Friday, December 29, 2023

Year End 2023 Portfolio Review

Markets have seen quite the rally in the past two months, my portfolio followed along, pulling my returns for 2023 up to 38.54% for 2023 versus 26.29% for the S&P 500.  My lifetime-to-date IRR is currently 22.47%, which continues to be above my 20.00% goal.  
Despite the good year, I'm still below my high water mark due to a disappointing 2022.  I admire anyone that invests professionally through volatile markets, my returns wouldn't be as good if I was managing outside capital.

Updated Thoughts on Current Positions
As usual, these brief updates were written over the past two weeks, share prices might have moved around a little, but hopefully still directionally relevant.  Excuse the inevitable typos.

Broken Biotech Basket:
  • Homology Medicines (FIXX) has been the laggard in the broken biotech basket, in November the company announced a reverse merger with Q32 Bio, a private biotech focused on the treatment of severe alopecia areata and atopic dermatitis, hair loss and a skin condition respectively.  The transaction assigned an $80MM ($60MM of cash, $20MM public listing) to FIXX exclusive of their legacy assets, which equates to roughly $1.38/share compared to the current share price of $0.55/share.  The cash at closing is expected to be $115MM, pre-merger FIXX shareholders will own 25% of the post-merger company, or roughly $0.50/share in cash.  It is not unusual in the current market for the enterprise value of a pre-revenue biotech to be near zero, but in addition to the NewCo, FIXX shareholders will get a CVR for the monetization of any legacy assets.  There's reason to believe that the CVR will have some value, FIXX's IP had initial positive Phase 1 results, but the data is still "immature and inconclusive".  Plus there's the JV, OXB Solutions, that will be put to Oxford Biomedia Solutions for 5.5x TTM revenue by March 2025.  My current plan is to hold through the reverse merger, maybe the name change, upcoming Phase 2 study data readouts (second half of 2024), conferences/investor reach out, etc., will encourage traditional biotech investors to rotate into the stock providing a slightly better exit.  And I'm bullish on the CVR, it'll act as a liquidating trust, Q32 Bio needs to use "commercial reasonable efforts" to dispose of the legacy assets.
  • Graphite Bio (GRPH) is a similar situation, they also announced a reverse merger in November, this one with LENZ Therapeutics, LENZ has a late stage product candidate for treating near sightedness that is expecting a Phase 3 read out in the second quarter of 2024.  GRPH shareholders will receive approximately a $1/share special dividend at close (targeted for Q1) plus will own 30.7% of the post-merger LENZ.  Post-merger LENZ is expected to have $225MM in cash after close (there's a $53.5MM PIPE), equating to another ~$1.20/share of cash per GRPH share.  GRPH currently trades at $2.33/share, giving it only a slightly positive enterprise value, seems cheapish for a biotech with a near term catalyst in a big addressable market.  I'll likely hold onto the stub and see what happens.
  • AVROBIO (AVRO) announced strategic alternatives in July and is still determining its next steps.  As of 9/30, the company has ~$100MM of NCAV, assuming another $10MM of cash burn (they further reduced their workforce in October) before a deal can be commenced would equate to $2/share of value without any value attributed to their IP.  AVRO sold one of their programs to Novartis for $80+MM, the other, HSC gene therapy for Gaucher, might have some value as a kicker.  Shares currently trade for $1.32/share, making it an attractive risk/reward.
  • Pieris Pharmaceuticals (PIRS) ran up quickly after my initial write-up, I took profits, but then it fell and I re-entered, a little too early in hindsight as shares have dropped roughly in half since.  As of 9/30, PIRS had $30.5MM in net current asset value, or $0.31/shares versus a current share price around $0.15/share.  That number doesn't include a number of IP assets and possibly valuable partnerships, but with limited cash on an absolute basis, they'll need to move fairly quickly.  Pieris did just terminate their operating lease, often a precursor to a deal announcement.  This one is on the riskier side, but could be interesting if you see any value in their hodgepodge of IP.
  • Sio Gene Therapies (SIOX) is a liquidation that's now a dark stock.  One reader has been keeping better tabs on the liquidation than me (see the comments), apparently they have two of their three subsidiaries liquidated and should have the third done soon.  The expected initial distribution in the proxy statement was $0.38-$0.42/share versus a current price of $0.37/share.  It's been an annoying wait with limited-to-no public disclosure, which is one of the downsides of investing in liquidations, you need to have a certain personality quirk to set it aside in the meantime.  Hope this liquidation is put to bed soon.
  • Cyteir Therapeutics (CYT) is in the final stages (as we've seen with SIOX, could last a while) of its corporate life, shareholders approved the liquidation plan on 11/16/23 and now we await timing of the liquidation distribution which is estimated at $2.92 to $3.31/share in the company's proxy.  Liquidation estimates tend to be conservative and this appears to be a cleaner situation than most as CYT is only holding back $500k for a reserve account.  Shares trade at $3.09/share, I likely wouldn't buy it today, but content to hold awaiting the liquidation distribution.
  • Kinnate Biopharma (KNTE) and Theseus Pharmaceuticals (THRX) are in similar situations to each other where Foresite and OrbiMed, as a group, have indicated plans to make an offer for each company.  Presumably the structure would result in a cash buyout for a discount to net cash plus a CVR for any IP value, similar to Pardes Biosciences (PRDS) which Foresite took private earlier in the year.  Both stocks trade for only a slight discount to my best guess of a take private offer (5-15% upside on each), but it's worth keeping an eye out for other biotechs where these two are involved as they pop up.  Late breaking news, on the Friday before the Christmas holiday weekend, Theseus announced they reached an agreement with Kevin Tang's Concentra Biosciences for $3.90-$4.05/share in cash, plus a CVR for 80% of legacy asset sales proceeds and 50% of synergies.  I'm a bit surprised that it was Tang versus Foresite/OrbiMed but hopefully that means well for Kinnate.
  • Eliem Therapeutics (ELYM) is a new addition to the basket, nothing too much has changed since that write-up.
  • Reneo Pharmaceuticals (RPHM) received an offer from Kevin Tang's Concentra Biosciences for $1.80 per share plus a CVR for 80% of any legacy asset sales.  Considering the company has not yet declared strategic alternatives formally, I think it might be some time before we here an official yes/no response to the offer or an alternative deal.  But with Tang tossing in a cash offer early, maybe it is less likely Reneo chooses the reverse merger path.
Esperion Therapeutics (ESPR) is a broken biotech adjacent idea, unlike the others, this is a revenue generating company that has a non-satin commercial product (Nexletol) for cholesterol.  Esperion is locked in a lawsuit with their primary commercialization partner, Daiichi Sankyo, over a disputed milestone payment tied to the amount of "relative risk reduction" for heart attacks and other cardiovascular diseases/events that was reported in the company's CLEAR Outcomes Study.  Esperion has a PDUFA date set for 3/31/24 that would expand the label of their primary asset to include cardiovascular risk reduction and a trial start date of 4/15/24 with Daiichi Sankyo.  This remains a speculative idea, but could be a multi-bagger if both catalysts go their way in the first half of 2024.

Mereo BioPharma (MREO) is more of a regular-way biotech, the original thesis revolved around Rubric Capital taking an activist stance and gaining board seats with a general plan to realize the sum of the parts valuation of MREO's hodgepodge of programs.  No publicly disclosed progress has been made in that regard, but the company did report positive Phase 2 results for Setrusumab in patients with osteogenesis imperfecta with partner Ultragenyx (RARE) that boosted the stock.  Following the announcement, Rubric Capital has been a consistent buyer of MREO shares, giving confidence that their plan is working out.

Albertsons (ACI) and previously unmentioned Spirit Airlines (SAVE) are two well covered merger arbitrage situations that don't necessarily need more inked spilled on them.  I'll use this post as a thank you to Andrew Walker and his wonderful Substack/Podcast, he really ramped up coverage on Spirit as the market became increasingly nervous in early November dropping the shares into the low $10s/share.  I picked some up and the market has bid up shares since awaiting a ruling any day now in their anti-trust case with the U.S. government.  Albertsons is facing similar push back, regulators are pointing to local market monopolies similar to Spirit, although I still believe the asset divestiture and any further divestitures should be able to create a compromise situation given Albertsons and Krogers general lack of national overlap.

MBIA (MBI) is a bond insurance company that has been in runoff for many years now.  It has confusing accounting due to a GoodCo/BadCo structure hiding the value of the GoodCo in their consolidated financials.  My original thesis centered around MBIA putting itself up for sale, but as rates increased (this company is also very interest rate sensitive due to their bond investment portfolio) and the Puerto Rico Electric Power Authority ("PREPA") restructuring continuing to drag on, the company paused the sale process since they presumably weren't getting anywhere near management's adjusted book value of $27/share.  At the start of December, shares were trading under $8/share, then some lucky news hit that National Public Finance Guarantee Corporation (the GoodCo) was dividending up to the parent $550MM in a special dividend.  Much of which was then going to be distributed to MBIA shareholders in an $8/share dividend, more than the shares were trading at the time.  Post special distribution, the company should have a book value of ~$11-12/share ex-BadCo and ~$19/share if you use management's adjustments and back out the unrealized losses on their investment portfolio and add in their unearned premiums.  On the 11/3/23 Q3 earnings call, CEO Bill Fallon (presumably knowing the National dividend was a possibility/probability) said, "With regard to the strategic alternatives, as we've suggested in the past, we think the optimal transaction would be a sale of the company."  With shares current trading for $6/share, there's still room for a healthy premium for MBIA shareholders and a discount to book for an acquirer.  Absent a deal, if rates do indeed come down and municipal credits remain strong, MBIA can continue to limp along in runoff, returning capital via either repurchasing shares or potentially more special dividends in future years.  I lost a fair amount on some call options speculating on a takeout earlier in the year, I won't make that same mistake with MBI today, but I continue to hold.

HomeStreet (HMST) is a regional bank based in Seattle that also does a lot of business in southern California, which was caught up in the deposit flight crisis last spring.  I bought it after a Bloomberg article suggested the company was exploring a merger or an asset sale, later we found out that several bidders have made offers for the company's DUS business line (a license that allows them to directly originate Fannie Mae commercial loans), but the company has thus far not been agreeable to a sale.  HomeStreet's deposits costs have risen dramatically, squeezing net interest margin, they've cut expenses, and reduced loan originations to the point where they could be classified as a zombie bank.  A full out sale is highly unlikely here in the near term, any acquirer would be required to mark-to-market HomeStreet's balance sheet, which currently would have negative equity value due to the current value of their loan portfolio (rate driven, not credit driven, yet).  Without the DUS asset sale as a catalyst, this bank is one big bet on lower interest rates, indeed in the last few weeks, shares have spiked back above $9/share.  Tangible book value is $26/share (ex-loan fair market value), if rates decline enough over the next year or two, HomeStreet will limp along until the accounting is satisfactory enough where they become an acquisition target by someone with a stronger deposit franchise.  That's a bit of thesis drift for me and I have plenty of interest rate risk elsewhere in my portfolio, so I might exit this position for future new ideas.

First Horizon (FHN) is a mid-to-large sized regional bank that does most of its business in the southeastern United States.  It came on my radar when their sale to TD Bank was terminated after regulators made it clear they were penalizing TD for previous anti-money laundering wrongdoings by not approving the merger.  The deal broke towards the tail end of the regional bank panic earlier this year and FHN sold off hard as arbs exited and market participants were unsure if the regional bank model was even sustainable anymore.  Six months later, things have calmed down considerably for banks, deposit costs are still rising but with the Fed about to pivot, many bank board rooms are breathing a sigh of relief.  First Horizon is a solid franchise, footprint has good demographics (although I've seen some stories about multi-family overbuilding in Nashville), minimal mark-to-market losses and strong capital ratios to the point where management has signaled plans to return cash to shareholders next year by repurchasing shares.  On the negative side, the bank had a surprise loan go bad for $72MM (Yellow maybe?) and they've got some expense ramp happening as FHN modernizes its technology stack.  Today it trades at $13.80/share, tangible book value is $11.22/share, a target valuation of 1.5x book still seems reasonable, which would yield a $16.83/share target price.  I'm content holding until we get a bit closer to that number, maybe get long-term capital gains tax treatment too.

Banc of California (BANC) is another regional bank that closed on their transformational merger with PacWest (PACW) after the former got caught up in last spring's banking crisis.  Following the merger, Banc of California should have a tangible book value around $14.25/share compared to the current share price of $13.43/share (0.94x book), with earnings guidance of $1.65-$1.80/share (12% ROE, sub-8x earnings).  My thesis continues to be that there will be significant realized synergies as the two banks had significant overlap which will become more apparent in 2025 earnings.  Until then, the bank is in pretty decent shape after an equity injection, low 80s loan-to-deposit ratio and sub-4% office exposure.

CKX Lands (CKX) is a micro cap (~$25MM) land bank in Louisiana where management is potentially looking to take it private (management hasn't said this explicitly, but the company is exploring strategic alternatives) as plans advance for a carbon capture sequestration plant on or near CKX's land.  Historically, CKX has generated revenue from timber sales, oil and gas royalties and other miscellaneous land fees.  The rock underneath CKX's land is porous rock that makes it suitable for carbon capture sequestration technology, which is essentially means collecting the pollutive output of the area's numerous refineries and piping it back deep into the earth.  If a sequestration plant is constructed on CKX land, the company would be entitled to a revenue share, management might be trying to get ahead of that event by taking the company private.  This article provides a great overview of the sequestration opportunity and mentions CKX CEO Gray Stream quite a bit.  I don't have a great sense of what the fair value is for CKX, but others more familiar with the situation have put an $18/share value of it, today it trades a bit under $13/share.

MRC Global (MRC) is a distributor focused on natural gas utilities, energy transition projects and servicing the upstream oil & gas industry.  No MRC specific news has really come out since my write-up, so it still holds up fairly well, the macro backdrop has improved a bit as LBO financing conditions have improved.  The company needs to refinance a term loan that comes due in September, the preferred shareholder is blocking any contemplated refinancing that wouldn't include taking them out, I still think a sale should work well for all sides here and is likely to happen.

Green Brick Partners (GRBK) is a homebuilder with a land development heavy model that continues to outperform, turning on its head the value investor idea that an asset-lite homebuilding model is necessary to succeed in this cyclical industry.  Count me as surprised too how their land sourcing and infill location model has continued to be a sustainable competitive advantage (key man risk with Jim Brickman?), but with migration trends continuing to be a tailwind for their Dallas and now Austin markets, their growth should continue.  GRBK currently trades at a reasonable 7.5x NTM earnings according to TIKR estimates and has $121MM remaining on their share repurchase plan.  I cut back on my position during the year, but still have confidence in Green Brick's medium-to-long term future although not necessarily an actionable idea today.

Acres Commercial Realty Corp (ACR) is a commercial real estate bridge lender, primarily to multi-family properties, but also a smattering of office, hotel and retail.  The market is particularly worried about lenders like ACR, they lend to developers/sponsors who are repositioning a property, which upon stabilization will then obtain long term financing to take out ACR's bridge loan.  Banks have pulled back, no one wants to extend new loans to office in particular, but multi-family also has some fears of covid induced overbuilding, the pull back in financing itself could cause a sinkhole in CRE asset value.  If the sponsor is unable to obtain new financing, ACR might be handed back the keys.  The formation of ACR was basically sponsored by Oaktree, the distressed specialist, my inclination is their loan book is stronger than the average commercial mREIT as a result.  ACR additionally is the odd REIT that doesn't pay a dividend, which gives them flexibility to plug credit holes or as they recently announced, return cash to shareholders via a share repurchase program.  Shares have rallied with the repurchase news and Fed pivot, but at $9.80/share, it still trades at a massive discount to book of ~$25/share.

Howard Hughes (HHH) is a real estate developer effectively controlled by Pershing Square's Bill Ackman, he has been a consistent buyer of shares this year as the stock has traded around $80/share in recent months.  With rates increasing, new commercial development has slowed at Howard Hughes, plus one of their main products in new office is all but dead for the next decade or so.  Even if commercial development slows in the near term, their land sales should be strong in the near term as homebuilders are increasing their activity to meet demand.  Absent some kind of Ackman take-private, the near term catalyst for HHH is their upcoming spinoff of Seaport Entertainment which will house the disastrous Seaport segment (much of which they operate themselves), the Las Vegas Aviators (presumably the stadium too, but they need lender approval) and the Fashion Show air rights.  They've hired Anton Nikodemus to be the CEO of Seaport, he previously was an executive at MGM where he ran the CityCenter properties and was instrumental in the development of MGM National Harbor and MGM Springfield.  Presumably that means they're finally serious about utilizing the Fashion Show air rights, but with several large new strip casinos coming online this year, their timing might not be right.  My initial reaction is the spin is a positive development, it'll remove the Seaport cloud from the pure play real estate assets, although I question how Seaport will be funded/financed.  The Aviators ballpark provides a nice steady revenue stream, but not enough to cover further Seaport losses, let alone develop their planned 250 Water St tower or a new Las Vegas strip casino.  I'll likely do a deeper dive once the Form 10-12 comes out on the spin.

DigitalBridge Group (DBRG) is in the final stages of its transition from a diversified REIT to a pure play asset manager focused on the digital infrastructure industry.  Continually increasing rates in 2023 were initially a negative for DigitalBridge as many of their portfolio companies were purchased at low entry cap rates, but the company was saved a bit by the artificial intelligence trend that has continued the need for data centers and other digital infrastructure assets.  This remains a bit of a jockey bet on CEO Marc Ganzi, he's a talented fund raiser, but he is losing his number 2 in CFO Jack Wu who is moving on to lead his own investment organization.  I don't have much to add to the discussion on DBRG, content to hold a while longer to see the full transition from a balance sheet play to an income statement story, we're still probably 1-2 years away from that being complete.

Transcontinental Realty Investors (TCI) is a heavily controlled real estate company that primarily owns multi-family properties in the sunbelt, but does have a smattering of office and land development projects as well.  This year was pretty quiet for TCI, they did start developing two new apartment complexes (one in FL, the other in TX), but otherwise simply deleveraged their balance sheet after the previous transformational Macquarie JV sale in 2022 (which in hindsight was very well timed, sold near the very top).  The recent proxy statement had two interesting proposals, one put forth by management that would clear some red tape in merging the Russian doll structure with ARL and IOC and another from a shareholder asking the company to hire an advisor and pursue strategic alternatives.  The shareholder proposal naturally failed since TCI is 85% owned by the controlling family.  But seems like there might be some movement in cleaning up the structure, it is still a bit puzzling why TCI is public, management does have an external management agreement, but it really only applies to the 15% of stock that is held by the public.  With NAV arguably over $100/share and the stock trading for $35/share, there's a lot of room for minority shareholders to be happy and management to transfer significant value to themselves in a take-private deal.  I had an outsized position in TCI to start the year, did trim my position by a third, content now to wait a year or two longer for a corporate action to happen here.

NexPoint Diversified Real Estate Trust (NXDT) is formerly a closed end fund that 18 months ago converted to a REIT.  Unfortunately, this story has been very slow to develop, not much has happened here post conversion, the REIT continues to be a confusing mess of limited partnership stakes, many of which are with related parties, and limited investor outreach to simplify the story.  Rising rates didn't help NXDT and its valuation has suffered, trading around $8/share today versus a $23.89/share reported NAV (as of 6/30) or a $22/share tangible book value.  CEO James Dondero (a controversial figure) continues to buy shares via funds he manages, personally and is taking their management in shares (although that's a bit of a negative given where the shares trade), all bullish signs for the underlying value compared to trading price.  The REIT doesn't cover its dividend with AFFO, it recently started paying 80% of the dividend in shares, I'd rather see them cut the dividend to zero and build some liquidity, only paying a special dividend necessary to comply with IRS REIT regulations.  In summary, it is just odd that NXDT doesn't publish press releases, conduct earnings calls or do the typical REIT conference circuit investor presentations.  All things I would have assumed they would do considering how they manage NexPoint Residential Trust (NXRT).  Similar to TCI, I'm willing to give management here another year or two to see what develops, but my confidence is lower than when I first bought into the idea.

Par Pacific Holdings (PARR) is a downstream energy company with refining, midstream and retail locations in geographically niche areas in the Rockies, Pacific Northwest and Hawaii.  Par Pacific has benefited from another year of above average refining crack spreads causing the company to gush cash.  They've successfully fixed their post-covid balance sheet and this year closed on the acquisition of a formerly Exxon refinery in Billings, MT.  The company is generating significant taxable earnings which are now offsetting their $1B+ NOL tax asset.  Par Pacific is additionally beginning to invest in renewable fuel assets, which might help people think through the terminal value question of oil refineries, but I tend to think that's premature by a couple decades.  The management team is formerly from Zell's Equity Group and continues to execute on value accretive deals (other than injecting additional equity in Laramie (a private natural gas producer PARR owns 46% of), it is hard to think of a bad deal they've done).  It's not necessarily actionable today, I did sell down some of position during the year, but at 5x NTM EBITDA and 6.75x NTM earnings (TIKR estimates, to be fair, they're overearning in the current environment), I continue hold due to being comfortable with the management team.

Closed Positions (since 6/30)

Broken Biotech Basket:
PFSWeb (PFSW) was a third party logistics ("3PL") provider that was acquired by GXO Logistics (GXO), the deal closed in October for $7.50/share, a nice result.

Sculptor Capital Management (SCU) was a hedge fund manager that put itself up for sale after a very public spat between founder Daniel Och and CEO Jimmy Levin.  The firm found a buyer in Rithm Captial (RITM) (fka New Residential), a little bidding war ensued but eventually Rithm Capital closed on the deal in November for $12.70/share.

Western Asset Mortgage Capital Corp (WMC) was a mortgage REIT that never recovered from the covid era liquidations, it was acquired by AG Mortgage Investment Trust (MITT) in a cash and stock deal.  I would anticipate seeing a few more of the small left for dead mortgage REITs acquired in the coming years, particularly if we see more stress on the CRE side.

Jackson Financial (JXN) is a 2021 spin of Prudential PLC that primarily provides variable annuity insurance products.  I liked the setup because it was a UK listed company spinning off a much smaller US listed company; Jackson Financial initially traded substantially below book value (still does) as it was an orphaned security with no initial index ownership and complicated financials.  Over the following two years, Jackson was added to indices, paid a healthy dividend and bought back a substantial amount of stock.  While that gameplan is still occurring and some potential excess capital could be dividended up to the parent (similar to MBIA) in the near future, my initial thesis has generally played out and I'm not a strong enough accountant to figure out their financial statements.  I decided to sell and relocate to newer ideas.

Carlyle Credit Income Fund (CCIF) (fka VCIF) was previously a residential mortgage closed end fund that transitioned to a CLO equity fund.  The thesis generally played out expect for one important risk, when it came time to sell the residential mortgages in the old VCIF portfolio and deliver the cash to Carlyle, the fund took a large 17% write-down.  I'm still not entirely clear why or what happened in the few weeks from the proxy to the asset sale, but that cut almost all my gains in the investment.  Carlyle is a quality manager and I generally like CLO equity as an asset class, but post transition and dividend reinstatement, my position was generally smallish and decided to move on.  Might re-visit it if we see some stress in private credit and the leveraged loan market.

Manchester United (MANU) is the famed English Premier League soccer club, my thesis revolved around the bidding war between Sir Jim Ratcliffe and Sheikh Jassim of the Qatari royal family, I wrongly guessed that Sheikh Jassim would come out victorious since his bid was for all MANU shares and at a higher price than Ratcliffe.  But for whatever reason, the Glazers choose Ratcliffe, after months/weeks of rumors, the official announcement was made this past week that Racliffe was tendering for 25% of both Class A and Class B shares at $33/shares, plus investing another $300MM at $33/share for club facility improvements.  I had hoped there would be some language around a path towards majority or full ownership, but didn't see anything explicitly stated to that effect.  Without a concrete timeline, and Ratcliffe taking operational control of the team, its uncertain why or when he'll buy economic control of the team, the prestige is being the ownership face, and he'll be that now.  As a result, I would expect MANU shares to trade at a significant discount following the tender and possibly be dead money for a while.  I was wrong, but didn't really lose any money on this one.

Performance Attribution
Current Portfolio
In addition to the above, I also have a bunch of CVRs, non-traded/illiquid liquidations, an illiquid bond and a litigation stub.

Please feel free to ask any questions or leave any interesting new ideas for 2024.  Thank you to all my readers, especially those that have reached with positive or negative feedback, new ideas, or just wanting to chat.  Happy New Year, hopefully 2024 is prosperous as well.

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 or concentration does not fully represent my risk tolerance.

Friday, December 15, 2023

Reneo Pharmaceuticals: Phase 2 Study Misses, Pre-SA Broken Biotech

The theme around here continues on -- Reneo Pharmaceuticals (RPHM) (~$45MM market cap) is another broken biotech, this week the company announced their Phase 2 study of Mavodelpar in adult patients with mitochondrial myopathies did not meet its primary or secondary efficacy endpoints.  The stock responded by crashing 80+% as this is a one shot on goal biotech without much of a remaining pipeline.  Reneo is now trading well below liquidation value, while the company has yet to announce a strategic review, it doesn't have many options left, I would expect the official strategic alternatives declaration soon.

This is another fairly clean balance sheet, Reneo disclosed that current cash is approximately $100MM as of yesterday, subtracting out their 9/30 liabilities, severance payments and an estimate of cash burn/liquidation costs (they only have approximately 12 employees following their reduction in workforce), I get an NAV or liquidation value of ~$2/share.  The company did put in place an ATM in November, it doesn't appear they've used it based on current cash and historical burn rate, but the share count above might be worth confirming.  

I could see a little bump in price if and when the company does formally announce strategic alternatives and then a second on some conclusion, whether a deal or liquidation of Reneo.

Disclosure: I own shares of RPHM

Tuesday, December 12, 2023

Eliem Therapeutics: Broken Biotech, Reverse Merger Risk

Eliem Therapeutics (ELYM) ($67MM market cap) is a broken biotech that previously was focused on developing therapies for mental health and central nervous system disorders. Back in February of this year, Eliem paused development on ETX-155 due to "challenging capital environment" despite having FDA support for a Phase 2 trial to treat major depressive disorder.  Points to some possible value and expense discipline.  The company did a reduction in workforce of 55% and refocused on the pre-clinical ETX-123. As we've seen with others, they ended up fully pausing all research and development in July, announced plans to explore strategic alternatives and completed an additional workforce reduction (which is captured in the severance costs below).

This one is rather straight forward, there's no debt, minimal lease obligations, ~$100MM of cash and a 49% shareholder in RA Capital.
RA Capital is an institutional player in life sciences, they invest across the pre-revenue/revenue spectrum, Andrew Levin from RA Capital is the chairman of the board for ELYM. He appears to be more of a scientist than an investor, but I'm sure straddles both.  All that to stay this situation probably leans towards a reverse merger -- it has been 4+ months since the strategic alternatives announcement, a scientist as chairman and controlling shareholder (might have something they own privately and want to bring public), but given the ownership alignment, hopefully a well thought out transaction.  The IP might also be worth something here to someone wanting to pursue a Phase 2 trial for ETX-155.

Disclosure: I own shares of ELYM

Tuesday, November 28, 2023

Kinnate Biopharma: Foresite/OrbiMed Potential Offer, Tang Involved Too

Kinnate Biopharma (KNTE) (~$100MM market cap) is a clinical stage oncology company, while not quite a broken/busted biotech under my usual definition (full white flag on development pipeline and announce strategic alternatives), Kinnate did do a restructuring in September which resulted in 70% of their workforce being laid off as KNTE reprioritized their research efforts to earlier stage programs.  The company recently reported $180.4MM in cash and securities as of 9/30, KNTE guided to having enough cash runway through Q2 2026 in the restructuring announcement, implying an ~$18MM/quarter cash burn rate going forward.

Normally this wouldn't be of interest to me, but on 11/13, 46.2% joint owners, Foresite and OrbiMed (who are also teaming together on a potential Theseus Pharmaceuticals (THRX) bid) indicated that they're exploring acquiring the remaining shares they don't currently own.  Foresite is a credible buyer as they did something similar with Pardes Biosciences (PRDS), buying that broken biotech for approximately 85% of the net cash value tossing in a CVR for 80% of any proceeds from the sale of the development pipeline.  Something similar here would result in a ~$2.65 bid here, or 20% upside and could happen fairly quickly in the next month or two.

In a fun wrinkle (at least around here), Kevin Tang has jumped into the fray here as well (he's also made a bid for THRX) with 6.3% of the shares.  In the last year plus, he's been pushing for similar discount of cash with a CVR type deals, as a minority shareholder, guessing he would support one here as well.  Tang's known to engage with management, hopefully the added pressure will push the board to accept Foresite/OrbiMed's forthcoming offer.  Downside here is more similar to a speculative merger arbitrage situation (large), however, management has limited options as Foresite included the line again that they're uninterested in other strategic transactions.

Disclosure: I own shares of KNTE

Friday, November 17, 2023

MRC Global: Preferred Dispute Overhang, Activist, PE Circling

MRC Global (MRC) ($920MM market cap) is a global distributor of pipes, valves, fittings ("PVF") and other maintenance products to gas utilities, industrials and energy end markets.  The market appreciates the MRO/distributor business model as many pure-play industrial distributors trade anywhere from 10-15x EBITDA, however MRC Global historically focused on the cyclical oil and gas drillers and has mostly traded at a significant discount to other industrial distributors (currently, about 6x EBITDA).  In the past decade, since the oil market broke in the mid-2010s, MRC Global has focused on diversifying out to adjacent but less cyclical markets like gas utilities, refineries (turnarounds/maintenance can only be deferred for so long) and energy transition projects (big beneficiary of the Inflation Reduction Act).  But credit for this mix shift has been hard to come by in public markets as they continue to trade inline with more upstream focused NOW Inc (DNOW) (although NOW is debt free).

Historically, MRC Global has battled being overleveraged, after a couple strong years they've finally gotten that under control with debt/EBITDA roughly at 1x (if you count the convertible preferred as equity).  This past spring, the company started the process to refinance their term loan that comes due in September 2024, however, a management described "business disagreement" with their convertible preferred shareholder (who filed a lawsuit attempting to block the refinancing) led them to pull the deal.  The company does have ABL capacity to redeem the term loan when it comes due next year, although that wouldn't be an ideal balance sheet outcome (interestingly, because of their liquidity, management has decided to account for the term loan as long term debt even though it matures in less than a year).

The convertible preferred is perpetual, pays a currently below market rate of 6.5% and has a conversion price of $17.88 (versus a current price of $10.88).  The preferred holder is Cornell Capital, the namesake Henry Cornell was an original architect in rolling up distributors to what would become MRC Global while he was managing Goldman's private equity business.  From their amended 13D following the lawsuit, it is clear that Cornell wants to be cashed out:

The Lawsuit seeks, among other things, (i) a declaration that the Issuer’s contemplated refinancing transaction violates the Issuer’s corporate charter and (ii) an order to enjoin the Issuer from signing or executing any definitive documentation with respect to, or otherwise consummating, the Refinancing. While MI objects to the Refinancing as contravening MI’s rights pursuant to the Certificate of Designations, MI has indicated to the Issuer that it desires to negotiate a resolution acceptable to all parties. Such a resolution could, for example, involve the Issuer repurchasing the preferred stock held by MI in whole or in part for cash or potentially other forms of consideration. However, there can be no assurance that any such transaction will occur, or the terms of any such transaction.

With that in mind, in appears the activist fund Engine Capital which owns approximately 4% of the shares outstanding, in their quarterly letter, they outlined thoughts that MRC Global could be sold for between $14-$18/share.  Now management is facing pressure from an upcoming loan maturity, a grumpy preferred shareholder and an activist common stock investor.  On Halloween eve, news comes out from Bloomberg News that MRC Global is exploring a sale after receiving interest from private equity firms.  A buyout would come with a new term loan in place, liquidity for Cornell Capital, appease Engine and potentially achieve an equity valuation that MRC Global won't in public markets.

Again, the closest peer is DNOW, although they're far more exposed to upstream oil and gas, there's a wide gap between where MRC and DNOW trade and other distributors.  Given the leverage here through the preferred shares, a buyer only has to give MRC a little multiple expansion credit for the improved business mix shift for equity shareholders to do well.

At 7.5x EBITDA (forward estimate from, which admittedly is a multiple grabbed slightly out of thin air, you're looking at about a $15/share target price, a nice premium to the current price.  If a deal doesn't happen, there's not much, if any, premium really baked into the price.  MRC Global is facing some covid hangover headwinds in their fast growing (and the best segment) gas utilities business as their customers are destocking like many others after supply chain issues caused utilities to overorder in 2021-2022.  But that segment has grown at a 10+% CAGR for a decade and should return to growth shortly.  MRC has been a favorite pitch of those wanting to be long oil and gas, but in a more sensible way than owning the producers, if energy does rally, MRC should benefit along with it.  In a way, it's the perfect hated small cap value stock.

Disclosure: I own shares of MRC

Tuesday, November 14, 2023

Theseus Pharmaceuticals: Straight Forward Broken Biotech

Theseus Pharmaceuticals (THRX) (~$140MM market cap), a cancer therapy researcher, is the latest addition to the broken biotech basket trade.  This week, Theseus announced a 72% reduction in workforce and the exploration of strategic alternatives "to consider a wide range of options with a focus on maximizing shareholder value, including potential sale of assets of the Company, a sale of the Company, a merger or other strategic action."  The company hasn't reported for Q3 as of this writing, but did disclose an estimated cash and securities balance of $225.4MM in the same press release.

The 6/30 cash and securities balance was $234.2MM, so the company only burned a bit under $9MM during the quarter despite attempting to push forward a few early stage programs (which may have some value?) after shutting down their Phase 1/2 trial for their lead candidate in mid-July, pointing to some expense discipline here.  Otherwise the balance sheet is fairly straight forward, there's a small lease obligation (already backed out in my NCAV number) and no debt.  Despite jumping 50% on the strategic alternatives news, I still think this one is attractively priced.

Disclosure: I own shares of THRX

Friday, September 15, 2023

Graphite Bio: Broken Biotech, New CEO, Operating Lease Questions

Graphite Bio (GRPH) (~$130MM market cap) is a clinical-stage gene editing biotech that paused development in January for their lead asset, nulabeglogene (a treatment for sickle cell disease), following a serious adverse event in the first patient dosed.  About a month later, Graphite Bio made the determination to explore strategic alternatives and did a large reduction in workforce.  In the months since, the company sold their IP in a couple transactions for nominal amounts, the CEO resigned to pursue other opportunities and they did a further layoff.

In August, the company brought in Kim Drapkin as the CEO (plus just about every other relevant executive function) to lead the strategic alternatives process.  Drapkin was previously the CFO of Jounce Therapeutics (JNCE), a similarly situated broken biotech, which accepted a cash bid plus a CVR from Kevin Tang's Concentra Biosciences (Tang does own ~4% of GRPH).  Interestingly, as part of Drapkin's compensation package, she receives an additional $200k in severance if a definitive agreement is reached within 3 months of her 8/21/23 start date:

The Company entered into a letter agreement, dated August 21, 2023 (the “Start Date”), with Ms. Drapkin (the “Offer Letter”). Pursuant to the terms of the Offer Letter, Ms. Drapkin will be entitled to a base salary of $550,000 per year. In addition, Ms. Drapkin will be entitled to cash severance payments in the amount of (i) $400,000 in the event of a termination of her employment other than for cause or death upon or within 12 months after the closing of a strategic transaction, plus an additional $200,000 if the definitive agreement for such strategic transaction is executed within three (3) months after the Start Date or (ii) $350,000 in the event of a termination of her employment other than for cause or death upon or within 12 months after the Board’s approval of a plan of dissolution of the Company under Delaware law, in each case subject to Ms. Drapkin’s execution and non-revocation of a separation agreement and release, as further provided in the Offer Letter.

While that's not enough to ensure a deal is reached in that timeframe, it certainly points to the expectation of a quick deal when she was brought on board.  Another attractive quality to GRPH, their net cash position (after deducting current liabilities) is well over $200MM, that's a meaningful amount of money to many potential bidders which should increase the quality of any deal counterparty compared to some of these true micro/nano cap broken biotechs.

The one large red flag here is their operating lease liability; near the top of the recent craziness, GRPH entered into a 120 month lease for some office and laboratory space in San Francisco (which only started after they raised the white flag).

On December 16, 2021, the Company entered into a lease agreement with Bayside Area Development, LLC (“Bayside”) for 85,165 square feet of office and laboratory space in South San Francisco, CA. The lease for the office and laboratory space commenced in April 2023. The term of the lease is 120 months with the option to extend the term up to an additional ten years. This option to extend the lease term was not determined to be reasonably certain and therefore has not been included in the Company’s calculation of the associated operating lease liability under ASC 842. During the three and six months ended June 30, 2023, the Company took possession of the Bayside lease and recognized a $32.0 million right-of-use asset and corresponding lease liability upon the lease commencement date. In addition, the Company recognized $27.2 million in leasehold improvements. Bayside provided a tenant improvement allowance of up to $14.9 million, of which $14.7 million was utilized and recorded in lease liability. 

In connection with the Restructuring Plan, the Company has determined that it will not utilize this facility for purposes of its own operations, and as a result, intends to sublease the vacant space to recover a portion of the total cost upon recognition of the lease.

They've yet to sublease the space or negotiate a termination payment with their landlord.  Given the state of Bay Area office space, it might be advisable to assume the entire long term operating lease liability against the NAV.

I'm going to assume only two quarters of G&A versus my normal four, to account for the time it has already taken since the original announcement plus the three month incentive fee, it doesn't appear this one should take too long once the operating lease is neutralized in one way or another.  Although the default expectation with these should be a reverse-merger, the odds of a simpler cash deal should be higher given Drapkin's experience at JNCE.

Disclosure: I own shares of GRPH

Homology Medicines: Strategic Alternatives, Potentially Valuable JV

Homology Medicines (FIXX) (~$70MM market cap) is a clinical stage genetics biotech whose lead program (HMI-103) is meant to treat phenylketonuria ("PKU"), a rare disease that inflicts approximately 50,000 people worldwide.  In July, despite some early positive data, the company determined to pursue strategic alternatives as FIXX wouldn't be able to raise enough capital in the current environment necessary to continue with clinical trials.  Alongside the strategic alternatives announcement, the company paused development and reduced its workforce by 87% which resulted in $6.8MM in one-time severance charges.

Outside of approximately $108MM in cash (netting out current liabilities), FIXX has a potentially valuable 20% ownership stake in Oxford Biomedia Solutions (an adeno-associated virus vector manufacturing company), a joint venture that was formed in March 2022 with Oxford Biomedia Plc (OXB in London).  As part of the joint venture, FIXX can put their stake in the JV to OXB anytime following the three-year anniversary (~March 2025):

Pursuant to the Amended and Restated Limited Liability Company Agreement of OXB Solutions (the "OXB Solutions Operating Agreement") which was executed in connection with the Closing, at any time following the three-year anniversary of the Closing, (i) OXB will have an option to cause Homology to sell and transfer to OXB, and (ii) Homology will have an option to cause OXB to purchase from Homology, in each case all of Homology's equity ownership interest in OXB Solutions at a price equal to 5.5 times the revenue for the immediately preceding 12-month period (together, the "Options"), subject to a maximum amount of $74.1 million.

 Poking around OXB's annual report, they have the below disclosure:

Using the current exchange rate, that's approximately $47MM in value to FIXX.  Now OXB isn't a large cap phrama with an unlimited balance sheet, so there is some counterparty risk that OXB will ultimately be able to make good on this put.  In my back of the envelope NAV, I'm going to mark this at a 50% discount to be conservative.

Unlike GRPH, the operating lease liability at FIXX is mostly an accounting entry as the company's office space is being subleased to Oxford Biomedia Solutions, but doesn't qualify for deconsolidation on FIXX's balance sheet.  I'm going to remove that liability, feel free to make your own assumption there.  Additionally, even though HMI-103 is very early stage, it wasn't discontinued due to a clinical failure and might have some value despite me marking at zero since I can't judge the science.

It is hard to handicap the path forward, maybe OXB buys them out, they could do a pseudo capital raise with FIXX's cash balance while eliminating the JV put option liability.  Or FIXX could pursue the usual paths of a reverse-merger, buyout or liquidation.

Disclosure: I own shares of FIXX

Friday, September 8, 2023

Manchester United: Glazers Under Pressure to Sell, Dual Share Class Concerns

Similar to the Albertsons post, not a lot of original thoughts here other than the spread to the rumored takeout/private market value is too wide and could close shortly if all goes right.  If not, the current valuation isn't too demanding.

Manchester United (MANU) ($3.25B market cap, $4.15B EV) is one of the most popular soccer/football franchises in the world.  Since 2005, the English Premier League mainstay has been owned by the Glazer family (originally Malcolm Glazer, he died in 2014 and distributed his stake evenly to his six children) who purchased the team via a controversial (at the time) LBO that saddled the team with debt.  In the eyes of Manchester United supporters, due to debt incurred, the team was forced to divert cash flow from improving the team/facilities to debt service.  It took a few years, but the team's performance has suffered as a result, the team last won the Premier League in 2012-2013, a long drought for the storied club.  With the influx of foreign money, especially from the Middle East into the Premier League, Manchester United is no longer the club with the most resources and faces stiff competition for talent, including from their cross town rival, Manchester City, which is owned by members of the UAE royal family.  Again, in the eyes of supporters, the Glazers either don't have or won't spend the resources necessary to compete at the highest levels in Europe and ManU's millions of fans want them out.  Pressure has built to a significant level, protests and criticism from the notoriously difficult British press, partially led the Glazers (who also own the NFL's Tampa Bay Buccaneers) to announce they were open to sale nearly a year ago.

My primary concern with publicly traded sports teams is that they're almost always controlled companies with dual share class structures, probably rightly so as it would be potentially chaotic for the leagues if not.  There has been plenty of ink spilled on how great of an investment sports franchises have been, the number of billionaires continues to go up while the number of marquee sports franchises (the ultimate status symbol) has remained relatively flat, pushing the value up each time one comes on the market.  However, since the appeal to sports team ownership is mostly as a status symbol, the value in being the owner is being the controlling owner and face of the franchise.  Team owners aren't investing in the team for the cash flow (there generally isn't much, otherwise that would anger fans, thus reducing the asset value of the franchise), in order to be the recognized as the team owner, a would be buyer only needs to acquire enough shares to be the majority shareholder.

Manchester United has a dual share class structure where the Glazers own 100% of the Class B shares and 4-5% of the Class A shares.  Class B shares carry 10 votes, while Class A shares get 1 vote, giving the Glazers 95+% of the vote.

What happens if a buyer only buys the Class B shares from the Glazers?

In the original offering document from the 2012 IPO, the Class B shares automatically convert to Class A shares if they're no longer owned by an affiliate of the Glazer family:


Each Class B ordinary share is convertible into one Class A ordinary share at any time at the option of the holder of such Class B ordinary share. Each Class B ordinary share shall be automatically and immediately converted into one Class A ordinary share upon any transfer thereof to a person or entity that is not an affiliate of the holder of such Class B ordinary share. Further, our Class B ordinary shares will automatically convert into shares of our Class A ordinary shares upon the date when holders of all Class B ordinary shares cease to hold Class B ordinary shares representing, in the aggregate, at least 10% of the total number of Class A and Class B ordinary shares outstanding.

But given the above Excel snip, even if the Class B shares were fully converted to Class A shares, a buyer of the Class B would still have a majority of the economic ownership and the vote.  This is the primary risk one has to get comfortable with in this sale situation, that MANU shareholders might not see the same economic benefit as the Glazers (the Glazers could also get a premium for the Class B over the Class A).  This is not a situation where a buyer would be potentially acquiring a majority voting stake for less than a majority economic stake that could be challenged in court.

However, the good news is the leader bidder, Sheikh Jassim bin Hamad bin Khalifa Al Thani ("Sheikh Jassim") of the Qatari royal family (brother of the Emir of Qatar), wants to buy the entire club outright for a reported £6B or ~$7.5B.  Subtracting out the $900MM in debt, that's roughly ~$40/share, about double where shares trade today, around ~$20/share for the Class A.

Why does it trade at such a wide spread to the rumor deal price?

  1. The Glazers appear reluctant to sell (the process has almost dragged on a year, there's some deal fatigue here) and have been reported to be looking for a £7-10B price tag.  If they don't get it, they're willing to wait a couple years (could be a negotiating tactic) until new media rights packages have been signed, the FIFA Club World Cup expansion is closer and other bidders emerge.
  2. The other bidder, British billionaire Sir Jim Ratcliffe (a big ManU supporter) has bid between £5-5.5B for just more than 50% of the shares (the initial risk outlined) that would also potentially keep the Glazers involved in the club.
Despite these risks, I'm comfortable owning MANU shares at ~$20 given the 50% discount to the report Qatari bid.  The Glazers are going to face increasing pressure from a notoriously rabid fanbase that is dying to return to top form, the Glazers have limited ability to monetize or dividend out their incredible capital gain in the franchise, and the Qatar royal family have a near unlimited budget (plus a clear desire to sportswash - see the 2022 World Cup).  Manchester United's stadium needs renovation, the team needs to reinvest in their players, only a new owner with an unlimited pocket book (and potentially a cultural/political rival with crosstown Manchester City) will placate fans.  Whether it happens this fall at £6B or in 2025 at £7-10B, current prices seem attractive for a trophy asset that's clearly in play.  Other recent sports franchises, Chelsea for $5.25B and the Washington Commanders for $6.1B, have been sold for prices far exceeding the stock market price of MANU, despite being less popular teams.

Disclosure: I own shares of MANU

Albertsons: Merger w/Kroger, Divestiture News

Apologies, this post is mostly for my benefit (I try to post on all new positions), there likey aren't any new thoughts below on combination of the country's two largest traditional grocery chains, Albertsons (ACI) and Kroger (KR), but I just wanted to acknowledge that I bought into the merger arb earlier this week.  Partially after hearing Andrew Walker and Daniel Biolsi discuss it in a recent Yet Another Value Podcast episode.

Nearly a year ago, the two announced that Kroger (~2700 stores) was buying Albertsons (~2300 stores) for $34.10/share in cash (the merger consideration has been adjusted down to $27.25 for a $6.85 special cash dividend ACI paid in early 2023), shares closed on Friday for $23.63, offering 15% upside to the adjusted closing price for a deal that is expected to close in early 2024.  Potentially a juicy IRR.

On its face, the merger appeares to have a significant anti-trust hurdles, but when you examine the industry, traditional grocers like KR and ACI are facing competitive pressure from big box stores like Walmart, Target and Costco, plus competition on the high end from specialty grocers like Sprouts and Whole Foods.  They've been share losers to both sides.  Although others don't always see it that way, regulators took a narrow view of the office supply industry and rejected the attempted Staples and Office Depot 2014 tie up, despite many alternative channels (notably Amazon) to buy office supplies.  Both companies have struggled since, hopefully regulators take a more holistic view here and realize that traditional grocery chains need a strong competitor to the big box concepts (Walmart, Target) that use grocery as an enticement to get shoppers into their stores to buy higher margin non-grocery goods.

From a Chicagoan's point of view (they have overlap significantly here), I was a bit surprised by the relative lack of overlap in the two chain's store map nationally.  Kroger has significant concentration in the midwest and southeast where Albertsons is generally absent, and Albertsons is more focused on the west coast and northeast where Kroger has less of a presence (other than Denver, Seattle, Southern CA):

To address the areas where they do have overlap, when the deal was initially struck, the two set the stage for a divestiture SpinCo that would house between 100 to 375 grocery stores.  In addition to the adjustment for the special dividend (since paid), the cash consideration was to be dropped by 3x the four-wall (store level, pre corporate overhead) EBITDA of the stores assigned to the SpinCo.  Traditional merger arbitrage investors don't like uncertainty in the total consideration, the ACI SpinCo (in the initial docs, it appeared that SpinCo would be ACI stores only) would have likely traded poorly or at had some uncertainty as to its public market valuation.  This uncertainty (in my view) has partially led to the wide merger arbitrage spread, along with concerns around regulatory approval.

Today's news that Kroger and Albertsons had reached a deal to sell 413 stores for $1.9B to C&S Wholesale Grocers ("C &S") should help in a couple ways:

  • Divesting the overlap stores in an arm's length transaction should help calm fears that a SpinCo would be filled with the worst stores and be destined to fail.  A spin would not have been arms length and could have been the ultimate garbage barge, but now the divested stores will be plugged into an established operator who has done their due diligence and should be ready to compete against the combined KR/ACI following the closing of the deal.  That couldn't be said for a spin structure.
  • If required by regulators, KR/ACI has also setup an option for C&S to buy an additional 237 stores if needed.  In the initial merger proxy, the two parties speculated that up to 600 stores would need to be divested in total, this option would firm that up and fully eliminate the need for a spinoff of uncertain value.
  • The original spin appeared to only for ACI shareholders, this divestiture package includes both ACI and KR stores, again highlighting that a third party fully evaluated the competitive position in each market, versus a dump into a SpinCo that might have failed.
  • Similar to above, but grocery stores are heavily unionized, by selling in an arm's length transaction versus a spin, this structure likely helps dispel fears that a SpinCo would fail or that stores would be closed.  C&W has committed to keeping stores open as-is which should help political perceptions around this combination.

That's pretty much my thesis, the divestiture firms up the merger consideration (shouldn't need the SpinCo any longer) and should appease regulators that a strong third party (versus a helpless SpinCo) has done their due diligence and purchased the divested stores in an arm's length transaction, thus ensuring proper competition.  Assuming this deal closes in mid-February, even after this week's run up, it is offering a 15% absolute return and a ~38% IRR.

If the merger is blocked or otherwise doesn't occur, Albertsons is valued at 8x earnings (roughly inline with peers) and is a semi-controlled company by Cerberus and other PE investors with capital allocation expertise.  The downside doesn't appear too significant.

Disclosure: I own shares of ACI

Thursday, August 24, 2023

Banc of California: PacWest Merger, Get in Cheaper than Warburg & Centerbridge

Banc of California (BANC) and PacWest's (PACW) merger is a bit old news at this point, but initial excitement has worn off and shares are now priced below $12.30/share, where PE firms Warburg Pincus and Centerbridge are making their PIPE investment (originally at a 20% discount, it will close with the merger).  This is less of a short-term special situation trade and more a medium-to-long term investment as we wait for the skies to clear in the regional bank industry and bet on the merged bank extracting a massive amount of synergies.  The merger is a complicated transaction, the basic terms are below, all of this is designed to clean up the larger distressed PacWest:

PacWest was one of the rumored next dominos to fall in this past spring's banking crisis.  Their strategy was to use low cost California deposits (including a venture capital deposit clientele) and then lend those deposits out across the country to CRE and commercial borrowers.  When their depositors fled, PacWest was forced to load up on expensive wholesale funding to plug the hole.  Part of the problem was their customers (both depositors and borrowers) didn't see them as their primary bank, borrowers weren't depositors and depositors weren't borrowers.  Banc of California contrastly operates more like a large community bank, they gather deposits and lend in the same geographic area, southern California.

The accounting here will be a bit quirky, in an acquisition or a merger, a bank needs to mark-to-market the assets of the acquired bank on their balance sheet.  As everyone is well aware, where current rates are, banks have large unrealized losses that aren't included on their balance sheet in both the loans held for investment and securities held-to-maturity portfolios.  Since Banc of California is in relatively better shape, PacWest will be the acquirer here so that BANC's assets are marked-to-market rather than PACW's.  There's a lot of moving pieces here (BANC is selling their residential mortgage and multi-family portfolios among other asset sales to plug the wholesale funding problem), but in the interest of brevity, Warburg Pincus and Centerbridge's investment was designed to plug the capital ratio hole created by this mark-to-market merger accounting, keeping the merged bank's capital ratios in the healthy 10+% CET1 range.

My high level core thesis here is mainly two fold:

  • Pre-regional bank crisis, bank mergers were highly scrutinized.  Back in the summer of 2021, President Biden released an executive order that "encourages DOJ and the agencies responsible for banking (the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency) to update guidelines on banking mergers to provide more robust scrutiny of mergers."  What this meant in practice, banks had to convince regulators/politicians to approve a merger by limiting branch closures and job cuts, make grants into the community, etc.  That's not the case here, regulators are rolling out the red carpet to ensure that the contagion doesn't spread.  The two parties are guiding to only a six month merger timeline as they've already previewed this deal with regulators.  While they'll be careful not to explicitly say it, but the two banks have a ton of geographical overlap that will get rationalized in the coming year or two post closing, likely blowing past their projected synergies.
  • Banc of California previously had a reputation as a bit of a renegade fast growing bank under Steven Sugarman (brother of SAFE's Jay Sugarman), they entered a lot of risky lines of business and even plastered their name on a new soccer stadium in LA for $15MM/year, quite the marketing expense for a small regional bank.  However, four plus years ago Sugarman was pushed aside, in came Jared Wolff to lead the bank, he grew up at PacWest (with a stop in between at City National, another LA bank) and knows it and its management team very well.  Wolff shed many of the risky lines of business, ditched the stadium licensing deal, instead focused on being a community commercial bank.  BANC has performed reasonably well since, trading between 1.1-1.4x book value.  This is a bit of a jockey bet that he can draw on both his experience turning around BANC and being the former president of PACW to merge these two organizations optimally.
In terms of valuation, BANC put out the below estimate for next year's EPS.  This is a full year view and not a run rate, one can assume the exiting run rate is likely above this range going into 2025.
Using an admittedly fairly simple analysis, but I think it works, using the $12.30/share price number where the PE firms are coming in and the EPS guidance mid-point of $1.72/share, BANC is trading for approximately 7.2x next year's earnings and even cheaper on a year end 2024 run rate basis.  The bank also gave a $15.13/share proforma tangible book value, or it is currently trading at 81% of book, compared to historically around 1.1-1.4x.  Book value doesn't include the mark-to-market losses on PacWest's loan portfolio or held-to-maturity portfolio, but with a bank run largely off the table, those losses will eventually burn off.  At 10x $1.80/share in EPS, BANC could be a ~$18/share stock by the end of next year.

Other thoughts:
  • This deal doesn't solve two issues the market has been worried about, geographic concentration and deposit concentration risk, the combined bank will still be commercial focused (lacking significant retail deposits) and in California.  But maybe neither should be a concern going forward?  Market could be fighting the last war, but something I've been thinking about and don't have a strong rebuttal.
  • One of BANC's pitches is there is a void to fill because many of the largest California headquartered banks have either failed or been merged away in recent years.  I don't entirely buy that as the money center banks have a large presence in California, banking is a relative commodity, while relationship community banking can be a good profitable niche, I struggle thinking there's massive growth opportunity here.  This is a merger execution story, not a growth one.
  • Proforma, 80% of deposits will be insured, like to see that a bit higher, but this is a commercial focused bank.  They'll still be a pretty small bank with only 3% deposit share in southern California.
  • Outside of the current bank environment risks, this situation does carry a fair amount of execution risk.  I've been apart of a few acquisitions before, things always take longer and are hairier than it appears to outsiders, need to have some patience.

Disclosure: I own shares of BANC and PACW

CKX Lands: Micro-Cap Land Owner, Strategic Alternatives

CKX Lands (CKX) (~$27MM market cap) is a sleepy micro-cap that goes back to 1930 when it was spun from a bank.  CKX owns 13,699 net acres (about half is wholly owned, the other half is through a 16.67% interest in a JV) in southwest Louisiana which it earns royalties from oil and gas producers, timber sales and other surface rents it collects.  Revenue skews towards oil and gas revenues, but the value of the land is likely more in its use as timberland (they don't give oil and gas reserve numbers). 

On Monday, CKX put out the below press release:

CKX Lands, Inc. Announces Review of Strategic Alternatives


LAKE CHARLES, LA (August 21, 2023)—CKX Lands, Inc. (NYSE American: CKX) (“CKX”) today announced that its Board of Directors has determined to initiate a formal process to evaluate strategic alternatives for the company to enhance value for stockholders. The Board of Directors and the management team is considering a broad range of potential options, including continuing to operate CKX as a public, independent company or a sale of all or part of the company, among other potential alternatives.


The company has engaged TAP Securities LLC as financial advisor in connection with the review process. Fishman Haygood, L.L.P. is serving as legal advisor to the company.


There is no deadline or definitive timetable set for the completion of the review of strategic alternatives and there can be no assurance that this process will result in CKX pursuing a transaction or any other strategic outcome. CKX does not intend to make further public comment regarding the review of strategic alternatives until it has been completed or the company determines that a disclosure is required by law or otherwise deemed appropriate.


CKX Lands, Inc. is a land management company that earns revenue from royalty interests and mineral leases related to oil and gas production on its land, timber sales, and surface rents. Its shares trade on the NYSE American market under the symbol CKX.


TAP Securities is an affiliate of TAP Advisors, an investment bank providing financial advisory, mergers and acquisitions and capital-raising services. TAP Securities is located in New York City, phone number (212) 909-9034.

The company's disclosures lack much detail, it is challenging to value this asset from the outside.  Management here has a significant informational edge over public market investors, but with this, they are signaling that CKX is likely worth considerably more than the current trading price.  Having read a few of these announcements over time, if I had to guess, the highlighted part sounds like management wants to take it private.

Additionally, management doesn't take any cash salary and instead the board granted them a generous stock incentive package that vests over time as CKX hits certain share price targets.

Presumably these are reasonable targets, the $12 threshold was previously met, but the shares currently trade at approximately $12/share.  To see if that's reasonable, on a quick back of the envelope, I have the shares trading for approximately $1350/acre.
To be worth $15/share, the acreage (mostly timberland) must be worth closer to $1900/acre.  By poking around Land Watch, for the below parishes, it does appear that $1900/acre is within reason.

I don't really have a good sense of how much CKX is worth, other than I like the setup, I'd be interested in hearing more complete thoughts from others that have done more work on CKX, please feel free to comment below.

Disclosure: I own shares of CKX