables from TIKR, I realize each is a bit different, especially throwing DISH in there.  I don't love the idea of adding another speculative merger position to my portfolio, but this one just seems to make too much sense for a PE buyer to take private.

Disclosure: I own shares of WOW

Friday, July 8, 2022

Rubicon Technology: NOL Shell, Tender Offer, Special Dividend

Thanks to Writser for pointing me to this idea

Rubicon Technology (RBCN) ($36MM market cap) is primarily an NOL cash shell with a small $4MM revenue, roughly break-even, industrial sapphire business.  RBCN was previously trading below net current asset value until 7/5 when Janel Corporation (JANL) offered to tender for 45% of the shares at $20/share.  Following the tender, Rubicon will distribute a $11/share special dividend (approximately their excess cash) to all shareholders including Janel and also delist from the NASDAQ along with suspending their SEC reporting requirements ("go dark").  If everyone fully participates in the tender offer (which they should, but is unlikely, probably a few forgotten shares out there), RBCN shareholders will receive a total of $15.05 in cash per share (45% x $20 + 55% x $11) in the next couple months, plus a dark NOL stub.  The shares roughly trade for the $15.05 cash consideration number today.

To fully access the NOLs, Janel will then be incentivized to make another tender offer on that residual stub in three years (IRS required waiting period to preserve the NOL) to get their ownership level above 80% so they can consolidate the financial statements.  Janel spells out that potential second step in their schedule 13D:

The purpose of the offer is for Janel to acquire a significant ownership interest in Rubicon, together with representation on Rubicon’s Board, in an attempt to (i) rejuvenate, reposition and restructure Rubicon’s business and brand by focusing on its profitable business line and implementing a lower cost structure to achieve profitability and (ii) allow Janel to be in a position to potentially more easily acquire such number of additional Shares of Rubicon three or more years thereafter that would, after which, should such transaction occur, permit Janel to consolidate the financial statements of Rubicon’s with its own, thereby allowing Janel to benefit from Rubicon’s significant net operating loss (“NOL”) carry-forward assets. Under federal tax laws, Janel would then be able to carry forward and use these NOLs to reduce its future U.S. taxable income and tax liabilities until such NOLs expire in accordance with the Internal Revenue Code of 1986, as amended.

Since the company isn't cash flow positive, they currently have a full valuation allowance against the ~$65MM in tax assets:

While the total tax asset is $65MM, about $39.5MM is federal which is likely more valuable and easily transferrable than the $13.3MM in state taxes (IL and IN), I'm guessing Janel could also take full advantage of the $6.75MM of capital loss carryforwards too.  Let's remove the state tax assets and call it $46.25 in value or $19/share (plus whatever you value the remaining business for) that Janel is paying $9/share ($20 minus the $11 special dividend).  You've got some time value of money in there since they'll need to wait 3 years for the next tender, and during that time some of the NOL will expire (it started expiring in 2021, but I don't know the amortization schedule of the NOL).  Sounds like potentially a great deal for both sides given RBCN traded for $9.00-$9.25 prior to the announcement.

I don't know much about Janel Corp, it is a $37MM market cap company traded OTC that is 42% owned by Oaxaca Group.  It appears to be a holding company of smallish operations in logistics, manufacturing and some health care.  We are taking some counterparty risk here in both the deal being completed successfully and Janel ultimately being able and willing to buyout the remaining stub in 3+ years.  They have committed financing already from the expansion of their established credit line with Santander (don't need to go to the syndicated or private debt markets like FRG/KSS for example).  Santander is also providing them with a bridge loan while they wait for the special dividend to get paid out.  The other minimum condition is 35% of holders tendering, four major shareholders including names people reading this blog would recognize own 27% of the shares have already agreed to tender, so that should be no problem either.

I go back and forth in my head on what value to ascribe to the stub position.  Post tender it will still have the same $19/share (or approximately that, again not sure how much will expire) in tax assets, Janel will be situated as the only bidder but also they'll have a sunk cost of purchasing 45% of it, we might be under a different corporate tax regime, it will be immediately useable so no discount for the time value or risk from their perspective that they won't get access to the NOL.  I don't see why the base case shouldn't be $9 again, but I could be too optimistic in that view, the good thing here is it doesn't matter much as it's a free roll once the deal closes.

Other thoughts:

  • Why is it cheap?  Post tender and special dividend, it will go dark and be a small stub with a catalyst 3+ years out, that doesn't appeal to many investors, particularly in the current environment when time horizons are shrinking as people are scared of the economy.  It is a CVR like asset, you've got some counterparty risk with JANL, it needs to have the ability and desire to acquire the remaining stub in 3 years.  Many investors are down for the year (me included!), potentially behind their benchmarks and don't want to invest in something where you're just going to get your money back in 2022, and have this illiquid hard to value dark security after that we won't know the true value for 3 years.
  • I like this better than other NOL shells, it is a better structure for current shareholders, as it doesn't rely on new management to make acquisitions at a time when there's still plenty of SPACs and busted biotechs looking at reverse merger style deals.
  • RBCN sold some raw land in Batavia, IL.  The sale hasn't closed yet, but the company expects to net $600k in cash, or roughly $0.25/share.  The company also owns their current industrial facility in Bensenville, IL which they bought for $2.3MM (or just under $1/share) in September 2018.  Even after the special dividend, there should be some residual liquidation value left in the operating business and possibly more if they can turn it around. 
  • Not sure yet of the tax implications of this idea, might be best to play it in a tax deferred accounts or given it is 2022 and a lot of us have tax losses, might not be so bad in a taxable account either.
  • There's currently not an odd-lot priority provision, I'm assuming that is on purpose by the four large fund shareholders, they do not want people piling in to the odd-lot provision and end up transferring value to small shareholders playing that arb game.  There's also no cancel provision based on a drop in the over market either like we've seen in other tender offers.
  • If you have access to the expert market, might be worth watching this one after the special dividend, especially if I'm right that the second step won't be done at a huge discount.

Disclosure: I own shares of RBCN 

Thursday, June 30, 2022

Mid Year 2022 Portfolio Review

Investing is a humbling endeavor.  For the first half of 2022, my personal account is down -27.26% versus the S&P 500 being down -19.96%.

Thoughts on Current Holdings
As I have during tough periods before, here's a quick summary thesis of each of my current holdings (in mostly alphabetical order):

  • Advanced Emissions Solutions (ADES) is a ~$90MM market cap company with NCAV of ~$70MM plus their activated carbon business/plant.  The company is now past month 13 of their strategic review, on their Q1 conference call in May, CEO Greg Marken responded to a review status question with: "while the process has drawn out, the fact remains that we are pleased with where things stand within the process are hopeful that we can provide an update soon."  This is a common theme in my portfolio right now, waiting on M&A in a semi-frozen environment for M&A.  Their activated carbon business is barely cash flow positive and pretty niche, likely only leaving a limited pool of strategic buyers that would be interested in it.  The delay could be blamed on a timing issue as it needs to be the right price for ADES and the right time/price for the handful of potential acquirers.  This is not as simple as selling an apartment complex was in 2021.  The price has come in quite a bit from my original post and remains reasonably attractive.  The bear case from here would be if they're unable to sell themselves, management then decides they'd be too small if they returned cash to shareholders and instead turn into an acquirer.
  • ALJ Regional Holdings (ALJJ) is mostly a cash shell now run by the controversial Jess Ravich, both asset sales have closed, the NOLs are exhausted and now the company is looking at strategic alternatives.  The RemainCo lost a significant contract with Humana recently that made up ~30% of the pro-forma revenue, but the market doesn't seem to be pricing in much if any value to the remaining operations.  NCAV is something like $2.70/share and the stock currently trades for $1.90 with the prospect of a catalyst on the horizon.
  • The only thing that has slightly changed for Argo Group International Holdings (ARGO) from my write-up in early May, the CEO who was previously on sick leave has officially resigned and the Chairman and interim-CEO, Thomas Bradley, now loses the interim designation.  Bradley is the one leading the strategic alternatives process, maybe I'm reaching, but it at least holds with the story that they'll sell.
  • Atlas Financial Holdings (CUSIP 049323AB4) completed the restructuring of their old baby bonds and issued new senior unsecured PIK toggle notes that are denominated in $1 increments to the old baby bond holders.  I don't believe these have traded hands yet in the secondary market, so not sure how relevant the story is anymore, but the equity does trade as AFHIF for those who like option-like bets on turnaround stories.  Atlas acts as an agent for insurance carriers in the light commercial auto market (think taxis, limos, shuttle buses, etc.), as the world is normalizes, both from covid and UBER/LYFT no longer being irrationally venture capital subsidized, one could envision a world where taxis and limos exist alongside ride sharing services.  The company however is still on questionable footing, it's burning cash and might end up needing to restructure again if the turnaround doesn't turn relatively soon.
  • The proposed Bally's (BALY) $38 go-private offer from 22% owner Standard General blew up in my face, the independent members of the board couldn't come to terms with Chairman Soo Kim from SG.  Whether this was ever a real offer is up for debate, but the offer was made right before the economic outlook got dicey.  Since then, the stock has tanked to ~$20, despite the market reaction, several good pieces of news have come out: 1) BALY's won the downtown Chicago bid (still needs to be approved by the Illinois Gaming Board), the mock-up of the casino looks great and its in the perfect location; 2) BALY's announced a $190 dutch tender offering for between $19.25-$22.00; and 3) just this week, they entered into a sale leaseback with GLPI to buy their Rhode Island casinos for $1B or a 7.8% cap rate, much of this will be used for the build out of Chicago and whatever they do with the Tropicana in Las Vegas.  BALY's also put out a three year cash flow projections in an 8-K that is worth playing around with if you're interested in the story.  The bear case is the impact of a potential recession and draining of liquidity from the system, but regional casinos continue to show their resilience and Bally's seems to be a rational actor in the sports betting/igaming space.
  • BBX Capital (BBXIA) is a $117MM market cap holding company run by the controversial Levan family, BBX has 5 core assets: 1) $115MM in cash; 2) $50MM note from Bluegreen Vacations Holding (BVH); 3) Florida multi-family real estate/developer; 4) Renin, a manufacturer of doors; 5) IT'SUGAR, the candy store.  The fair value of all that is probably in the low-to-mid $20s per share, but it's currently trading in the $7s, below $8 where the company completed a tender offer last July and $11.10 where they bought out Angelo Gordon in November.  The company approved a new $15MM share repurchase program in January, but haven't appeared to use it.  So the question is why isn't the company buying back shares here?  Maybe they're going to deploy capital somewhere or they're prepping for another large tender offer.  I cringe a bit when I type this, but they do seem to be pretty good capital allocators and they've hit a home run in their real estate development business, every few months they sell an apartment complex well above their cost basis, here's the latest example.  The bear case is fairly obvious, it is the Levan family discount and whether that ever closes.
  • DigitalBridge Group (DBRG) has now almost fully transformed into an alternative asset manager focused on the "digital infrastructure" sector, a term that CEO Marc Ganzi popularized.  They've done a few likely value creating actions lately, they purchased AMP Capital for 8.4x EBITDA, reacquired 100% ownership of their investment management business from Wafra (switching from a REIT to a C-Corp in the process) and sold a stake in their DataBank position for well above carrying value.  Time is starting to tick on Ganzi's $100MM incentive package, he needs to get the stock to trade above $10 for 90 trading days prior to the summer of 2024.  I've bought Jan '24 $5 call options to juice the upside, he's delivered on everything so far, with all digital infrastructure theme tailwinds, I think it's smart to assume he continues to deliver.  The bear case is rates increasing bring down the cap rates on digital infrastructure assets, hurting returns in DBRG's funds and limiting their ability to raise future capital.
  • We're still awaiting the outcome of Franchise Group (FRG) potentially buying Kohl's Corp (KSS), the three week exclusivity period came and went without either side saying a peep.  CNBC reported that Franchise Group was trying to re-cut their bid from $60 to $50, taking $50 might be unacceptable for the KSS board after they said the stock was worth $70 a few months ago.  It could be Brian Kahn's (FRG CEO) diplomatic way of getting out of the running for KSS.
  • Green Brick Partners (GRBK) is a homebuilder and land developer that's primarily focused on the Dallas metroplex (with additional exposure to Atlanta, Austin, Colorado Springs and Vero Beach FL), David Einhorn remains the Chairman and Jim Brickman, a long time Dallas developer, is the CEO.  Things have changed quickly for homebuilders in the last few months, mortgage rates have basically doubled, but demographics and migration trends should be in GRBK's favor.  Unfortunately, Green Brick made a strategic decision last year that doesn't look so great now, limiting pre-orders to build more spec homes in order to capture higher margins and have more price certainty around costs.  They're likely stuck with a high level of inventory and will need to slash prices.  Shares are down -34% this year in anticipation of the housing slowdown, we'll find out how bad things are at the next quarterly earnings call.  The stock trades for 1.1x book value and a little more than 4x an increasingly cloudy estimated earnings.
  • Howard Hughes Corp (HHC) is a real estate developer with their primary assets located in Las Vegas, Houston, Columbia MD, Honolulu, New York and the recent addition of Phoenix.  The company put out an investor day in April that laid out a $170/share NAV including corporate overhead, they've recently been an aggressive buyer of the stock at ~$95/share, the stock now trades for ~$65/share reflecting investors concerns about the company as we head into a potential recession.  During peak covid fears, Bill Ackman did a capital raise with himself at advantageous prices, let's hope that doesn't happen again.  HHC has similar housing concern headwinds, they fund new commercial real estate development with the sale of land to homebuilders, if homebuilders stop buying land in their communities, the development engine grinds to a halt.  But looking longer term, if higher inflation is here to stay, hard to think of a better hedge than land banks in low cost of living growth markets.
  • INDUS Realty Trust (INDT) is a small cap industrial/logistics REIT that's led by a few members of the old GPT management team.  There is some concern around logistics properties being overbuilt and news coming out that Amazon is pulling back on building/occupying new warehouses after their big covid growth spurt.  However, INDT is small and can be selective in their new markets and new developments and there's always the Blackrock BREIT bid in the background of industrial and multi-family REITs.  Shares have come in a bit, I have the stock trading at about a 5.5% cap rate, pretty cheap for a high quality portfolio and currently with minimal net debt.
  • Jackson Financial (JXN) is the variable annuity provider that was spun from Prudential PLC last fall, the structure of the spinoff attracted me in that a foreign list company was spinning a much smaller U.S. listed company.  That's a lot of potential index related selling followed by buying.  Shares ran up as the company has bought back a significant amount of stock out of the gates and then has fallen right back down given the economic backdrop and opaque nature of their financial statements.  One way I'm thinking about the company is on a shareholder yield basis, JXN has committed to returning $425-$525MM in capital to shareholders this year.  At the mid-point, that's 20% of the current market cap.
  • Liberty Broadband's (LBRDK) primary holding is a 50+ million share investment in Charter Communications (CHTR) alongside a small operating business in GCI.  Assigning a 7x EBITDA multiple to GCI, I get an NAV of ~$140/share while the stock trades at $115/share, they continue to participate in CHTR's buyback on a pro-rata basis then turnaround and buyback their own stock, about 15% of the shares have been retired in the last year.  Sentiment is pretty poor around the big cable companies but that only makes the buyback math more attractive, I'm content to hold for now.
  • LMP Automotive Holdings (LMPX) is a shaky microcap auto dealer that is potentially in the process of selling themselves.  LMPX has delayed their financials and needs to restate previous ones but has provided some financial updates, including a cash balance of $30MM at the end of 3/31 against $85MM of debt, the market cap is $50MM, so the EV is only $112MM against an EBITDA of ~$40-50MM (my estimate, could be totally wrong).  There might be some working capital shenanigans in their cash build, they could have just liquidated inventory, we don't know.  I compare this one to a REIT selling their portfolio, auto dealerships are pretty ubiquitous and get bought/sold regularly.  LMPX does have a slightly different model where they don't own 100% of the dealerships and have some non-controlling interests remaining with the operators of the dealerships.  Bear case is pretty scary, this could be a dumpster fire, they have accounting issues and a weak board, power is concentrated in the hands of the CEO who got the company in this mess. 
  • NexPoint Diversified Real Estate Trust (NXDT) is a closed end fund that is still in the process of converting to a REIT, but the end should be imminent as the fund has received all the proceeds from Amazon buying MGM Holdings, the movie studio not the casino operator, removing a significant securities position from NXDT's balance sheet which was one of the SEC's issues with the conversion.  With REIT status comes index inclusion, not just from REIT indices but from broad indices as well that don't include CEFs or BDCs.  The stock trades for $16.50/share, the published NAV is $26.26/share, so it is trading for 63% of NAV.  I expect that discount to narrow as the company converts to a REIT and tells their story to the market.  The controversial James Dondero has been regularly buying shares in the open market ahead of the conversion. 
  • Par Pacific Holdings (PARR) is a niche downstream energy company, they operate three refineries in small markets (Hawaii, Tacoma WA, Wyoming) and related logistics/retail networks.  As anyone that has filled up their gas tank recently knows, refining margins have blown out significantly and there's a lot of talk about the U.S. not having enough refining capacity after several refineries were mothballed during covid.  PARR has completed their recent rounds of maintenance turnarounds and should be running at full utilization during this high tide period.  Additionally, PARR owns a 46% interest in Laramie Energy, an upstream natural gas company in Colorado, given the natural gas price backdrop, the company is finally looking at strategic alternatives for their investment.  It has been completely written down in their financials for some time and they still have their massive NOL to shield any taxable gains.  Speaking of the NOL which is about $1.6B and starts to expire in 2027, CEO Bill Pate said in their recent conference call "based on our outlook for the business, we really don't see NOLs expiring.  We anticipate that we'll be using those tax attributes to offset profits."  The company has yet to hit the NOL after many years, so take that with a grain of salt.  The other thing worth mentioning, Sam Zell's fund has come to the end of its life and has been selling/distributing shares to investors, providing an overhang to the stock.  PARR has under performed the sector, part of that is their niche position which likely won't fully participate in the industry tailwinds, part of it might be the selling pressure from Zell's fund.
  • PFSweb Inc (PFSW) is a similar idea as ADES, PFSW previously operated two businesses, it sold one last year and is now sitting on $155MM in cash with no debt and a $265MM market cap.  The remaining business is a subscale third party logistics (3PL) provider to mostly consumer retail companies needing an e-commerce logistics provider.  The company was late on their financials because of the complicated nature of their asset sale, they're now current and according to CEO Michael Willoughby on their recent earnings call: "We continued to work with Raymond James on the review of a full range of strategic alternatives for PFS.  As we've previously communicated, we believe that completing a second transaction represents the most efficient way to return the significant capital we hold to shareholders... completing this process remains our top priority."  I'm guessing there should be more strategic buyers of a small 3PL business than for ADES's activated carbon plant, but similarly, here we are a year after the initial strategic alternatives announcement with no deal.  Hopefully the M&A market unfreezes a bit soon, but with the big cash pile and marginally profitable 3PL business, the downside seems pretty minimal here other than opportunity cost.
  • The only update since my May post on Radius Global Infrastructure (RADI) is it appears that DigitalBridge is actually interested in buying RADI, just a waiting game now to see if a transaction materializes.
  • Regional Health Properties (RHE PRA) is a struggling lessor/operator of skilled nursing and assisted living facilities, the company's balance sheet is upside down and they're trying to exchange their existing preferred into a creative new preferred security, but haven't gotten the votes necessary to date and have pushed the latest vote off to 7/25.  It's hard to handicap if they'll ever get the votes, the common stock only has a ~$4MM market cap, so its fair to say that no institutions own it, probably just sitting in some Robinhood accounts where the owners deleted their app after everything crashed.
  • Sonida Senior Living Inc (SNDA) is an owner operator of primarily mid-priced independent living and assisted living facilities.  The company did an out-of-court restructuring with Conversant Capital in 2021 providing an injection of capital and effectively taking control.  Sonida has a significant amount of financial leverage (through mortgage debt, they own, don't lease their properties) and the senior housing business model features a lot of operating leverage (occupancy and margin are the KPIs), a potent upside cocktail recipe if the industry recovers (or the opposite if it doesn't).  Senior housing should have significant tailwinds: 1) recovery from covid; 2) demographic tailwinds, SNDA operates the entry care level facilities (rather than nursing homes) which should benefit first; 3) limited new construction/supply given covid and with inflation, any new construction would be costly and targeted at the upper-price points, away from SNDA's mid-priced position.  On the bear side, the industry continues to be plagued by increasing labor costs and the use of contract labor, potentially squeezing the stabilized margin profile of the business.  Shares trade at a discount to where Conversant invested ($25) and the subsequent rights offering ($30), meanwhile the company's occupancy numbers continue to climb.
  • I recently re-wrote up Transcontinental Realty Investors (TCI) after the company sold their JV creating a lot of liquidity, now the question is whether the 85% controlling shareholder will tender for the remaining 15%?  Shares currently trade at approximately 50% of proforma book value after the JV deal closes.
Additionally, I have a several true liquidations, both Luby's (LUB) and HMG Courtland (HMG) went non-traded during the first half of 2022, the third, Sandridge Mississippian Trust I (SDTTU) rarely trades and typically only in tiny amounts as we await the dismissal of a shareholder lawsuit.  The primary asset at HMG was recently sold, hopefully we'll see a distribution this year, but there's limited to no disclosures now, so a bit in the dark.

Sold positions
Opportunity Cost Sales:
  • Accel Entertainment (ACEL) is a good business model, they are in distributed gaming where ACEL owns the video gaming terminals (aka slot machines) and partner with bars or taverns who then operate them (legacy operations are all in IL) as mini-casinos.  It should mint free cash flow.  However, their growth story seems a little cloudier than it did several years ago, new states don't seem to be lining up to pass VGT legalization legislation nearly as enthusiastically as they're willing to pass mobile sports gaming and icasino legislation.  One is kind of an eye sore that takes time to rollout, the other is a downloadable app on your phone which instantly creates tax revenue.  Maybe recognizing this trend, ACEL bought Century Gaming in a deal that just closed, Century is an established operator in Montana and Nevada, two mature distributed gaming states.  That might be the play from here, just consolidate the legacy states.  Despite holding for ~2.5 years, I never had a big position and ACEL's stock has held up well in this downturn, I sold to re-allocate elsewhere but will continue to follow the business.  
  • Odonate Therapeutics (ODTC) is a failed biotech cash shell (there are a lot of these at the moment!), they went dark and IR never responded to my inquiries, some investors are perfectly comfortable with dark stocks, I tend not to be one of them.  Especially when it is run by a CEO I don't trust, so I sold my shares.
  • Technip Energies (THNPY) is an engineering and construction firm focused on large energy infrastructure projects, the stock tanked following Russia's invasion of Ukraine due to uncertainty around their a project in the Russian artic, and if TE would be able to finish the project or get their money out of the country.  The shares have recovered some, the company is a major player in LNG facility construction which should have some tailwinds as Europe needs to rethink their energy strategy.
  • Laureate Education (LAUR) runs five for-profit universities in Mexico and Peru, last year they returned cash to shareholders via a couple special dividends.  The stock is probably still cheap, I don't think it will last long in its current form, but any M&A is probably put off for a while.  Refinitiv did report that Laureate was looking to take out a term loan for a dividend recap and put leverage back on the company, that might be interesting but the stock has held up well this year and I sold it to invest in new ideas.
  • ECA Marcellus Trust I (ECTM) is a tiny natural gas trust, I sold this one early in the year as the rally was just getting started in natural gas, thus I missed most of the run up.  I'm not a good commodities investor and just got lucky with this one in the first place, but it was a big win for me overall.
  • Logan Ridge Finance Corp (LRFC) and PhenixFin (PFX) are two small BDCs in the midst of a transition, I still think PFX should sell itself but the company isn't doing that, both of these might be revisits for me at some point but there are more interesting ideas out there than owning a subscale BDC at a discount to NAV heading into a potential recession.

Option Positions that Expired:

  • I owned Jan '22 calls in Marathon Petroleum (MPC) which was a covid crisis leaps proxy for PARR and Bluerock Residential Growth (BRG), both great wins.
  • My speculative BRT Apartments (BRT) calls weren't as great of a call and expired worthless, BRT is trading a significant discount to private market value, they're pursuing a strategy of buying out their JV partners which should simplify the story a bit.  Might be worth looking at if you're still a believer in the sunbelt multi-family thesis.
  • Nam Tai Property (NTP) has been a complete disaster and my call options expired worthless, new management still hasn't been able to take full ownership of the company's properties in Shenzhen.  If there are any authors out there looking for new material for a book, this story has the makings of a great read.


  • My write-ups on Altisource Asset Management (AAMC) and Armstrong Flooring (AFI) both read almost like a short thesis, probably a sign of the times as those were both near the top of the market, lesson learned, when I start reaching for the really dicey ideas where you need to squint to see the upside, probably time to just sit on my hands.  Armstrong ended up filing for bankruptcy, there are still buyers interested in the company but Pathlight grew impatient, one to monitor as a restructuring play.  Altisource just seems like a clown show, they were suspended from trading for months, then regained eligibility, now turning into a hard money lender and a crypto ATM company, just all seems haphazardly put together.  Luxor still hasn't settled, they hold all the cards and I still don't buy into the idea that their convertible preferred has no teeth.
  • I sold Orion Office REIT (ONL) at a small loss, ONL is the suburban office spinoff from the Realty Income merger with VEREIT.  In hindsight I talked myself into liking this one despite it being an obvious garbage barge due to the merger-spin setup which has worked well in the past.  Repurposing office real estate is going to require a lot of time (decade plus?) and capital, something public REIT investors shun.
Current bullpen/watchlist:
  • Bluerock Homes Trust (BHM) is the pending spinoff of single family rentals just prior to the close of Blackrock's purchase of Bluerock Residential Growth (BRG).
  • Uniti Corp (UNIT) is the PropCo spin of Windstream, Windstream went bankrupt a few years back and re-cut the lease with Uniti Corp.  Uniti owns a lot of fiber assets and is another digital infrastructure M&A candidate that DBRG's portfolio company Zayo was rumored to be interested in buying and recombining with Windstream.
  • WideOpenWest (WOW) is a cable overbuilder that has a couple rumored buyers circling, they sold assets last year for 10-11x EBITDA and currently trade for 8x.
Current Portfolio:
Cash was withdrawn in early April to pay for 2021 taxes, leverage is high as I got smoked the last two months, but I can move funds over to this account if necessary to plug the hole.

As usual, always looking for new ideas, feel free to share yours or critique mine.  Thanks for reading and enjoy your holiday weekend (for U.S. readers).

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

Wednesday, June 22, 2022

Transcontinental Realty: VAA JV Properties Sold, What's Next?

Over the weekend, news came out that Transcontinental Realty Investors (TCI) and their partner, Macquarie, sold the assets inside their Victory Abode Apartments joint venture for a total of $2.04B (which was the original thesis from my December 2021 post for some background).  On an annualized Q1 2022 NOI basis the sale was done at a 3.85% cap rate, on a forward basis it is probably a bit above 4% as rents are resetting considerably higher in this sunbelt portfolio.  Given the current economic backdrop, that price seems like a great exit for TCI as I was nervous shareholders would be disappointed with no sale or one around the recent $1.4B appraised value (as disclosed on p13 of their recent 10-Q).  The sale is a bit complicated in that 53 properties were sold in total with 7 of those properties being sold back to TCI at the same valuation as the rest of the portfolio.  After paying off mortgage debt and transaction fees, TCI expects to net $320MM in cash from the sale after $100MM they've earmarked for taxes.

The sale is expected to close within 75 days (~early September), post deal closing TCI will screen extremely cheap on a price to book basis as their equity VAA joint venture is being carried on the books for $50.6MM while they're netting $320MM in cash plus the value of the 7 holdback properties, that delta in my estimation almost doubles the book from $45/share to $86/share.  Shares trade for around $43, even after the sale announcement, about 50% of proforma book value.

The sale press release gives limited details, but using the Q1 10-Q and some swag math, we can back into the value of the 7 holdback properties.

A $2.04B topline price tag, minus the $851MM of mortgage debt, nets $582+MM in value to TCI.  Then backing out the remaining earnout owed to Macquarie, some transactional costs and the company's estimate of taxes, the plug to get to $320MM is about $125MM in value for the holdback properties.  I'm probably off there, so as always, correct me if I made any major mistakes.

Then Pillar, the external manager owned by the controlling shareholders, is due an incentive fee for the capital gains related to the VAA sale, the math is challenging and difficult to model out, but they're due 10% of any capital gains above a 8% annualized hurdle rate.  TCI estimates their tax rate at 21%, if the company's estimate of $100MM in taxes is accurate, let's just guess the incentive fee is roughly $35MM for our purposes.

With some simple math, adding the net cash to TCI, estimated value of the holdback properties, subtracting out the incentive fee and the previous carrying value of the JV partnership.  I get the below proforma book value.

Once Q3 earnings come out and book value is reported (November time frame if it closes in Q3), maybe some quantitative strategies take notice?

Of course, book value tends to understate the value of real estate companies due to depreciation and historical cost factors.  Below I've taken most of TCI's balance sheet and pulled it apart, I'm missing a couple things in their restricted cash and their other assets, there's limit disclosure around those two line items.  I've put market multiples on the multifamily and commercial segments, grossed up their land at their Windmill Farms development to approximately equal what the going rate for their acreage has been recently.  I get a little under $100/share in NAV, which is probably on the conservative side.

One potential source of hidden value is in their convertible loans, here they lend money to developers with the option to convert the loan to 100% equity ownership in the properties.  The terms aren't disclosed but 6 of the 9 development loans in that bucket are on stabilized assets.

But the big question remains, what will TCI do with the proceeds from the asset sale?  In the press release, the company says:
the Company intends to use of most of the cash flow it will receive from the aforesaid in subsection 3 above to make new investments and to expand its multifamily residential property portfolio.
That doesn't sound too promising for the prospect of minority shareholders being bought out and likely why it didn't pop on the JV sale news.  But the controlling shareholders own 85% of TCI (mostly via ARL), leaving ~1.3 million shares in the float, if insiders offered shareholders $65 that would be an $85MM check, well within reserving "most of the cash for new investments" and would also transfer $45+MM of value to insiders if my NAV is believable.  They've never had this much liquidity before, the patriarch died three years ago, Pillar Asset Management has a new CEO that has inherited this crazy structure, maybe we see something happen once the deal closes.

Other thoughts/items:
  • Yes, this is externally managed, there's a 0.75% management fee on gross assets plus a 10% fee on net income and capital gains.  Not super shareholder friendly, but they're really only grifting on the 15% of minority shareholders.  I don't see a lot of benefit to them staying public even with the management fee structure, they haven't attempted to grow (they don't even issue shares to themselves, share count has remained steady over the years), there's public company costs that they're bearing (on three different levels, ARL, TCI, IOR), it would seem to make the most sense to take advantage of the big discount in the market by tendering for the remaining float.
  • The corporate structure here is really confusing, almost all of TCI's assets are in the Southern Properties Capital entity that was created to issue bonds in Tel Aviv.  The commercial properties, the remaining and holdback multi-family properties, all should provide plenty of collateral to back the outstanding Israeli bonds giving them liquidity to do a tender offer.
  • ARL and TCI are both entering the Russell 2000 on Friday.  ARL traded strangely for a while, trading well above parity with TCI, I switched from ARL to TCI, but it is worth monitoring both of them in the future.  I'm guessing most of the index buying has taken place ahead of the reconstitution but given the extremely low float (what a dumb index that would include either of these at their full market cap!) we could see some strange price action.
  • One lazy error in my back of the envelope model -- one of the properties in the wholly owned multi-family segment was included in the asset sale, so there's likely a tiny bit of double counting, but shouldn't be too material.  There's limited disclosure to parse apart, so I just ignored it. 

Disclosure: I own shares of TCI

Sunday, June 12, 2022

Franchise Group: In Exclusive Acquisition Talks w/Kohls

Franchise Group (FRG) is one of my largest positions, naturally I feel obligated to post something on the headline grabbing news that FRG is the apparent winner of the auction for struggling retailer Kohl's (KSS).  Kohl's would be a transformative acquisition, FRG is currently a $2.7B enterprise value company and press reports have them paying $8B for KSS ($60/share).  FRG is currently guiding to $450MM in 2022 EBITDA, TIKR has the consensus KSS estimate at $2.1B.  The combination of FRG being smaller than the target, little known outside of certain value/event-driven circles and fears of credit markets tightening seem to have the market doubting this deal gets done (KSS last traded for $45.75).  But I have faith in CEO Brian Kahn, FRG entered my portfolio as a special situation when it was then called Liberty Tax, which went about a complicated merger and tender offer transaction that looked novel and interesting from an outsider perspective.  Here is FRG's most recent investor presentation for what the company looks like today, a lot has changed, including FRG selling the original Liberty Tax to a SPAC (sponsored by NexPoint).  My thesis in the last two years has mostly revolved around "in Kahn we trust", given the news leaks around credit providers being lined up, it appears this deal is getting done.  I've added some KSS as a small speculative merger arbitrage position alongside FRG.

Taking a few steps back, in April, news broke from Reuters that FRG was joining the bidding for struggling retailer Kohl's (KSS), I was a bit surprised but not entirely, Kahn is a creative deal maker and likely looks at many acquisition opportunities that don't fit Franchise Group's stated strategy of "owning and operating franchised and franchisable businesses".  My guess is the "franchise" part is more aspirational than truth, it is a generic name and strategy, they just look for attractive deals.  Kohl's certainly doesn't seem to fit the franchise mold, hard to imagine someone operating a department store as a franchise, but the deal does resemble other recent FRG acquisitions as the non-core assets could be used to finance the transaction.

Last November, FRG entered into a transaction to buy southeastern furniture retailer W.S. Babcock for $580MM.  Subsequently, FRG went on to sell Babcock's credit accounts receivables to B Riley (RILY) for $400MM, the retail real estate for $94MM, and the distribution centers and corporate headquarters to Oak Street Real Estate Capital for $173.5MM.  More than paying for the acquisition with asset sales and still expecting to receive $60MM in proforma LTM EBITDA.  A similar transaction seems to be in store for Kohl's, the department store chain owns their corporate headquarters, almost all of their distribution and e-fulfillment centers, and own 410 of their retail stores outright and another 238 of them owned but on ground leases.

Reports have FRG re-teaming up with Oak Street Real Estate Capital (part of Blue Owl's platform) to provide $6B in financing based on the corporate headquarters and distribution facilities real estate (might also include the retail real estate, so my 6% cap number below might be too low), and $2B (fuzzy, Seeking Alpha number) from Apollo in non-recourse Kohl's level term loan financing, with FRG kicking in the additional $1B via an upsized term loan.  Apollo isn't the ideal lender, but since they're a direct lender and aren't relying on syndicating the loan immediately like a large regulated bank, the financing seems more secure in the current uncertain environment.  It is an interesting structure, FRG is using no equity, financing it all with debt and will fully own a levered equity stub KSS.

Putting together a quick back of the envelope proforma, I come up with the below:

As always, probably a few mistakes above, feel free to point them out, and obviously, this is all excluding the capitalized leases which is real leverage even if it is non-recourse, but even if you did an EBITDAR valuation, the proforma company would be extremely cheap.  But I think it shows the creativity of Kahn and FRG, they're creating a diversified series of levered bets via non-recourse sale leaseback financing.

Other thoughts:

  • While not a "bet the company" deal, it is pretty close and certainly risky.  The market doesn't like highly leveraged companies, FRG will likely trade cheaply for a while as they bring down the debt and eventually further diversify away from Kohl's with future deals.  Kohl's is certainly a weak business, it is in the middle ground of not really having an identity, I can't think of anything you must buy at Kohl's that you couldn't get elsewhere. There's a lot of debt here, things could go horribly wrong.
  • There is some political pressure to reject the deal, particularly in Kohl's home state of Wisconsin, likely if FRG acquires KSS, long term this is a slow motion liquidation.  FRG often partners with B Riley, the two are intertwined some, B Riley has a retail liquidation business and often invests in these distressed retailers.  Selling to FRG probably cements Kohl's as a declining business and that might face political backlash.
  • FRG is heavily into home furnishings (previously mentioned Babcock, they also own American Freight which sells clearance appliances and Buddy's, a rent-to-own retailer), based on the recent Target inventory debacle, people aren't buying home furnishings anymore now that covid is mostly in the rear view mirror.  Cynically, FRG might be doing this deal to distract from issues at the core business.  However, Brian Kahn has sounded sober through the pandemic regarding inventory, supply chain, going forward expectations, he hasn't sounded surprised by the slowdown and thus far hasn't had to drastically change guidance.
  • Macellum Capital Management has been engaging in an activist campaign against Kohl's, they lost their proxy fight recently, but have been putting significant pressure on the company to sell themselves.  Kohl's management believed they were worth $70+, but with the recent downturn and disappointing Q1 earnings, bids have come in lower, so it might be an opportunistic time for FRG to swoop in and be the white knight.  FRG also runs a decentralized management structure, so it could be seen as a preferred buyer for management as they could keep their jobs.
  • FRG did recently put a $500MM buyback in place (after it was reported they were a KSS bidder), things could get pretty wild if they use the KSS cash flows to buyback shares versus paydown debt given their Debt/EBITDA ratio would likely remain within there target range immediately upon closing of the transaction.
  • Brian Kahn has never been shy about buying shares in the open market (did a lot during that initial Liberty Tax/Buddy's transaction, signed big boy letters with anyone that would sell him shares) and his private equity firm, Vintage Capital, owns 25+% of the company.

Disclosure: I own shares of FRG and KSS

Friday, May 13, 2022

Radius Global Infrastructure: Tower Ground Leases, Rumored Sale

Now onto something that is a little more in my historical wheelhouse.

Radius Global Infrastructure (RADI) is a holding company that owns 94% of the operating company APWireless (but I'll just refer to the company as Radius/RADI going forward).  Radius is a wireless tower ground lease company (the legal structure can vary by country, but in each case works similar to a ground lease) that purchases rent streams mostly from mom and pops, individuals or smaller investors who own the underlying real estate.  Historically, before tower REITs really took off, the wireless carriers would build their own towers and lease the land/rooftop from individuals or building owners.  Today, tower companies mostly develop and own the land under their new structures, but there's a large fragmented global market of leases for Radius to rollup.

Radius checks a few other boxes for me:

  • RADI is not a REIT and doesn't pay a dividend, although the business model would lend itself well to both, thus limiting its investor pool today.  This would be a great YieldCo (see SAFE).
  • RADI doesn't really develop new towers, but they have a global originations team that scours the market to create new leases, as a result their SG&A looks high for their current asset base (it doesn't screen particularly well), but their SG&A could arguably be separated and thought of as growth capex (HHC or INDT are semi-similar, but RADI's distinction is probably cleaner).  Their origination platform would likely be valuable to someone with access to lots of capital, for example, an alternative manager like DigitalBridge (DBRG).
  • Bloomberg recently reported that Radius was exploring strategic options including a sale.  RADI has some financial leverage and given the stability of their lease streams could trade privately for a low cap rate juicing any returns to equity holders.
A bit more about the business, stealing slides from their latest supplemental:

Radius has all the major tower companies and wireless companies as tenants, wireless infrastructure is an essential service that is only increasing in importance.  As a ground lessor, Radius is senior to the tower companies which are great businesses and have historically traded at high multiples.

In the current environment, everyone is concerned about inflation, Radius has inflation indexed escalators in 78% of their portfolio against a largely fixed rate debt capital structure, further increasing the attractiveness of their lease streams.

For a back of envelope valuation, I'm simply going to take the annualized in-place rents minus some minimal operating expenses to create an NOI for the as-is portfolio.  This portfolio should have minimal expenses other than a lockbox to cash the rent checks as there is no maintenance capex (these are structured as triple net leases).  Note the RADI share price below is my cost basis, things are moving around so much this week, don't know what the price will be when I hit publish.

The other challenging thing for RADI is all the dilutive securities.  There's also an incentive fee that is rebranded as the Series A Founder Preferred Stock dividend, I've left that out for now but may try to workout how much it would dilute any takeover offer, although I think there's enough room for error here either way.  As usual, I've probably made a few mistakes, please feel free to correct me in the comments.  But above is roughly the math if the acquirer buys Radius and fires everyone, sits back and collects the inflation-linked levered cash flows.

The piece I struggle valuing is the origination platform, but I have a feeling someone like DBRG (just as an example, any private equity manager really) would be very interested in it as they could deploy a ton of capital over time and generate pretty reliable returns.  RADI has guided to originating $400MM of new leases in 2022 at an average cap rate of 6.5% inclusive of origination SG&A and other acquisition costs.  Even using the current market implied cap rate of 5.1% above, the origination platform would create ~$110MM in additional value this year by putting the 5.1% public market valuation on the lease streams they originated for 6.5%.  RADI's management thinks they have a long runway for origination growth as they've just scratched the surface (low-mid single digit penetration) of this fragmented market.  Any value prescribed to the origination platform would be above and beyond my simple math in the Excel screenshot.

Interestingly, during the Q1 DBRG conference call, DBRG CEO Marc Ganzi said the below with regards to the digital infrastructure M&A environment (transcript from bamsec):

We do see public multiples retreating in some of these different data center businesses or fiber businesses or ground lease businesses. There's been a pretty sizable contraction and the window is beginning to open where we see opportunity. And I think by being once again by being ultimately a good steward of the balance sheet and being prudent in how we deployed that balance sheet last year, we've taken our shots where we have good ball control, and we've taken our shots that are candidly going to be accretive

And there's reason to take Ganzi's comments quite literally as DigitalBridge made a splashy deal this week in one of the three categories he called out by purchasing data center provider Switch (SWCH) for $11B.

I've bought some RADI common this week and also supplemented my position with some Aug $15 call options.  Similar to other ideas over the years, I like call options here, there's no reason to really think that RADI's business is deteriorating alongside the overall market, their leases are inflation linked and structurally very senior in an infrastructure like underlying asset.  There's financial leverage, low cap rates and an origination platform that could be valuable to someone, all of which could lead to a big takeout premium if they strike a deal.

Disclosure: I own shares of RADI (plus DBRG, HHC, INDT) and call options on RADI

Friday, May 6, 2022

Argo Group International: New Activist Pressure, Pursuing a Sale

This will be a brief post and not the most exciting idea given the current chaotic market backdrop, but I wanted to throw something out there as it has been a while since hitting publish. I've mostly just been sitting tight, waiting for events to play out and adding to a few current positions during this downturn.  I also don't have much experience with insurance companies so be easy on me in the comment section.  

Argo Group International (ARGO) is a specialty insurer (~$1.5B market cap) that first popped up on my radar screen in 2019 when it faced a proxy contest from Voce Capital, their largest shareholder (9-10%), which eventually added three representatives to the board.  Voce put out an entertaining deck that outlined the now ex-CEO's lavish lifestyle (corporate penthouses, art collection, sailing sponsorships, private jets, etc.) that was essentially being expensed through Argo.  

In the ~2 years since Voce refreshed the board and the ex-CEO resigned, Argo has gone about shedding unprofitable or volatile business lines to highlight the strong U.S. focused specialty insurance business. 

The crown jewel is their excess and surplus business line that focuses on risks that standard insurance markets are unwilling or unable to underwrite.  This the non-commoditized, less regulated corner of the insurance market and thus should be more profitable.  The transformation goal has been to uncover and highlight this business: 

However, the perceived slow speed of the transition and a surprise reserve adjustment in February brought forward another activist pushing for board representation in Capital Returns Management, an insurance focused hedge fund.  Capital Returns has also insisted the company put itself up for a sale and the board agreed last week to run a strategic alternatives process which includes exploring a sale of the company.  While, Capital Returns argues the board doesn't have skin in the game (in aggregate they own ~1% of the company), there are three Voce representatives on the board and they've moved the business down Voce's suggested path.  My guess is Voce is in agreement that now is a good time to pursue a sale and the board is unlikely to resist a reasonable offer.  In short, this may go from semi-hostile to friendly, the verbiage from the recent earnings call seems to imply that as well:

Thomas A. Bradley Argo Group International Holdings, Ltd. – Chairman of the Board & Acting CEO

Thank you, Greg, and thank you to everybody for joining us today. Before I jump into our results for the quarter, I'd like to take a moment to discuss our announcement last week. Over the last year, Argo has instituted a number of substantive strategic initiatives, actions that we believe have positioned the company for a clear and consistent long-term path to stable growth and profitability. The Board of Directors and management team, however, do not believe these initiatives are adequately reflected in the company's current market valuation.

After much thoughtful and deliberate discussion and analysis, our Board with the assistance of our advisers has initiated an exploration of potential strategic alternatives. In this review process, our objective is simple: to maximize the value of the company's strategy and its considerable long-term prospects for the benefit of all shareholders. To that end, the Board will consider a wide range of options for the company, including, among other things, a potential sale, merger or other strategic transaction.

What would be a reasonable valuation in a sale?  Again, I've only looked seriously at 1-2 insurance companies here in the last decade.  But below is a list of U.S. based peers that I took from Capital Returns' proxy, and the data is from TIKR.
This is admittedly rudimentary, but for a business that's proforma combined ratio should be in the low 90s, a 1.5x book valuation seems reasonable for a strategic buyer?  Kinsale Capital (KNSL) is a pure play excess and surplus insurer which trades for a high valuation, there's a KNSL short thesis on VIC worth reading, giving a little bit of comfort that other players will be interested in ARGO and that it should trade at a reasonable premium to book.

The sale process could take some time, maybe we hear something in 5-7 months, so again, there are likely more immediate/actionable opportunities in the current market dislocation, but keep this one on the watchlist.

Disclosure: I own shares of ARGO

Friday, March 11, 2022

LMP Automotive: Car Dealer Rollup Gone Bad, Pursuing a Sale

Full warning, similar to Armstrong Flooring (AFI), this could be a terrible idea, it has significant red flags and is highly speculative.

LMP Automotive (LMPX) is a micro-cap (~$45MM market cap) that came public in late 2019 with a car subscription model where users could rent a car month-to-month, positioning itself as splitting the difference between a short-term car rental and a traditional car lease.  LMPX then put an online dealer/mobile app business model spin around it to market the stock.  In 2020, LMPX became a bit of a meme stock, briefly trading up alongside other e-commerce car dealers like Carvana, but then crashed as they were unable to source cars economically to run their subscription model.  Instead, the company pivoted to be a traditional car dealership rollup business and went on a debt fueled acquisition spree in 2021.  LMPX finished the year with 15 new car dealerships and 4 used car dealerships across 4 states.  On 2/16/22, the company said they were unable to secure new financing for their previously announced but not yet closed acquisitions (7 of them!) and quickly pivoted to pursuing a sale:

Sam Tawfik, LMP’s Chief Executive Officer, stated, “The Company intends to terminate all of its pending acquisitions in accordance with the terms of their respective acquisition agreements, primarily due to the inability to secure financial commitments and close within the timeframes set forth in such agreements.”

“The Board of Directors believes that LMP’s current stock price does not reflect the Company’s fair value. Given the record M&A activity in our sector and multiples being paid for these transactions, LMP’s Board of Directors has directed management to immediately pursue strategic alternatives, including a potential sale of the Company.”

The stock closed at $5.25/share on 2/16, it now trades for ~$4.25/share.

Putting aside terminal value questions (auto OEMs bypassing dealers, electric cars needing less maintenance), car dealerships are fairly high cash flowing business and were big covid beneficiaries. There is a lack of supply (nationwide, dealership inventory is ~1/3rd of normal, going to take a while to normalize) that has raised prices and reduced the need for car salespeople (dealerships have been slow to rehire those laid off during the pandemic) as more people browse online and the low inventory has all but eliminated haggling.  Car owners are also holding onto to their cars longer creating more high margin service revenue.  Some of these covid changes may be lasting, many dealers talk about inventory being permanently lower as dealers become more of a distribution center and less of a place where people walk the lot to find the car they want, they've already decided on the specs online before going to the dealer.  

There are thousands of dealerships across the country, they're reasonably liquid assets that change hands regularly (similar to why I like REIT special situations, the assets are fungible and there's a large pool of buyers).  Here, there are 7 large publicly traded dealership groups (KMX, LAD, PAG, AN, ABG, GPI and SAH, but only ~10% of all dealerships) and many other large private ones.  The windfall profits of the last few years has prompted the larger public players to do a lot of M&A, rolling up this fragmented market.  While large dealership groups are thriving, many smaller dealerships are struggling to source inventory and are at risk of failure, in order to press their scale advantages, the big are getting bigger.  Awkward long way of saying, I don't think LMPX will have trouble finding buyers for their dealership assets, but it is more a question of price.

Given the rapid rollup nature of LMPX, nailing down the valuation causes a bit of brain damage to work through the financials, here's what CEO Sam Tawfik said in the Q3 earnings call:

Our third quarter annualized run rates excluding the acquisition we closed this quarter, which we expect to be immediately accretive to income this quarter are $565 million in revenue, and $47.6 million in adjusted EBITDA.

The acquisition referenced above is the White Plains Chrysler Dodge Jeep Ram Dealership that closed in October, purchased for $19.2MM that was estimated to generate $2.6MM in 2022 EBITDA.

Then in the company's annual letter on their website, Tawfik provides:

We completed the acquisition of our contracted White Plains, New York Chrysler Dodge Jeep Ram in the early fourth quarter using approximately $5 million in cash from the company’s balance sheet, 55,000 shares of common stock and $1.3 million in cash from our existing credit facility. This acquisition will be immediately accretive to earnings in the fourth quarter of this year. As a result of this year’s acquisition activity, the company currently owns 15 new vehicle franchises, operates 4 pre-owned stores across 12 rooftops in 4 states which generate over $600 million in annualized revenue.


 We intend to pay down our existing term debt by approximately $11 million in the fourth quarter of 2021, resulting in a balance of approximately $85 million, of which the company allocates $53 million to its real-estate holdings and $32 million to its dealership blue sky purchase debt. Essentially at the current pace of cashflow generation, if we choose, the company can extinguish its current blue sky debt in less than a year.

Adding it up together:

The car business does have some seasonality to it, Q1 is usually lower than the other quarters, so annualizing Q3 EBITDA isn't a perfect run rate.  I attempted to normalize that and LMPX's focus on tier 2 dealerships (domestic and economy imports brands) which fetch a lower valuation than luxury in the 4x EBITDA multiple.  Obviously, I'm not a automotive sector expert, feel free to correct or push back, but seems like there could be something here despite all the risks below.  I bought a smallish position this week.

Risks/Red Flags:

  • Obviously, top of the list, LMPX went on a crazy acquisition spree in 2021 and couldn't raise capital to complete them (credit conditions have tightened slightly this year, but still pretty open).  Most of these deals included a combination of debt and stock, struck when the stock was $15-$17, by the time it came to close these transactions the air was being let out of the growth balloon, the stock was $7 and the window to raise capital closed on LMPX.  Buying dealerships at 7x EBITDA while the stock trades well below that doesn't make much sense.  It could be nastier than that simple explanation under the hood, but the Q3 numbers look fairly decent, this is a mess but was at least cash flow positive during the last reported quarter.
  • Tawfik owns approximately 35% of the company, he appears to be the sole decision maker and doesn't seem to have a strong board around him.  There are a number of related party transactions, none appear overly egregious but in total they don't look great, plus in October, Tawfik bought a company plane for himself only a few short months before it all fell apart.  His biography includes founding Telco Group which was sold to Leucadia back in 2007 for $160MM and also founded PT-1 Communications which was sold to Star Communications in 1998 or $590MM.  Presumably he's not totally incompetent but might have just gotten caught up in the market hysteria last year.
  • Tawfik has been selling a small amount of shares regularly as part of a 10b5-1 plan, I'm not an expert on these insider selling plans, not sure if they can be cancelled halfway through, but it is not a great look if you think the stock is materially undervalued.
  • LMPX reports EBITDA per share versus enterprise value, that's always a red flag for me as it is intentionally comparing apples to oranges.
  • Their current term loan matures in March 2023, so they've got a little time to get this process done and less of a forced sale than AFI.

Disclosure: I own shares of LMPX