Year End 2022 Portfolio Review

This year in the markets wasn't fun.  While I didn't participate in the headline driving speculative manias (growth stocks, SPACs, crypto, etc), I did get caught with a leveraged PA heavy in real estate and pre-arb/takeover situations which were hit by rising interest rates and M&A financing markets tightening up.  I was down -35.31% for the year, versus the S&P 500 finishing down -18.11%, my worst absolute performance and relative result to the markets since beginning investing in individual stocks.  My lifetime to-date IRR fell to 21.09%.

Current Positions Updates
As usual, I wrote these intermittently over the last week, some of the share prices/valuations might be slightly stale. Presented in mostly random order:

• My largest holding by a fair amount -- partially because it has held up in price this year versus everything else falling -- is Transcontinental Realty Investors (TCI), TCI's joint venture with Macquarie recently completed the sale of their portfolio, including the holdback of seven properties by TCI.  The book value of TCI jumped to approximately $90/share, but this possibly understates the value created in the JV sale transaction, the holdback properties were valued at market in the split between TCI and Macquarie, but remain at historical cost in TCI's book value.  Reasonable people can argue where sunbelt multi-family would trade today (lower) versus earlier in the year when the JV sale was announced, but the likely fair value of TCI is more than $100/share while it trades for ~$43/share.  Of course, TCI shareholders will never see that amount, but the larger the gap between fair value and the share price, the more likely it is that the Phillips family's incentives would align with a go-private proposal.  The current stated plan for the JV cash is "for additional investment in income-producing real estate, to pay down our debt and for general corporate purposes."  Optimistically, I view that as boilerplate language and doesn't rule out a go-private offer with the proceeds, however, if a portion of the proceeds get swept back to the Phillips family via their role as "Cash Manager", that will be the signal to exit as they'd be getting liquidity for themselves but not minority shareholders.
• In hindsight, lucky for Franchise Group (FRG) they got cold feet in their attempt to buy Kohl's (KSS) (I sold my position in KSS at a loss after the potential deal was called off), despite the upside potential due to extreme financial engineering.  Following that pursuit, the current economic environment's grim reaper came for FRG's American Freight segment (liquidation channel furniture store concept where unlike their corporate name, they own and operate these locations).  Management made the covid era supply chain mistake of buying anything they could get their hands on, when consumer preferences shifted, they were left with inventory that was no longer in demand.  FRG remains bullish on American Freight, on the last conference call Brian Kahn stated in the context of his M&A appetite, ".. if we even pick what you might consider to be a low multiple of 5x, which not many businesses go for we can go investor our capital in opening more American Freight stores at less than 1x EBITDA."  I'm guessing next year, Kahn will stay out of the headlines and refocus on the business.  Most of FRG's problems are centered in the American Freight segment, their other two large segments, Vitamin Shoppe and Pet Supplies Plus, continue to perform well.  Excluding their operating leases, using TIKR's street estimate of $375MM in NTM EBITDA, I have it trading for approximately ~5.5x EBITDA.  June 2024 LEAPs are available, I bought some versus averaging down in the common stock.
• My valuation was sloppy on Western Asset Mortgage Capital (WMC), the hybrid mREIT recently announced that their current estimated book value is $16.82/share (not including the $0.40 dividend) versus $24.58/share at the time of my post.  I called out that the $24.58 number was overstated and was going to come down, but didn't anticipate the magnitude.  The company is currently up for sale, there will be an additional ~$3/share in a termination fee to the external manager, so if the current book is relatively stable, looking at ~$11-12/share value in a takeout after expenses and need to split part of the discount with the buyer.  Surprisingly, the shares have traded up since the current book value disclosure, trading today for ~$10.00/share.  I should probably sell given I'm surprised by that reaction, but my current inclination is to wait for a deal announcement.  There should be plenty of buyers, there are always credit asset managers looking for permanent capital, and a deal shouldn't rely on the M&A financing window being open like an LBO (it'll be a reverse-merger like transaction).  On the negative side, they have remaining commercial loan exposure to the albatrosses that are American Dream and Mall of America, their residential assets (the core of the portfolio) are high quality non-QM adjustable rate mortgages, but most are in their fixed rate period and thus susceptible to rate volatility.
• In contrast, Acres Commercial Realty Corp (ACR) is a clean mREIT with minimal legacy credit problems, all floating rate assets and floating rate debt (via CRE CLOs) that should minimize interest rate risk.  A majority of their loans are to the multi-family sector, reasonable people can argue that multi-family is being overbuilt in many areas of the country today, but these are not construction loans to future class A properties that are at higher risk for oversupply, but rather to transitional properties that are undergoing some kind of repositioning, value-add cycle.  ACR is trading for an absurd 32% of book value, mostly because of its small size ($70MM market cap) and lack of a dividend.  Instead of paying a divided, ACR is using their NOL tax asset generated by prior management to shield their REIT taxable income (thus not being required to pay a dividend) to repurchase stock at a discount.  First Eagle and Oaktree are large shareholders, two well regarded credit shops, that might keep management honest.  If the shares don't fully rerate by the time the NOLs are burned off, I could see a similar scenario to WMC where it makes sense to sell, despite needing to pay the external management termination fee.
• One mistake I made in 2021 that carried over into 2022 was oversizing my initial position in Sonida Senior Living (SNDA).  SNDA was an out of court restructuring sponsored by Conversant Capital, which controls SNDA now, that resulted in an injection of cash, but still a very levered entity (SNDA doesn't have leases, they own their properties).  After the shares have been more than cut in half this year (likely due to inflation/shortages hitting their labor cost structure and slower than anticipated occupancy recovery), the market cap is roughly 10% (pre-convertible preferred stock conversion) of the overall enterprise value.  SNDA features both high financial leverage and high operating leverage, occupancy sits at around 83%, if occupancy moves another 5-6% higher to normalized levels, SNDA is likely a multi-bagger.  But the opposite could be true also.  I'm sitting on a big loss, but sticking it out with the original thesis that occupancy levels will normalize as Covid-fears subside and aging demographics shift in their favor.
• PFSweb Inc (PFSW) recently distributed the cash ($4.50/share) from their 2021 sale of LiveArea, what remains is a third-party logistics ("3PL") business that is subscale but has navigated the current environment better than you'd expect from a Covid-beneficiary, signing up new clients and estimating 5-10% revenue growth in 2023.  While investors were likely disappointed that PFSW hasn't sold the 3PL business to-date, they did re-iterate on their Q3 earnings call that completing a transaction is their top priority and extended their executive team's incentive comp structure based on a sale through 2023.  I've got PFSW trading for approximately ~4.6x 2023 EBITDA (using the TIKR estimate), extremely cheap for a business that should have multiple 3PL (there are dozens of them) strategic buyers, just need the M&A window to open back up.  I'm comfortable seeing that process through to completion.
• The rose is off the bloom with DigitalBridge Group (DBRG), shares have retraced most of their gains since the summer of 2020 when the transition to an infrastructure asset manager was in its infancy.  That transition is largely completely, they still own a slug of BrightSpire Capital (BRSP) -- likely cheap on its own, trades at 61% of book -- and equity positions in two data center companies that they're in the process of moving to managed vehicles.  Multiples likely need to come down for previously high-multiple digital infrastructure investments in a non-zero interest rate world, it's hard to know how accurate their marks are inside their funds and how the current environment is impacting future fund raising.  I attempted to catch a bottom too early, purchasing Jan 2024 LEAPs that have a post-split adjusted strike price of $20/share.  Shares currently trade for $10.45/share, well short of my LEAPs and well short of CEO Marc Ganzi's $100MM pay day at $40/share.  Activist investor Legion Partners Asset Management has recently pushed DBRG to put itself up for sale if shares don't recover.
• INDUS Realty Trust (INDT) and Radius Global Infrastructure (RADI) have similar characteristics, each have high overhead expenses compared to their asset bases as they look to develop/originate new assets.  Both have been hurt by rising rates this year as they're focused on low cap rate asset classes with long term leases (RADI thus far hasn't been able to flex its CPI-linked resets, possibly an unfair criticism as they're on a lag), but both have relatively recession proof cash flows.  The weakness in their share prices is almost entirely rate driven.  Both companies still have reasonably long growth runways without needing to raise capital, but looking out, both might benefit from being in private hands where the cost of capital might be lower or at least less volatile.  INDT has a public $65/share bid from Centerbridge outstanding and RADI has been the constant target of deal speculation throughout the year, the latest firm said to be interested is infrastructure manager EQT.  I underestimated how high interest rates would rise this year and hope one or both of these holdings is successful in shopping themselves early in the new year.
• NexPoint Diversified Real Estate Trust (NXDT) finally did fully convert to a REIT from a closed end fund.  However, the shares haven't reacted much to that change, the company did put out regular way SEC financials for their 9/30 10-Q, but disappointedly haven't hosted an earnings call or put out a supplemental that would make the tangled web of holdings more digestible.  I get a lot of questions about my current thoughts on NXDT, and the "no change" answer is probably unsatisfying, but I'm content holding this for another several years and letting the story slowly (a little too slowly right now) unfold.  There's a lot of wood to chop, this is one of those balance sheet to income statement stories that'll take time, I could see it being a triple from here (~$11.50/share) over the next 3 years.
• Howard Hughes Corp (HHC) continues to be a value trap, anyone who spends time doing the bottoms up analysis comes away saying it is undervalued but it's just never going to be fully appreciated by public markets (due to complexity, Ackman, development/capital allocation risk, etc., take your pick).  In October, Pershing Square (Ackman's investment vehicle) attempted to take advantage of this value disconnect by launching a tender offer at $60/share, later raising it to $70/share, and still got very few takers.  James Elbaor on Andrew Walker's fantastic podcast offered some speculation that Ackman could do a reverse merger of Pershing Square into HHC in order to redomicile.  Pershing Square currently owns ~30% of it and it's a double discount inside the publicly traded PSH as the fund trades at a wide discount as well.  Maybe Ackman does something one of these years, but in the meantime, I'm emotionally vested to continue to hold.
• BBX Capital (BBXIA) is essentially the publicly traded family office of the disliked Levan family.  Shares trade for ~$9.40/share and the 9/30 book value was $20.72/share, included in the $20.72/share is approximately $11.63/share of cash, securities and their note from related party Bluegreen Vacation Holdings (BVH).  Additionally, they own a spattering of multi-family real estate in Florida, a real estate developer, door maker Renin (slightly financially distressed) and candy store IT'SUGAR (you've probably seen these is airport terminals).  Management isn't to be trusted here, but similar to my hopeful thesis in TCI, the discount between the share price and fair value is so wide that management's greed is sort of on the shareholders side at the moment.  BBXIA recently completed a $12MM tender offer for 1.2 million shares, that makes the proforma book value ~$21.70/share.  Shares trade for just 43% of that value, and still have $11.75/share in cash/securities to buyback more stock.  Because the shares trade below that number, each repurchase below that line are actually accretive to the cash/securities per share metric.  While it is hard to see a firm catalyst to get the shares much higher in the near term, the discount seems too severe to sell into their periodic tender offers.
• A stock that likely won't mention again for three years, I bought back into Rubicon Technology Inc (RBCN) this month as the stock has sold off considerably, presumably sellers getting out before the company stops reporting here soon (might trade with expert-market status), following the transaction with Janel Corporation (JANL).  To recap, Janel effectively paid $9/share for RBCN's NOLs in the tender offer, they're restricted from purchasing more RBCN for three years, but now the shares trade for ~$1.40.  There's plenty of room in there for JANL to pay a premium in three years and get a fantastic deal for themselves.  The main remaining risk is JANL going bust in the meantime.
• My energy tourist hedge is Par Pacific Holdings (PARR).  PARR is a rollup of niche downstream energy businesses in remote locations (Hawaii, Washington, Wyoming, soon to be Montana).  Their thesis is these refineries are overlooked by the large players but also have a defendable market position because of cost advantages in their local markets due to their remote locations (high transportation costs for competitors).  2022 was finally the year when stars aligned, crack spreads widened out significantly and PARR's refineries were running at near fully capacity with no significant downtime for maintenance capex projects.  In Q3 for example, PARR reported $214MM in adjusted EBITDA, roughly their mid-cycle guidance for an entire year.  Similar to other energy businesses, this year's cash flows allowed PARR to clean up their balance sheet and now are positioned to once again buy another refinery, this time Exxon's Billings refinery.  The deal should close in the first half of 2023, just maybe PARR is turning a corner and has gained enough scale to finally start significantly chipping away at their large NOL (that was my original thesis 8 years ago).
• Similar to PARR, I've owned Green Brick Partners (GRBK) for 8+ years and just sort of let it sit there.  Despite new housing development hitting a wall in the back half of 2022 as mortgage rates briefly peaked above 7%, GRBK shares are actually up 20% since 6/30.  It's fairly certain that tough times in housing will continue in the near term.  But I'm guessing it won't last overly long, single family homes have been underdeveloped following the excesses of the GFC, politically overly tight mortgage conditions for a long time seems untenable, and millennials need homes.  With attractive land in short supply, I don't see the large scale write-downs of the GFC reoccurring, maybe asset heavy homebuilders like GRBK will be seen to be attractive again versus asset-lite builders.  Shares trade for a relatively undemanding 7x TIKR's NTM (trough?) earnings estimates.
• Another sloppy buy from me was Argo Group International Holdings (ARGO), shortly after my post the specialty insurer came out with disappointing results and dropped significantly despite being in the middle of a sale process (the initial interest from potential buyers was reported to be muted).  I tax harvested my position and re-entered at lower prices.  Management recently survived a proxy contest from activist Capital Returns, now appears to have found religion and reiterated time and time again they're committed to their restarted sale process.  My conviction is pretty low here, hoping for a sale in 2023.  It trades well below peers on P/B, optically for a P&C insurer tourist like myself, a sale should make sense for both a buyer and ARGO. 
• Mereo BioPharma Group (MREO) similarly faced a proxy contest in the fall, instead of fighting like ARGO, MREO saw the writing on the wall and let activist Rubric Capital on the board.  Rubric's stated strategy for MREO is to monetize/liquidate much of the company's assets, we've yet to see movement on that (I'd argue it is still early, but others might disagree).  Despite the potential for a strategy change, shares have dropped roughly in half as money burning biotechnology companies continue to be out of favor in a rising rate in environment.  MREO is an option like equity at this point, could be a multi-bagger or shareholders could get significantly diluted.
• Another pick of mine that is down significantly despite little news is Digital Media Solutions (DMS).  DMS has an a $2.50/share bid from a consortium of management and PE sponsors that own 75% of the DMS shares.  No news has come out since 9/8/22 non-binding offer, shares have fallen all the way to ~$1.30/share today.  There's a great discussion in the comment section of my post speculating on various scenarios, anyone interested should sift through them.
• I don't have any original thoughts on either Jackson Financial (JXN) -- seems like most of the index buying has happened -- or Liberty Broadband Corp (LBRDK), others are going to speak more intelligently than me.  Each are buying back a significant amount of stock, optically cheap, could be coiled springs if recession fears break, but both also have challenging/complex business models in their own respects.  I might sell one, both, or none to fund new ideas early in 2023.
• Nothing has really changed in the last two weeks for Sio Gene Therapies (SIOX), it is a failed biotech liquidation, which likely will be a continued theme for me in 2023.  Other liquidations I continue to hold include Sandridge Mississippian Trust I (SDTTU), Luby's (non-traded) and HMG Courtland Properties (non-traded).  One old 2019 liquidation, Industrial Services of America (non-traded), recently made its final distribution and ended up being a disappointing low-single digit IRR.  To round out the miscellaneous stuff, I own the Atlas Financial Holdings bonds (CUSIP 049323AB40) which don't appear to have traded since the exchange offer, and remaining CVRs in Prevail Therapeutics, Applied Genetic Tech, OncoMed and the BMYRT potential ligation settlement.

Closed Positions

• One of the most puzzling M&A transactions of 2022 has to go to Advanced Emissions Solutions (ADES).  Management dragged shareholders on a long strategic alternatives process in which it was widely assumed that ADES would be a seller and return their cash to shareholders.  Instead, ADES flipped around and became a buyer of an early stage venture company, destroying value in the process.  Shares traded for $6.28 the day before the deal announcement and now trade for $2.23, I don't know how this deal even closes.  If it weren't for the poison pill to protect the NOL (which I believe is being disqualified in this transaction anyway), I'd assume an activist would come in here and block the deal.
• My original thesis for ALJ Regional Holding (ALJJ) centered around the NOLs being monetized following a couple asset sales, thus the reason for the vehicle existing was gone and Jess Ravich would take out minority shareholders with the new liquidity on the balance sheet.  That didn't happen, instead Ravich delisted ALJJ and went on a mini-buying spree, turning ALJJ into a family office.  I moved on after that.
• Ballys Corp (BALY) was a tax harvesting casualty for me (despite the terrible performance, I still realized gains in 2022, mostly holdovers from very early in the year), I still like the company and follow it.  The Chicago casino project will be a home run, likely the same for whatever they do with the old Tropicana on Las Vegas Blvd strip.  It is cheap and worth a look.
• WideOpenWest (WOW) was another sloppy mistake, the M&A financing environment changed and I didn't change my framework as quickly, thought that an LBO could get done, but with the limited free cash flow, it just didn't make sense.  Despite the few rumors around it, nothing got done, if the M&A market reopens, WOW could be one of the early targets.
• I sold Regional Health Properties (RHE-A) recently to harvest the loss, the company's preferred exchange offer failed to get enough of the common stock to vote in favor of the unique proposal.  Shares have drifted significantly lower since, the company's fundamentals are still strained, their operators are suffering under the same labor issues as SNDA, RHE has been forced to takeover management of these underperforming nursing facilities.  The asset value appears to still be there in a liquidation like scenario, but not sure how that gets initiated, the preferred stock is in a tough spot.  I might re-enter a position, there's a commenter on my RHE posts looking for others to exchange notes on where the preferred stockholders should go from here.
• LMP Automotive Holdings Inc (LMPX) and Imara (IMRA) were my two big winners this year, both situations played out very quickly.  IMRA didn't pursue a liquidation, but rather a reverse merger, I exited shortly after that, still making a large quick gain, but missed the run up to the top by a good margin. Still working on when to sell these when day traders get ahold of them.

Performance Attribution

Current Portfolio

Current Research/Watchlist

These are companies that I'm actively researching, many I'll never buy but are currently interesting to me in one way or another, if you have strong thoughts about any of them, please reach out to swap notes, or use them as additions to your watchlist:

• STAR/SAFE, BHM, SRG, AAIC, ACEL, SCPL, ABIO, ANGN, SFE, ADMP, MBI, NWSA, TV, MACK, FPH, AIV, ILPT, CMRX, ADMP, SCU

As usual, thank you to everyone who reads, comments, shoots me an email.  I apologize if I don't get back to you quickly, but I do appreciate all the feedback, it helps me as an investor.

Happy New Year, excited to turn the page to 2023.

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 (I also have a stable/growing career, don't need this money anytime soon).  As a result, the use of margin debt, options or concentration does not fully represent my risk tolerance.

Sio Gene Therapies: Small Liquidation

In the IMRA post comments, I mentioned that Sio Gene Therapies (SIOX) (~$30MM market cap) was a likely liquidation candidate.  Sio Gene Therapies is one of the many pre-revenue biotechnology companies -- this one was originally focused on gene therapy for Parkinson's disease -- that has given up development and was pursuing strategic alternatives due to poor clinical results and/or tough capital raising conditions.  Often these broken biotechnology companies end up doing a reverse merger, but here the company never really had its own IP, they had licensed the IP from third parties and their NOLs are primarily domiciled in Switzerland where corporate taxes are low, thus limiting their value.  Other than a public shell, which isn't in much demand these days when SPACs are all liquidating and the IPO market is fairly quiet, SIOX has little value remaining outside of its cash.  This week, SIOX announced the board approved a plan of liquidation (requires shareholder approval).

The balance sheet is fairly simple at this point (9/30 10-Q):

They've already laid off most of their staff and gotten out of their office leases (no non-current liabilities are remaining), this should be a fairly straight forward liquidation.  The remaining cash burn should be limited to some remaining G&A and liquidation costs.  They do mention in the same 10-Q that "we continue to conduct one pre-clinical research and development program" but it must be small and likely easy to pause.  In addition to the above balance sheet, they do have a CVR-like payment of up to $7MM after their sale of Arvelle Therapeutics, while that's a nice lotto ticket, it also means the future liquidating trust might be around a while (unclear to me how long these milestone payments extend) which would lower the potential IRR.

The current market cap is about $30MM, versus a pretty liquid book value of $49MM ($0.66/share) as of 9/30, that gives plenty of room for G&A and liquidation expenses.  My guess (similar to a commenter in the IMRA post) is that we end up with ~$0.55/share, much of that returned early as there's really not a business here remaining.  I own a smallish/tracker position, may try to add more if it falls on a delisting, etc.

Disclosure: I own shares of SIOX

INDUS Realty Trust: Potential Offer from Centerbridge

On a quiet Black Friday, private equity firm Centerbridge Partners filed a 13D on INDUS Realty Trust (INDT) ($590MM market cap) stating they "anticipate submitting a Potential Proposal" to acquire all the outstanding shares they don't own.

Item 4. Purpose of Transaction

The Reporting Persons initially acquired the shares of Common Stock for investment purposes. From time to time since the date of original investment in the Issuer, the Reporting Persons have engaged in evaluations of the Issuer and its business, including engaging in discussions with management, other shareholders and other persons. In connection with their regular review of their investment in the Issuer, and based on current market conditions and other factors, the Reporting Persons have changed their intent. On November 14, 2022, Centerbridge determined to explore possible strategic transactions involving the Issuer, including pursuing a proposal to acquire the outstanding shares of Common Stock not currently held by the Reporting Persons (a “Potential Proposal”) and to communicate with, among others, management, the Board of Directors of the Issuer (the “Board”), stockholders and other stakeholders of the Issuer, potential acquirers, service providers and debt and equity financing sources, and/or other relevant parties regarding the foregoing. The Reporting Person may exchange information with any such persons, which may be effected pursuant to one or more confidentiality or similar agreements which may include customary standstill provisions.

While the Reporting Persons have engaged in evaluations of the Issuer and its business, including engaging in preliminary discussions, the Reporting Persons have not definitively determined to make a Potential Proposal or otherwise with respect to any specific actions regarding the acquiring, holding, voting or disposing of any securities of the Issuer. However, based on the status of their evaluation of the Issuer and its business to date and based on current market conditions, the Reporting Persons anticipate submitting a Potential Proposal to the Issuer. Any such action may be made alone or in conjunction with stockholders and other stakeholders of the Issuer, potential acquirers, service providers, debt and equity financing sources and/or other relevant parties and could include one or more purposes, plans or proposals that relate to or would result in actions required to be reported herein in accordance with Item 4 of Schedule 13D.

The Reporting Persons have not yet determined what the terms of any such Potential Proposal may be and no assurances can be given that any Potential Proposal will be made, that any Potential Proposal, if made, would be accepted or that any transaction contemplated by the Potential Proposal with the Issuer will be consummated. No binding obligation on the part of any of the Reporting Persons will arise unless and until mutually acceptable definitive documentation has been executed and delivered.

INDUS is a pretty simple REIT, they own, develop, purchase industrial/logistics properties and lease them out on a triple net lease basis.  Despite concerns that Amazon is pulling back on their warehouse spending spree, demand for industrial properties remains high and cap rates low, according to INDT CEO Michael Gamzon (from BamSEC) on their recent Q3 earnings call:

William Thomas Catherwood BTIG, LLC, Research Division – Director & REIT Analyst

Appreciate that, Michael. And can I stick with that cap rate comment that you made. Obviously, you're in a select targeted set of markets. But with the comment that the cap rates on transactions would be below kind of what the market is expecting right now, do you have a sense of how much cap rates have moved in your specific markets?

Michael S. Gamzon INDUS Realty Trust, Inc. – CEO, President & Director

Yes, I think, akin to that comment, it's really hard to pick a number because it's sort of -- there's so few deals. They just feel almost your cherry picking. I can give you an example. In Charlotte, there was a nice portfolio located near the airport. It had 3.5 years of weighted average lease term. We thought the rents were kind of 25% to 30% below market, about a 600,000 square foot portfolio. We've heard that's been awarded, went through kind of a multiple round process -- and so this is real time last month, and we've heard it's kind of a 4.2%, 4.3% cap rate, which I think feels pretty low. I'd say peak of the market, maybe I would have guessed that would be kind of a 3.8. So has that moved 40 basis points. That seems pretty tight compared to where debt spreads have widened and other things, but that's where that's traded.

We know there's been a closed deal in Savannah with not a lot of mark-to-market and 5 years of lease term that traded at a 4.25% Again, it's not a market we're in. We've mentioned in the past, we look at it, so we track it a little bit. That feels pretty low. There is a deal kind of in the Berks County, which is kind of the Western submarket of the Lehigh Valley. We feel the core of the 2 Eastern counties. But -- this is further West. So we think it's not as good a location typically is traded wide of the Lehigh Valley, and that closed, I think, 2 months ago at 4.25%.

So it's really hard to say exactly how much things have moved. Some things that are going to have a very, very long 15 or 20-year single-tenant net lease with not a lot of bumps. That's going to be typically wider, probably 100 to 125 basis points wider. These other deals are anywhere from, call it, 25 to 75, but it's really hard to put a pin on it.

Those numbers seem difficult to believe in the current market, especially when INDT's shares were recently trading with an implied cap rate in the high 6%'s, higher than where they're currently acquiring and developing new industrial/logistics properties.  With their equity trading where it is, raising future equity after completing their current pipeline (2023) seems temporarily off the table.  It makes sense that private equity would come knocking on their door, so what might Centerbridge be willing to pay?

It is a little bit tricky, because of INDT's small size and growth posture, they're growing over 20% based on their acquisition and development pipeline in the next year.  Relying heavily on their recent Q3 earnings supplement (particularly pages 23, 24 and 27):

At a 5% cap rate, again, sort of hard to believe that industrial/logistics cap rates haven't moved higher recently, I come up with ~$79/share value, or 38% higher than Friday's $57.28/share closing price.  Centerbridge initially invested in INDT during the 2021 capital raise, they know the company/asset base well and should be seen as a legit buyer.  At a minimum, maybe they're trying to put INDUS in play and Blackstone enters with their unlimited checkbook to roll INDT's assets alongside Gordon DuGan's (chairman of INDT) GPT assets he sold to BX a few years back.

I've gotten a lot of speculative M&A wrong this year so I'm not rushing to add here, but optimistic the value of INDT's real estate will be realized one way or another.

Disclosure: I own shares of INDT

Acres Commercial Realty: Trading Well Below BV, Buybacks Over Dividends

This is a similar idea to WMC, Acres Commercial Realty (ACR) ($73MM market cap) is also a mortgage REIT trading at a similar discount to book value (38% of BV)  but without the near term catalyst of a potential sale.  ACR has gone through a few name and manager changes over the years, it was originally Resource Capital (RSO), then became Xantas Capital (XAN), and following a 2020 margin call of their CMBS portfolio, current management came in and once again rebranded.  This is my third bite at the apple and is less of a short term event driven idea and more a 2-3 year transformation path back to a normal commercial mREIT.  

While ACR doesn't have the near term catalyst of WMC, the assets and balance sheet are cleaner at ACR and a majority of the cheap price can be attributed to its small size, current market conditions and lack of a dividend, the latter being the main appeal of mREITs to retail investors.  The reason ACR doesn't pay a dividend is two fold, both of which should appeal to readers of this blog: 1) since shares trade at a significant discount, management have been buying back shares, approximately $30MM worth (significant for an entity this size) since November 2020, with $10MM remaining on their authorization; 2) following the 2020 margin call, ACR has a significant amount of both net capital losses and net operating losses ("NOLs").  To monetize the net capital losses, ACR has created a side pocket of opportunistic equity real estate investments with turnaround plans that if executed should generate taxable income or gains.  Those proceeds would then be reinvested in the core business of originating and holding transitional commercial real estate loans.  The tax asset is valued at $21.6MM (again, meaningful for an entity this size), but has a full valuation allowance against it on the balance sheet.  Once the tax assets are soaked up and the shares trade closer to book value, the REIT will turn the dividend back on and retail investors should return.

ACR lays out the tax monetization strategy in one of their slides, but this doesn't include the potential for more accretive buybacks.  Shares currently trade for $9.26 vs. $8.19 below and I wouldn't count on it trading for book ($24.48) anytime soon, but the math they layout is quite attractive.

ACR's core business is originating and holding "transitional" commercial real estate loans, this typically means ACR will help a developer or investor finance a value-add property, the equity owner will execute on their plan over a couple year period and then will refinance the property at stabilization, taking out ACR's loan in the process.  Over 3/4ths of ACR's loans are to multi-family properties, I remain reasonably bullish on this sector, at least from a lender's perspective.  With interest rates increasing, potential new homeowners will be stuck renting for a few more years and ACR's heavy concentration to FL and TX (44% between the two) should have continued demographic tailwinds as people/businesses migrate to sunny skies and lower cost of living geographies.  If multi-family properties do get hit, ACR does have a reasonable equity cushion below each loan with a weighted average loan-to-value of 72%.  ACR's loans are floating rate, thus should have minimal duration risk, although as rates continue to increase, that added interest expense borne by their borrowers will start to increase credit risk at a certain point.

To fund their loans, ACR predominately relies on the CRE CLO market.

Newly originated loans are placed in the "CRE - term warehouse financing facilities" and once of sufficient size, they'll raise longer term CRE CLO financing (also floating rate) and transfer the warehoused loans into the CRE CLO.  ACR retains the junior bonds and equity of the CLO.  CLOs are great because they're not mark-to-market vehicles and give the manager flexibility to repurchase problem loans inside the SPV to avoid any tests failing that would cause cash flows to be diverted from junior tranches.  During the height of covid, CRE CLOs continued paying all noteholders and no test failures occurred, unlike in the CMBS market where the collateral has an observable mark and was financed via repurchase agreements that were marked-to-market daily.  The CRE loans inside ACR's CLOs are whole loans that are not syndicated and don't have live marks available on them.  ACR is likely still being punished for 2020, but the manager is gone and the CMBS assets that cause the blow up are gone too.  The CLOs originated by the old manager all performed fine.

There is an external manager here, Acres Capital, with a fairly traditional mREIT fee agreement that includes a base fee of 1.5% of equity and 20% of earnings above a 7% hurdle, that's not great, but they otherwise seem to be doing the right thing even if it goes against their incentive in the near term (like buying back a significant amount of stock).  One thing I don't like about the fee agreement, the manager receives 25% of their incentive fee paid in stock, at this discount that's highly dilutive to minority shareholders.  But overall, they own 6+% of the company and seem to be reasonable corporate stewards.  There is also the presence of two sophisticated credit investors which is a plus, Oaktree remains a significant shareholder following the 2020 bailout with 9% and First Eagle Credit Management (large CLO equity investor, they manage ECC which owns CLO equity and bonds) with 12.5% of common, plus a good slug of the preferred stock (check those out if you like yield).

Most of the commercial mREITs are trading at a discount to book value in today's market, the best of breed like Starwood Property Trust (STWD) and Arbor Realty (ABR) trade right at book, but even the small cap external peers like NexPoint Real Estate Finance (NREF) and Lument Finance Trust (LFT) trade for about 2/3rds of book (both pay a low double digit dividend), putting the same multiple on ACR would be about 75% upside.

Disclosure: I own shares of ACR

Applied Genetic Technologies: No Deadline CVR

It has been a while since I've dipped a toe into the CVR ("contingent value rights") pond, full disclaimer, I've only had one payout in the last 7-8 years, these normally don't work out.  But Applied Genetic Technologies (AGTC) ($25MM market cap) is an interesting situation because it has two buckets of CVR payments with attractive twists: 1) the miscellaneous AGTC assets the acquirer doesn't want that have values you can point to on AGTC's balance sheet; 2) your traditional FDA approval and sales milestones style payment thresholds but without a clock or deadline that often have the appearance to be gameable by CVR counterparties.

AGTC is the typical clinical-stage biotechnology company that relies on open capital markets to fund its development program, with current tight market conditions and their liquidity quickly draining, AGTC announced Monday it is being acquired by Syncona (LON: SYNC) for $0.34/share plus a CVR.  The alternative was bankruptcy as the company has near term debt and only had a cash runway through the end of the year.  AGTC's area of focus is gene therapy treatments, primarily for a rare eye disease, X-Linked Retinitis Pigmentosa ("XLRP"), that approximately 20,000 people suffer from in the U.S. and Europe.  No approved treatments exist for this condition.  In May, the company reported positive clinical results for their AGTC-501 product (positive based on their press release, I have no expertise to be able to confirm), but they don't have the resources to continue development themselves.  This *might* be a non-zero value asset that is just caught up in a terrible biotech capital raising market, Syncona is at least making that bet.

The shares currently trade for $0.37/share, a $0.03 premium (8%) to the $0.34/share cash consideration.  There's no financing condition, the buyer is real, the deal is scheduled to be a quick close (via a tender that launched tonight), now its just time to look at the CVR (link to the agreement) which has 4 potential milestone payments:

Milestone 1. Parent will be obligated to pay up to $12.5 million, in the aggregate, upon the (a) sale, license, transfer, spin-off of, or the occurrence of any other monetizing event, whether in a single or multiple transactions, involving, all or any part of the Non-RPGR Assets (as defined in the CVR Agreement), (b) the sale or transfer of the Bionic Sight Equity (as defined in the CVR Agreement) and/or (c) the sale, lease or transfer of the Manufacturing Assets (as defined in the CVR Agreement), in each case, that closes on or prior to the date that is eighteen (18) months after the date of the closing of the Merger. The aggregate amount payable in connection with such milestone will be equal to the amount by which the sum of (i) 60% of the Gross Proceeds (as defined in the CVR Agreement) attributable to the Non-RPGR Assets and/or (ii) 100% of the Gross Proceeds attributable to the Bionic Sight Equity and/or (iii) 100% of the Gross Proceeds attributable to the Manufacturing Assets (reduced by the amount of certain taxes and expenses as more particularly described in the CVR Agreement), collectively, exceeds $5.0 million;

Milestone 2. Parent will be obligated to pay an aggregate amount equal to $12.5 million upon obtaining U.S. Food and Drug Administration (the “FDA”) approval of a Biologics License Application (BLA) for AGTC-501 to treat patients with XLRP caused by mutations in the RPGR gene, as evidenced by the written notice of such approval by the FDA, which approval (a) must be consistent with the patient population, at a minimum, as established by the inclusion/exclusion criteria of patients studied in the pivotal clinical trial, (b) may be subject to conditions of use, contraindications, or otherwise limited, and (c) may contain a commitment to conduct a post-approval study or clinical trial (the “Marketing Approval”);

 Milestone 3. Parent will be obligated to pay an aggregate amount equal to $12.5 million if, as of the date of the Marketing Approval, no other AAV gene therapy product expressing the RPGR protein (including any derivative or shortened version of the RPGR protein) has received a marketing approval from the FDA; and

Milestone 4. Parent will be obligated to pay an aggregate amount equal to $12.5 million the first time that Net Sales (as defined in the CVR Agreement) of AGTC-501 in any calendar year is equal to or exceeds $100.0 million.

For simplicity, putting these in my own words, the first one is if Syncona decides (unfortunately I don't see anything that forces them to try) to monetize the non eye disease assets of ATGC.  These non-core assets include a 15.2% stake in Bionic Sight (partner in their optogenetic program) which is on the balance sheet for $7.8MM, ATGC's Manufacturing Assets, which I read to mean their $4.7MM in PP&E, plus other early stage programs that AGTC has abandon/paused.  If the total is more than $5MM within 18 months of closing ("Milestone 1 Deadline Date"), the CVR holders receive 100% of the excess for Bionic Sight/Manufacturing Assets and 60% of the excess for the other pipeline assets.  Some big "ifs" ahead, but if Syncona sells the assets in Milestone 1, and if they go for their book value (attributing no value to the other pipeline assets), that equals $12.5MM, or $7.5MM ($0.11/share) in excess of the $5MM threshold to CVR holders.  That would more than cover the $0.03-$0.04 the market is valuing the CVR above the $0.34 cash consideration.

The other three milestones are typical FDA approval and sales related, interestingly, combing through the CVR Agreement, they don't appear to have a termination date other than:

7.8 Termination. This Agreement shall be terminated and of no force or effect, the parties hereto shall have no liability hereunder (other than with respect to monies due and owing by Parent to Rights Agent), and no payments shall be required to be made, upon the earlier to occur of (a) the payment of the full amount of each potential Milestone Payment required to be paid under the terms of this Agreement, (b) the termination of the Merger Agreement in accordance with its terms and (c) the final determination that no further Milestone Payments will ever be payable under of this Agreement. Notwithstanding the foregoing, no such termination shall affect any rights or obligations accrued prior to the effective date of such termination or Sections 2.4(e), 3.2, 7.4 to 7.8 and 7.11, which shall survive the termination of this Agreement, or the resignation, replacement or removal of the Rights Agent.

There is a "Milestone 1 Deadline Date" but no corresponding ones for milestones 2-4.  This leads me to believe there isn't one, that is it open ended intentionally and doesn't allow Syncona the option to slow roll the development of AGTC-501 to reduce their CVR liability.  The total payout if all milestones are met is $0.73/share, to be clear that's highly unlikely to happen, but it seems like a lottery ticket worth taking given the structure of the CVR and the quick close on the deal.

Disclosure: I own shares of AGTC

Western Asset Mortgage Capital: Trading Well Below BV, Exploring a Sale

Western Asset Mortgage Capital (WMC) ($56MM market cap) was one of the mortgage REITs caught up in the margin call wave of 2020 when otherwise safe mortgage back securities ("MBS") suddenly went no-bid.  Mortgage REITs often financed their MBS with daily mark-to-market short term financing, when MBS prices suddenly dropped (they would later recover), financing counterparties forced liquidations and significant shareholder value evaporated in the process.  WMC did survive, but in a wounded and subscale form.  Around the end of last year, they started to transition their portfolio away from commercial mortgages to residential mortgages, primarily in Non-QM loans (financed via RMBS under the Arroyo branded shelf).  Non-QM is short for non qualifying mortgages, those that aren't eligible to be purchased by the GSEs, most of these are actually to prime borrowers (746 average FICO) but those borrowers don't have regular W-2 income to meet tighter post-GFC mortgage underwriting standards.

Getting straight to the point, WMC trades for $9.35/share despite having an economic book value of $24.58/share, or WMC is trading at just 38% of book.  Their book value will likely come down a fair amount when they release Q3 earnings due to rates rising and spreads widening since 6/30, but it should still be very cheap to its net asset value.  WMC is managed by large fixed income specialist Western Asset Management, they've already cut their fees 25% for 2022, have no chance of raising additional capital to regain scale, and are thus waving the white flag by announcing they've commenced a strategic alternatives review process.  It is likely just not worth Western Asset's time at this size (their management fee is based on equity, not assets).

Here is WMC CEO Bonnie Wongtrakool discussing the rationale in their Q2 earnings call:

The primary way to achieve scale as a mortgage REIT is to issue additional common equity, but our philosophy and practice has been to conduct equity offerings only at such times when they have not been materially dilutive to existing shareholders. The last time we issued any meaningful amount of equity was in the second quarter of 2019, when we raised nearly $50 million, which was done at a modest discount to our book value at that time.

Unfortunately, when COVID hit the following spring, our portfolio experienced a significant decline in value and our stock price experienced an even greater decline relative to book value. Since then, our overarching goal has been to improve and stabilize our future earnings power.

Over the last two years, we have made significant progress by taking actions to improve our liquidity and balance sheet and by shifting our investment focus towards residential real estate. Nonetheless, we do not see these positive actions being reflected in our stock price. Therefore, we believe that yesterday's announcement regarding our decision to review strategic alternatives is the best path forward towards unlocking shareholder value, and we are committed to analyzing alternatives that may involve a sale, merger or other transaction involving the company.

I'm always a little skeptical of externally managed mREITs looking to sell themselves, sometimes it means they're simply selling the management contract to another asset manager that will just rebrand and the discount to NAV won't close much.  But here the discount is so wide and the language sounds slightly more focused on shareholders.  There is likely some middle ground in between the share price and book value to get a deal done that pleases all three parties: 1) WMC shareholders get some premium to current prices; 2) Western Asset rids themselves of the distraction and receives some value for their management contracts; 3) one of the countless potential acquirers gets a publicly traded permanent capital vehicle or a current mREIT gets some additional scale and fees for their manager.

Similar to LMPX, this is a completely commodity/fungible type business or balance sheet that trades hands regularly, even in this currently strained M&A market, a willing seller (which sounds like they are) should find no problem finding plenty of willing buyers.  Most likely this will be a stock-for-stock deal or reverse merger with a non-traded REIT, so the upside won't be as big as a liquidation or cash deal, but still an attractive risk/reward.  My best guess is $12-14/share in value.

Other thoughts:

• Their balance sheet is a mess and difficult to untangle.  For example, one of their legacy commercial investments is a mezz tranche of the Mall of America CMBS (CSMC Trust 2014-USA) and due to accounting rules, WMC actually consolidates the entire SPV.  WMC's economic exposure is $10.7MM, but they consolidate the $1.4B in liabilities on their balance sheet.  Mall of America's future is certainly cloudy, they did restructure the loan during the pandemic, but as an important tourist attraction for the Twin Cities MSA, I would expect it to get political support to survive as a destination/entertainment mall.  In 2020, alongside the restructuring, Trep did put a $1.9B value on the mall, for whatever that's worth.
• They also have one big problem CRE loan, "CRE 3" in their disclosures which is described as an entertainment/retail property in New Jersey.  I couldn't find it in their disclosures, but it wouldn't surprise me if that was the troubled American Dream mall as it shares ownership with Mall of America.  CRE 3 has been in non-payment status for about a year, if WMC needs to write down the full value of the loan, that knocks about $4/share off the book value.
• Their Non-QM loans are highly concentrated in California, about 2/3rds.  LTVs look good (originally 65% at the time of underwriting) at the current moment, but we're early in any housing correction and California typically exhibits higher price volatility than other markets.  WMC disclosed that about 15% of their Non-QM loans have near term rate resets (these are ARMs) that will slightly help offset the price pressure of higher rates.

Disclosure: I own shares of WMC

Mereo BioPharma: Activist Proxy Fight

Back in the March 2019, I wrote up the merger between U.K. based Mereo BioPharma (MREO) (~$100MM current market cap) and OncoMed Pharmaceuticals (formerly traded as OMED) as a way to play the contingent value rights that were issued to OMED shareholders.  The CVR part of the thesis hasn't worked out, at least yet, there are still potential milestones on Navicixizumab in play before the CVR expire on 4/23/24.  Since closing out that trade (I received MREO shares in the merger but sold immediately at $5.30, shares trade for $0.95 today), I've checked in on the company occasionally as the CVRs naturally have Mereo counterparty risk.  On the most recent of those check ins, I came across two Seeking Alpha write-ups (here and here) by Dalius Taurus of SSI that piqued my interest.

Mereo BioPharma has six product candidates, four purchased from larger biopharmaceutical companies (Novartis and AstraZenca) that previously received considerable investment in the pre-clinical stage but were no longer strategic priorities and two product candidates inherited from the OncoMed acquisition.  MREO's market cap is approximately $100MM (MREO trades as an ADR, each MREO share equals 5 ordinary shares) and last reported a cash balance of $105MM (current conversion rate, MREO reports in GBP) as of 2021 year end, after some cash burn, it likely has a small positive enterprise value.  

Similar to most pre-revenue biotechs these days, Mereo's investors have lost their patience funding development pipelines, Rubric Capital (~14% owner) has stepped up as an activist to stop the cash burn by attempting to reconstitute the board of directors.  Rubric has its eyes on gaining control of the board, then monetizing assets and returning cash to shareholders in what amounts to a liquidation.  Rubric is run by David Rosen, who was a portfolio manager at SAC Capital (now Point72) before going on his own in 2016.  It just so happens that the second largest MREO shareholder is Point72 with 8.6%, likely friendly to Rubric, further increasing the likelihood that Rubric gains board seats in the proxy campaign as the current board/management owns an insignificant amount.

Below is the back of the envelope valuation math provided by Rubric in their 6/9/22 letter:

I have little way of confirming or refuting their valuation, but even if they're wrong by half the stock is approximately a double from here.  Mereo's most valuable asset according to Rubric is their partnership with Ultragenyx (RARE) on Setrusumab (originally purchased from Novartis) which is a treatment for a rare bone disease, osteogenesis imperfecta ("OI"), that currently has no approved therapies.  Mereo retained the commercial rights for Setrusumab in the UK and Europe, otherwise Rubric is ascribing no value to Mereo's other product candidates, including Alvelestat which is a treatment for a rare lung disease undergoing clinical trials.

Alvelestat is the one product candidate that came from AstraZenenca (AZN). In June, which to be fair is a lifetime ago in this market, The Times of London reported that AZN was considering a bid for MREO:

Word is that it is considering a bid for Mereo Biopharma, a specialist in cancer and rare diseases.

Mereo, which has developed a portfolio of six clinical-stage product candidates, is based in London but listed on the Nasdaq exchange in New York and lists AstraZeneca among its partners alongside Novartis, OncXerna and Ultragenyx. There are suggestions that at least one other suitor, possibly another partner, may also be on the prowl.

Shares in Mereo have been a stinker, shedding almost 80 per cent of their value in the past year, although they jumped by 8.5 per cent to 69 cents on Wednesday, valuing the company at $81 million. Analysts have an average target price of $7 and the talk is that Mereo would accept $5, equating to $500 million including American depositary receipts or ADRs. Evercore and Citigroup are said to be involved as advisers.

This article came out around the same time as the Rubric letter, they might be related, or it might be coincidence.  Even if the Setrusumab valuation is overstated, there might be other assets worth something here.  Rubric and Mereo's management have been going back forth on Rubric's request for a special meeting, Mereo seemingly was citing every technicality why Rubric's request was ineligible but eventually relented and the special meeting is now set to happen sometime in November.  It appears that a new board will be put in place shortly, we'll see what happens from there.  I bought a small position.

Disclosure: I own shares of MREO and some non-tradable OMED CVRs

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.

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

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

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

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

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