Thursday, January 26, 2023

Sesen Bio: Plan A Reverse Merger w/ Carisma, CVR; Plan B Liquidation

Sesen Bio (SESN) (~$130MM market cap) is another failed biotech themed investment idea.  Sesen Bio has one late-stage product candidate, Vicineum, a treatment for a type of bladder cancer, where a biologics license application (BLA) was filed with the FDA, but Sesen was sent back to the drawing board when the FDA issued a CRL (not a denial, but a "needs work") in August 2021 citing deficiencies in the original application that would require Sesen to complete a new (and long/expensive) Phase 3 trial before refiling.  Sesen believes that Vicineum still has a path to approval, but the stock traded well below net current asset value on the news, limiting Sesen's capital raising ability to move forward alone with a revised Phase 3 trial.  The company then announced they were pursuing strategic alternatives, which in failed biotech language usually means a reverse merger, if that doesn't work out, a liquidation.

In September 2022, Sesen's board went with Plan A, by announcing a reverse merger with Carisma Therapeutics, another cancer focused biotech with a supposedly promising platform ("CAR-M") but very much early/clinical stage.  The original deal was for 34.4% net ownership of Carisma and a CVR that would pay $30MM or ~$0.15/CVR out if Roche initiates a Phase 3 trial on EBI-031 (Sesen was f/k/a Eleven Biotherapeutics); Roche currently has Phase 2 trials ongoing with an estimated completion date of September 2024.  Importantly, none of the cash was to be return to shareholders and the combined Carisma would receive any proceeds from other asset sales.  Later it was first adjusted to include a special dividend of up to $25MM, based on the excess cash over $125MM delivered to the new merger entity from Sesen.

Shareholders disliked the deal, the stock promptly dropped on the news.  As an heathcare/biotech outsider, it can be difficult to tell which reverse mergers will pop and which will fail, often it seems to be timing, where the market's risk appetite is at any given moment.  But here, going from a liquidation candidate (similar to the situation over at ADES) to the board approving investing shareholder cash into a clinical stage company was a poor read of the room.  An investor in Sesen could sell their shares and invest in countless other similar science experiments, didn't need Sesen's board to do that for them.  What makes things worse here, management and the board own very little stock themselves.

Two investors came forward (dubbed "Investor Group", they own 8.5% of SESN) against the deal, instead pushing for Plan B, a liquidation.  Some back and forth went on behind the scenes, thanks to the activists, Sesen and Carisma recut the deal but it still is insufficient according to the Investor Group, who are still planning on voting against the reverse merger on the upcoming 3/2 shareholder meeting (if approved, deal will close shortly after).

Here's the new recut deal, for context, shares trade for $0.62/share today:

  1. $75MM or $0.34/share special dividend
  2. CVR that would receive the sale proceeds from Vicineum and other pipeline assets (no good guess here, but possibly a meaningful amount), plus the $30MM ($0.14/share) milestone payment from Roche if Roche initiates a Phase 3 trial for EBI-031 prior to 12/31/26
  3. 25% ownership in Carisma Therapeutics (CARM will be the new ticker), at the stated deal value of $357MM, that's $0.41/share of value to SESN shareholders.  This is the value pre-closing financing partners (which includes a few blue chips names like AbbVie and Merck) are purchasing shares in Carisma ($30MM at $15.60 per share, 37.7924 exchange ratio into pre-reverse split SESN shares) which should have some haircut applied
Investor Group is still pursuing a liquidation, claiming that Sesen could return $140MM in the near term, or $0.70/share with the remaining legacy assets monetized over the three years it would take to wind up the entity in Delaware.  Sesen struck back, saying they could only make an initial distribution of $0.40-$0.60/share.  I'm sort of indifferent to the outcome, could make arguments for both sides, a liquidation would provide a low floor/low ceiling return and the reverse merger also seems pretty protected on the downside here (assuming Vicineum does indeed have some value) with the immediate $0.34/share cash return but with upside of the CARM stub as the market begins to heat back up.  Luckily for me, I don't have to make a voting decision as the record date has already been set as 1/17, before I purchased shares.  I bought some shares this week to follow along with the drama, welcome others thoughts on this situation.

Disclosure: I own shares of SESN 

Tuesday, January 17, 2023

Vertical Capital Income: Carlyle Deal, Transitioning to CLO Equity Fund

Last week, Vertical Capital Income Fund (VCIF) ($98MM market cap) announced a proposed manager and strategy change, if approved, Carlyle Group (CG) will assume management of the closed end fund and transition the portfolio from residential whole loans to CLO equity and debt.  To encourage the proposal passing, Carlyle will make a one-time payment to VCIF holders of $10MM or $0.96/share.  Then to ensure alignment, Carlyle will tender for $25MM at NAV and invest an additional $25MM in the fund through a private placement done at NAV.  Following these transactions, Carlyle will own ~40% of the fund.

CLO stands for collateralized loan obligation, these are securitized pools of below-investment grade senior secured bank loans made to corporations (largely PE sponsored).  CLO equity sits at the bottom of the securitization's capital structure and receives the residual cash flow after all expenses and interest is paid to senior noteholders in the transaction.  CLO notes feature term financing with no mark-to-market, meaning CLOs can withstand volatility in the underlying bank loan market and often the manager can "build par" to offset any losses in the portfolio by purchasing loans at a discount and holding them through repayment at par.  CLO equity is generally underwritten to a mid-teens IRR.  There are several publicly traded CLO equity funds today, two prominent ones are Eagle Point Credit Company (ECC) and Oxford Lane Capital (OXLC), both trade roughly inline with NAV or slightly ahead (NAV is lagging, loans are up 1.80% to date, CLO equity values are likely up a bit).

Carlyle is one of the largest CLO managers, by taking over this fund, the PE giant will have a permanent source of equity capital for future CLOs.  This is important for future fund formation and why Carlyle is willing to pay $10MM to holders directly.  Fees to fund holders are going up in the transition as well (but roughly on par with similar funds/BDCs), VCIF currently pays 1.25% of assets, now will pay 1.75% of assets plus a 17.5% incentive fee above an 8% hurdle rate.  Carlyle does get to double dip a bit, they'll likely purchase Carlyle Group managed CLOs where they also earn a management fee.

VCIF currently trades for $9.38/share against a 12/31 NAV of $10.25/share, or an 8.5% discount (without factoring in the $0.96/share payment).  The vote is mostly secured at this point, 36% of shareholders have signed a support agreement.  I quickly sketched out what the return stream might look like in the next six months (the deal is set to close in the first half of 2023):

The biggest assumptions I'm making:
  • NAV is constant, the portfolio is marked monthly, the current holdings are mortgages with interest rate sensitivity, it'll move inversely with rate expectations (mortgage rates are flat-to-slightly down YTD).  As part of the transaction, current management has committed liquidating to cash at least 95% of the gross assets in the portfolio, thus reducing the NAV risk.
  • Only the January distribution is made and it doesn't erode NAV.  Additional interest income we'll assume goes to pay for any deal expenses the fund is expected to pay.
  • All holders participate at 100% in the tender offer.  If less than 100% participate, it improves the realized IRR.
  • Following the transition, the shares trade at a 15% discount to NAV.  In the last 12 months, the fund's shares have traded at an average discount of 12% and as mentioned earlier, the prominent CLO equity funds trade roughly in line with NAV.

I come up with a ~18% IRR for the 5+ months it'll take to close this deal (feels like it should happen sooner pushing the IRR above 20%) and might hold after closing when it will be rebranded as Carlyle Credit Income since CLO equity is reasonably cheap today.

Disclosure: I own shares of VCIF 

Tuesday, January 10, 2023

MBIA Inc: Puerto Rico Exposure Cleaned Up, Sale Next?

MBIA Inc (MBI) ($680MM market cap) is now a shadow of its former self, prior to the 2007-2009 financial crisis, MBIA was the leading financial guarantee insurer in the U.S., where MBIA would lend out its AAA rating to borrowers for an upfront fee.  This business model probably never made sense, it assumed the market was consistently mispricing default risk, the fee MBIA charged had to make it economical to transform a lower rated bond to a higher rated one.

In the early-to-mid 2000s, MBIA was leveraged over 100 times, they guaranteed the timely payment of principal and interest on bonds that were 100+x that of their equity, only a small number of defaults would blow a hole into their balance sheet.  When the business was first founded, MBIA focused on municipal debt through their subsidiary National Public Finance Guarantee Corp ("National"), with the thesis being that even if some municipal bonds weren't formally backed by taxpayers, there was an implied guarantee or a government entity up the food chain that would bail out a municipal borrower.  That has largely proved true (minus the recent quasi-bankruptcy in Puerto Rico), however MBIA was greedy and grew into guaranteeing securitized vehicles (via subsidiary MBIA Corp) prior to the GFC.  MBIA and others (notably AIG Financial Products) got caught, finding themselves on the hook for previously AAA senior tranches of ABS CDOs and subprime-RMBS that went on to suffer material principal losses.  There was no one up the chain to bail out a Cayman Islands special purpose vehicle with a P.O. box as a corporate address.  A lot has happened in the 15 years since 2008, MBIA Corp stopped writing new business almost immediately, National continued to write new business on municipal issuance but stopped in 2017 after Puerto Rico went further into distress, National had significant exposure to island.  The business has been in full runoff since then.  

The distinction between National (municipal bonds) and MBIA Corp (asset backed securities) is important, MBIA Corp and National are legally separate entities that are non-recourse to the holding company, MBIA Inc.  MBIA Corp's equity is way out of the money, completely worthless to MBIA Inc, the entity is being run for the benefit of its former policyholders.  National on the other hand has positive equity value, but when consolidated with MBIA Corp on MBIA Inc's balance sheet, results in an overall negative book value.  But again, these are two separate insurance companies that are non-recourse to the parent.  The SEC slapped MBIA Inc's wrist for reporting an adjusted book value based on the assumption that MBIA Corp's negative book value was no longer relevant to the parent, as some compromise, MBIA Inc stopped providing the end result, but still provides the components of their adjusted book value (not sure how that's significantly different, but whatever).  Here are the adjustments for Q3:

By making these adjustments, MBI's adjusted book value is roughly $28.80/share, today it trades for $12.50/share.  The last two items in the adjusted book value bridge are more runoff-like concepts, these are the values that MBIA Inc would theoretically earn over time as the bonds mature in their investment portfolio and erase any mark-to-market losses (largely driven by rates last year) and then any unearned premiums assuming their expected losses assumptions are accurate.

I've kind of skipped over Puerto Rico, I've passively followed it over the years via Reorg's podcasts, it is too much to go into here, but MBIA Inc's (via National) exposure is largely remediated at this point (announcing in December that they settled with PREPA, Puerto Rico's electric utility that was destroyed in Hurricane Maria), clearing the way to sell itself.  From the Q3 earnings press release:

Bill Fallon, MBIA’s Chief Executive Officer noted, “Given the substantial restructuring of our Puerto Rico credits, we have retained Barclays as an advisor and have been working with them to explore strategic alternatives, including a possible sale of the company.”

Essentially all of the bond insurance companies have stopped writing new business, the only one of any real size remaining in the market is Assured Guaranty (AGO) ($3.7B market cap).  Assured has significant overlap with National that would drive realistic synergies.  Street Insider reported that AGO and another company are in advanced talks with MBIA.  They're the only true strategic buyer (maybe some of the insurers that bid on runoff operations might be interested too), AGO also trades cheap at roughly 0.75x GAAP book value.  AGO would need to justify a purchase to their shareholders that would at least be on par with repurchasing their own stock (which they do constantly).

In my back of the envelope math, I'm only pulling out the negative book value associated with MBIA Corp from the adjusted book value, then slapping a 0.75x adjusted book value multiple on it.  Again, the other two items in MBI's adjusted book bridge seem more like market risks a buyer would be assuming and should be compensated for bearing the risk of eventually achieving.  AGO should be able to justify paying the same multiple for MBIA Inc since it will include significant synergies.  I come up with a deal target price of approximately $16/share, or 28% upside from today's prices.

I bought some shares recently (I know, another speculative arb idea!).

Disclosure: I own shares of MBI