Mid Year 2023 Portfolio Review

This will be more of a brief check-in rather than a full review.  Unfortunately, my recent spell of underperformance has continued into the first half of 2023, my portfolio is up marginally, 6.75% versus 16.89% for the S&P 500.  I'm still above my long term goal of 20+% IRR; the show goes on.

The main performance detractors were oversized positions in MBIA (MBI) and Transcontinental Realty Investors (TCI), two speculative M&A candidates that have failed to materialize.  Many of my other speculative M&A ideas did announce deals, but well below where I had penciled them out.  As a result, I've leaned more on smaller position sizes in the broken biotech basket and other flavors of special situations for new ideas recently.

The one outsized performer was Green Brick Partners (GRBK), homebuilders have exceeded low expectations as single family home inventory has remained tight despite rising interest rates.  I've begun to sell down my position, it had become too large and doesn't really fit into a value or special situation bucket any longer.

Closed Positions

• Radius Global Infrastructure (RADI), INDUS Realty Trust (INDT) and Argo Group International (ARGO) all received bids that were a bit disappointing from elevated early 2022 expectations when rumors surfaced that each were for sale.  All were interest rate sensitive businesses where the value declined as rates rose faster than initially expected.
• In the broken biotech basket: 1) sold Talaris Therapetuics (TALS) after their recent reverse merger with Tourmaline Bio for a nice gain; 2) sold Oramed Pharmaceuticals (ORMP) for minimal gain after a few readers pointed out their promotional (maybe being kind) management and then saw it first hand; 3) Sold Carisma Therapeutics (CARM, fka Sesen Bio) after the reverse merger, was left with a stub position (received the non-tradable Sesen CVR) that I sold fairly indiscriminately for a small loss.
• The Franchise Group (FRG) story ended rather disappointingly, have a bit of a bitter taste in my mouth, after rumors surfaced early in the year that CEO Brian Kahn was considering taking the company private.  FRG then went on to have a terrible Q1 where they breached a covenant in their credit facility, preventing them from continuing their dividend, that was disclosed at the same time as the company agreed to Kahn's $30/share buyout.  Since the company is kind of a one-of-one based on Brian Kahn's deal making, with a covenant breach, it was unsurprising that no other bidder came forward during the go-shop period.
• I sold Star Holdings (STHO) shortly after the close of iStar/Safehold transaction after a few readers reached out with some concerns on SAFE.  I'll re-evaluate down the road, this is one I'll likely rebuy again at some point in its liquidation journey.
• My thesis in Liberty Broadband Corp (LBRDK) was stale, I originally bought General Communications as a merger arb and held through GCI Liberty into Liberty Broadband.  Sold it more because of the opportunity cost, reinvested those proceeds into more current ideas.
• Digital Media Solutions (DMS) ended up rejecting management's buyout offer and instead took on debt to make an acquisition, now it's trading below a dollar.  I want to believe the existence of all these busted SPACs will eventually turn into more special situation type opportunities, but these are questionable management teams and it might take a little while longer for management and boards to fully come to their senses.
• Sonida Senior Living (SNDA) disclosed a going concern warning, I mentioned some place else that I oversized this position given the combination of operating leverage and financial leverage, should have treated this more as an option than a core position.  Shares have recovered a bit, but they still face a challenging labor environment and a lack of scale.

Current Portfolio

I do also have an assortment of non-traded securities (CVRs, liquidating trusts and a bond without a market) that I've omitted above.  Thanks for continuing to read and follow along, also thank you to all that have sent me ideas.  Everyone please have a safe holiday.

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.

Cyteir Therapeutics: Liquidation Announced

Cyteir Therapeutics (CYT) ($92MM market cap) is another broken biotech, unlike others, this one is forgoing a reverse merger and announced today they were simply liquidating:

Planned Liquidation and Dissolution

 

Due to the planned discontinuation of CYT-0851 development, and the previously announced discontinuation of Cyteir’s discovery pipeline, the Company’s Board of Directors intends to approve a Plan of Liquidation and Dissolution (“Plan of Dissolution”) that would, subject to shareholder approval, include the distribution of remaining cash to shareholders following an orderly wind down of the Company’s operations, including the proceeds, if any, from the sale of its assets. Prior to winding down operations, the Company intends to complete regulatory and patient obligations from the ongoing clinical trial. The Company will engage independent advisors, who are experienced in the dissolution and liquidation of companies, to assist in the Company’s dissolution and liquidation. The Company also intends to call a special meeting of its shareholders in the second half of 2023 to seek approval of the Plan of Dissolution and will file proxy materials relating to the special meeting with the Securities and Exchange Commission (the “SEC”). If the Company’s shareholders approve the Plan of Dissolution, the Company would then file a certificate of dissolution, delist its shares of common stock from The Nasdaq Global Select Market, satisfy or resolve its remaining liabilities, obligations and costs associated with the dissolution and liquidation, make reasonable provisions for unknown claims and liabilities, attempt to convert all of its remaining assets into cash or cash equivalents, including through a potential sale of CYT-0851, and return remaining cash to its shareholders. The Company will provide an estimate of any such amount that may be distributed to shareholders in the proxy materials to be filed with the SEC. However, the amount of cash actually distributable to shareholders may vary substantially from any estimate provided by the Company based on a number of factors.

The company isn't going to put out an estimate until they file their proxy, but let's attempt to make a conservative guess on how much they could distribute to shareholders.  Cyteir did layoff approximately 70% of their employees in January and incurred severance payments in Q1, so their expense run rate is probably significantly lower in Q2 and beyond given this announcement.  I have no clue how to value CYT-0851, but it doesn't sound like a total zero, there might be some additional value here.

Here's my quick, likely wrong, swag at a liquidation scenario:

I'm estimating $20MM of cash burn, which might be too high, especially during a period where money market funds are returning 5%, helping to offset some G&A.  I'm assuming a year end initial distribution of 90% of the cash, and then just 30% of the holdback amount in 3 years when the liquidating trust winds down.

Disclosure: I own shares of CYT

Astrotech Corp: Strange Microcap Net-Net, Unsolicited Takeover Offer

Astrotech Corp (ASTC) (~$24MM market cap) is an odd little microcap that IPO'd in 1995 as an aerospace company dubbed SPACEHUB, however, when the U.S. wound down the manned space program the company sold most of their operations to Lockheed and pivoted to "mass spectrometry technology" (don't ask me what this means) in the mid-2000s.  Astrotech has struggled to find a use case for their technology, they're currently pursuing testing for explosives in travel settings, cannibas industry applications and viral/COVID testing, all while generating minimal revenue in the past half decade.  The one thing they have sold plenty of is stock, during the mania of 2020-2021, Astrotech sold $79.4MM in equity in a series of capital raises.  As of 3/31, they only have $44.1MM of cash remaining and no debt, making it a net-net, albeit a low quality cash burning one.  If there was any doubt of management's lack of capital allocation skills, Astrotech announced a new ATM equity program earlier this month despite shares trading at an extreme discount to net cash.

Earlier this week, BML Investment Partners (good firm to watch, often involved in a lot of these broken biotechs and other net nets) re-entered the picture by amending their 13D to include an offer to buy the shares they don't own (currently own 13.1%) for $17.25/share.  In the exhibit, they included a brief letter below:

The CEO, Thomas Pickens III, owns 8.3% of the company (management has a whole owns 9.7%), he pays himself handsomely, some $1.2MM in 2022 which included a $450k salary and $375k cash bonus, added together that's just under the $869k in revenue the company did during the same timeframe.  So at first glance, I didn't like BML's chances of convincing the board to take their offer.

But an interesting thing happened yesterday afternoon, a day after receiving BML's offer, the company did indeed cancel their ATM program, which is a stipulation of the deal.  Why do that if they weren't serious about evaluating the offer?  Especially since the shares spiked up, making it more attractive to execute the ATM if that's the path they wanted to take.  That action alone is worth a small position for me.  BML did put a strangely tight timeframe on a response, but hopefully the company has already met that threshold by cancelling the ATM and acknowledging the offer in an 8-K.  From my memory, I don't remember BML buying a company outright, but they are experienced in liquidation scenarios and have likely helped companies execute them behind the scenes.  This doesn't seem like a stretch for them and there's no financing condition.

Shares currently trade for $14 or roughly a 20% discount to the offer price.  

Disclosure: I own shares of ASTC

Magenta Therapeutics: Likely Liquidation If Reverse Merger Vote Fails

Magenta Therapeutics (MGTA) ($39MM market cap) is a member of my broken biotech basket, I'm bringing it forward again to highlight the opportunity for shareholders to vote down the proposed reverse merger with privately held Dianthus Therapeutics.  In MGTA's S-4, the company strongly hints that if the deal is not approved, a dissolution and liquidation is on the table:

If the merger is not consummated, Magenta’s board of directors may decide to pursue a dissolution and liquidation. In such an event, the amount of cash available for distribution to its stockholders will depend heavily on the timing of such liquidation as well as the amount of cash that will need to be reserved for commitments and contingent liabilities.

There can be no assurance that the merger will be completed. If the merger is not completed, Magenta’s board of directors may decide to pursue a dissolution and liquidation. In such an event, the amount of cash available for distribution to its stockholders will depend heavily on the timing of such decision and, with the passage of time the amount of cash available for distribution will be reduced as Magenta continues to fund its operations. In addition, if Magenta’s board of directors were to approve and recommend, and its stockholders were to approve, a dissolution and liquidation, Magenta would be required under Delaware corporate law to pay its outstanding obligations, as well as to make reasonable provision for contingent and unknown obligations, prior to making any distributions in liquidation to its stockholders. As a result of this requirement, a portion of its assets may need to be reserved pending the resolution of such obligations and the timing of any such resolution is uncertain. In addition, Magenta may be subject to litigation or other claims related to a dissolution and liquidation. If a dissolution and liquidation were pursued, Magenta’s board of directors, in consultation with its advisors, would need to evaluate these matters and make a determination about a reasonable amount to reserve. Accordingly, holders of its common stock could lose all or a significant portion of their investment in the event of liquidation, dissolution or winding up.

Included in the S-4 is also a management prepared liquidation analysis (the distribution estimate here assumes a May or June 2023 distribution, clearly that's not a realistic timeline, additional liquidation costs will be incurred if MGTA does end up down that road):

In light of the foregoing factors and the uncertainties inherent in estimated cash balances, stockholders are cautioned not to place undue reliance, if any, on the Liquidation Analysis.

The below summary of the Liquidation Analysis is subject to the statements above, and it represents Magenta management’s estimates of Magenta’s cash which may be distributed to stockholders as permitted under applicable law pursuant to a plan of dissolution.

Key assumptions underlying the Liquidation Analysis included (i) that the entire distribution of Magenta’s net cash would be made in either May 2023 or June 2023, (ii) that Magenta would have approximately $65.2 million and $63.9 million of net cash as of May 2023 and June 2023, respectively, after deducting costs and expenses, including legal fees, the fees payable to Magenta’s strategic financial advisor, accounting fees, employee retention bonuses, severance and benefits, insurance expenses and other transaction-related costs, with no adjustments for taxes; (iii) that these costs and expenses were forecasted to total approximately $11.8 million assuming the closing of a liquidation in each of May 2023 and June 2023; and (iv) approximately 60.7 million total shares outstanding as of April 27, 2023. The analysis resulted in an estimated cash distribution per share in May 2023 and June 2023 of $1.07 per share and $1.05 per share, respectively.

Today, shares trade for $0.64 per share, well below management's liquidation estimate.  There's a reasonable presumption a liquidation would indeed follow a "no" vote to the merger, per the merger agreement, MGTA would be required to pay a termination fee of $13.3MM (huge in comparison to their cash balances or market cap) if MGTA enters into another merger within 12 months.

Termination Fees Payable by Magenta

Magenta must pay Dianthus a termination fee of $13.3 million if (i) the Merger Agreement is terminated by Magenta or Dianthus pursuant to clause (e) above or by Dianthus pursuant to clause (f) above, (ii) at any time after the date of the Merger Agreement and prior to the Magenta special meeting, an Acquisition Proposal with respect to Magenta will have been publicly announced, disclosed or otherwise communicated to the Magenta board of directors (and will not have been withdrawn), and (iii) in the event the Merger Agreement is terminated pursuant to clause (e) above, within 12 months after the date of such termination, Magenta enters into a definitive agreement with respect to a subsequent transaction or consummates a subsequent transaction.

A liquidation would be their only realistic option, 12 months is a long time to wait it out for a cash burning biotech with no pipeline (they sold all their assets in April).  In order to close the deal, MGTA needs a majority of the votes cast to vote in favor of the merger (edit: they need a majority of the shares outstanding), the support agreement only has 6.9% of the shares, leaving quite a bit of ground to cover.  Tang Capital Management owns just under 10% and presumably is the Investor named in the background section of the S-4 who proposed a cash tender offer:

Between March 1, 2023 and March 28, 2023, a stockholder of Magenta (the “Investor”) made several unsolicited inquiries to Stephen Mahoney, the President, Chief Financial and Operating Office of Magenta, to inquire whether Magenta would have an interest in the Investor proposing a cash tender offer for Magenta at a discount to its current cash position. No specific proposal, terms or valuation were discussed during this conversation, or any subsequent conversation between the Investor and representatives of Magenta.

It is unlikely that Tang would vote in favor of the reverse merger at this point, given the current discount to cash.  I'm guessing it will be challenging for management to get the 50% of the vote necessary, but as we've seen in other microcaps, getting investors to vote at all could be an issue.  A non-vote here doesn't impact the vote one way or another, likely benefitting management.

MGTA's target net cash position at the time of closing (Q3) per the merger agreement is $60MM, if we assume that the vote fails and MGTA pursues a liquidation, let's guess that they holdback $10MM for additional winddown expenses or contingencies.

Above is my potential IRR math, I'm assuming an initial distribution by year end and then a small one ($3MM of the $10MM holdback) in 3 years.  In addition, the company did sell their pre-merger assets in April, $20MM in combined milestone payments are in play too, but I'm assuming those are worthless.  The merger vote hasn't been set yet, but I would expect it in early-mid Q3.  I bought more recently.

Disclosure: I own shares of MGTA

Quince Therapeutics: Trading Below Cash, Facing Activist Pressure

Quince Therapeutics (QNCX) ($55MM market cap) is a broken biotech that is trading well below cash and is facing activist pressure from two parties looking to either acquire the company for cash or put the company into liquidation.  In the first half of 2022, Quince (known as Cortexyme at the time) bought Novosteo in a reverse merger, then in this past January, the company sold their old drug portfolio back to the previous management of Cortexyme who now run privately held Lighthouse Pharmaceuticals for a 7.5% equity stake in Lighthouse (plus a CVR of up to $150MM based on meeting certain milestones).  Alongside the asset sale, Quince also announced a 47% reduction in force and that they would be pursuing an out-licensing strategy for their remaining drug candidate, NOV004, which is designed to accelerate bone fracture healing.  The go-forward strategy now is:

On January 30, 2023, the Company provided an update on its development pipeline and business outlook for 2023. The Company intends to prioritize capital resources toward the expansion of its development pipeline through opportunistic in-licensing and acquisition of clinical-stage assets targeting debilitating and rare diseases. The Company plans to out-license its bone-targeting drug platform and precision bone growth molecule NOV004 designed for accelerated fracture repair in patients with bone fractures and osteogenesis imperfecta.

This acquisition strategy appears to be dubious given their track record, the current market mood towards reverse mergers and/or speculative biotech companies.  Biotechs in this position should show some humility, liquidate and let the shareholders decide where to redeploy that capital, not management.  My super simple back of the envelope math for these broken biotechs is as follows:

This situation has caught the attention of two investors: 

1. Kevin Tang owns just under 10% of the shares and based on other similar situations, one can assume he's asked if management would be open to an offer to buy QNCX for some discount of cash plus a CVR for any proceeds the pipeline brings in a sale; 
2. Echo Lake Capital submitted a non-binding proposal to buy QNCX for $1.60/share, which was formally rejected by the company, who then adopted a poison pill.  Echo Lake followed up this week with another letter criticizing management.

While management hasn't given up here like I would prefer to see, they have cut costs and this is basically a cash shell at this point with no business, not to dissimilar to other ideas in the broken biotech basket.  If Tang or Echo Lake manage to force management's hand, a strategic alternatives or liquidation announcement could be a catalyst to move the stock higher.

Disclosure: I own shares of QNCX

Check-Cap: Failed Biotech, Trading Below Cash

Check-Cap (CHEK) (~$12MM nano cap) is an Israeli based clinical-stage medical device company that is trading well below cash and recently announced that it hired Ladenburg Thalman (they've generated a few buzzy reverse mergers in the past) to run a strategic alternatives process.  The company previously was developing a colon cancer screening test but those efforts failed and alongside the strategic review announcement, Check-Cap also announced they are laying off 90% of their workforce, fully raising the surrender flag.

Running it through a really basic liquidation analysis (it should be noted the company didn't include a liquidation in the list of strategic alternative options, but rather they're looking at a sale, licensing agreement or reverse merger):

The severance costs for the 90% reduction in force weren't disclosed, so that's a guess, along with the G&A, but this one still trades at a wide discount to what it could distribute in a liquidation.  Now there are some red flags, I don't see a significant shareholder to protect shareholder interests and the foreign company listing and raising money in the U.S. risk is present here, although not entirely uncommon for biotech/bio medical device companies to be based in Israel.

Note this is a tiny company, don't use market orders, but the discount here is wide enough for me to add a small position to my growing basket of broken biotech liquidation candidates. 

Disclosure: I own shares of CHEK