Syncora Holdings: Operating Business Sold, Cash and NOL Stub

Syncora Holdings (SYCRF), through its subsidiary Syncora Guarantee ("SGI"), is a provider of bond insurance that ran into a whole bunch of trouble following the financial crisis.  Like the other bond insurers, Syncora branched out beyond municipal insurance (to be fair, they did also suffer with Detroit and Puerto Rico) to subprime RMBS, CDOs and other toxic securitizations of the pre-crisis era.  During and following the recession, many of the supposedly AAA structured securities were impaired and Syncora was called upon to make good on their guarantee which forced the insurer to the brink of insolvency.

In the decade since, Syncora has been in constant litigation (they scored several huge settlements with banks that issued subprime RMBS) and restructuring mode.  Previously a bit of a black box, Syncora last month sold SGI to an affiliate of credit manager Golden Tree Asset Management for $392.5MM with a go-shop period through September 13th.  It then re-struct the sale price higher with Golden Tree this past week to $429MM plus the assumption of some preferred share pass-thru securities that wasn't originally included in the deal after receiving an unnamed unsolicited offer (the go-shop was also cancelled).  Once the transaction with Golden Tree closes in Q4/Q1, Syncora plans to distribute the sale proceeds to shareholders, all that will remain is $30+MM of cash and miscellaneous assets (valued at $45-60MM total including the cash) plus around $300MM of net operating losses.

Syncora has 87 million shares outstanding, assuming about $20MM in leakage and other deal related expenses, the company will likely distribute cash back to shareholders roughly equaling today's $4.70 share price.

Assumes no value attributed to the NOL

What is the company going to do with the stub after the SGI deal closes?  Anyone's guess, it will be a tiny shell with a few random assets (waterfront raw land in Detroit, 80% of Swap Financial), management claims to be in active conversations with their advisers on a transaction, but the NOL monetization dream is elusive for many if not nearly all similar NOL shell stories.  So maybe the 30% discount to NAV needs to be a touch higher, at a 50% discount I come up with a 16% IRR, still an attractive situation.

Disclosure: I own shares of SYCRF

MMA Capital: Externalizing Management, Transforming into BDC-Like Vehicle

Woke up to some fun news Tuesday, MMA Capital (MMAC) is selling its asset management business and some other assets to Hunt Investment Management for $57 million resulting in Hunt becoming the external manager of MMA Capital.  Once the dust settles, if you squint hard enough, MMA Capital will look like a BDC or yieldco but maybe without the high dividend to attract in retail investors.  Even though my thesis is almost played out (original idea: this was a pile of assets that was hidden by GAAP accounting choices, maybe one day becomes an operating company), the current price may offer a short term opportunity as the series of transactions with Hunt are completed.

Here's the deal deck (try not to cringe, MMAC clearly didn't pay high priced advisers): https://mmacapitalmanagement.com/wp-content/uploads/docs/MMAC-Shareholder-Presentation.pdf

Who is Hunt Investment Management?

Hunt is a privately held asset manager that focuses on real estate and infrastructure sectors, they specifically mention they manage $12B in real estate related assets and have some expertise in public-partnerships, military housing, and other sectors that might have some parallels with MMA Capital's affordable housing and solar energy verticals.  All of MMAC's employees will move over to Hunt and keep their same employment contracts which still do call for much of management's bonuses to be invested in MMAC's stock in open market purchases.

The new management fee agreement is the biggest concern I see in the deal, it's 2% annually (0.5% quarterly is how its presented, hate that optics game) of shareholder equity up to $500MM and tiered down to 1% annually after that.  We're a long way from $500MM, so its effectively 2% for the foreseeable future.  Plus Hunt will get a 20% carry on shareholder returns above 7%, so this is a fairly standard (bad) external management agreement like you'd typically see in the BDC industry. There is a carve out for this year that adjusts the equity value up to the proforma book value of ~$33.50 shown in the presentation when calculating 2018 fees and will be adjusted to exclude the effects of the companies NOLs in the event the valuation allowance is removed and a deferred tax asset is recognized.  There's also a termination payment of 3 years fees, so yes, while this is standard and I assume Hunt required this to protect their $57 investment, its far from a shareholder friendly deal.

What's Left?
This transaction removes the main remaining 'hidden asset' the company had, the asset management platform it had built in affordable housing, South Africa multifamily, and solar energy.  What's remaining is the bonds themselves, their investment in one of the South African funds, and two real estate projects.  Additionally they have ~$400MM in NOLs that are worth less under the new tax code.  If they ever are realized it'll be because MMAC was able to raise capital, scale up, and generate some taxable income (their plan), but that also means a higher share count and the value of those NOLs will be significantly diluted to current shareholders by the time their realized.

In their own words:

The new strategy sounds very much like a specialized BDC (maybe the altruistic mandate will appeal to some people) attempting to earn a ~10% ROE, general rule of thumb is a 10% ROE financial should trade for roughly book value.  Today it trades for $28.60, leaving 17% upside to the proforma book value, maybe that discount is deserved for reasons discussed below, but I'll continue to hold for now and wait for the dust to settle.

Other thoughts:

• The company is doing a capital raise with Hunt, where Hunt will be purchasing $8.375MM worth of MMAC stock at $33.50, afterward Hunt will own a little more than 4% of the company.  This is in addition to the $57MM headline number, mostly for PR to show alignment of incentives with the public shareholders.  While not an arms length transaction, still shows someone is willing to pay book value.
• MMAC is providing seller financing to Hunt for the full $57MM amount, 7 year term at a 5% coupon.  Hunt will be receiving about a $4MM annual base management fee off of the proforma equity base of ~$200MM.  When coming up with a new NAV, might be reasonable to discount it, not necessarily for credit reasons (the base management fee easily covers the annual interest payments) but because MMAC's capital is now tied up in an asset that wouldn't meet its targeted return requirements even if levered up.  They'll have a little drag in the portfolio until its redeemed.
• CEO Michael Falcone owns over 182k shares (~3.15% of the company) and his lieutenant Gary Mentesana owns over 167k shares (~2.87%), they've been surprisingly transparent on conference calls, structured their compensation to align with shareholders, bought back as much stock as they legally could; they're mostly aligned with shareholders in this deal despite now being employees of Hunt.  I don't see this as a typical dirty BDC-like management stealing the company type move.
• They didn't specifically touch on it, but the company will likely need to pay a dividend in order to raise capital in the future, that's at odds with most NOL companies mantra to retain all earnings in order to grow and pull the NOL forward as much as possible.  I think a dividend would be the right move once the transactions are finalized, as mentioned earlier, the NOL is going to get diluted anyway, might as well get the valuation uplift from yield based investors.

I started this post with the idea that shares were unfairly undervalued after the deal, but maybe the price is approximately right given the deal closing risks, interest rate risk in the current environment, and the discount applied to externally managed companies.  Most of all, the deal is probably management signaling the heavy lifting is all but complete in bringing MMAC back from the brink after the financial crisis.  So this is more of an update and an interesting twist in this deep value micro cap story, would love to hear from other MMAC shareholders too.

Disclosure: I own shares of MMAC

LGL Group: Gabelli, Rights Offering, Acquisition Proposal

LGL Group (LGL) is a micro-cap ($15MM market cap with a vintage space age logo) that makes frequency control components for the defense, aerospace and electronics industries.  Their market is mostly a commoditized industry but they've been shifting towards higher margin offerings in recent years with some success.  LGL Group has about $10MM in federal NOLs plus some other state and research credits, but this isn't a typical patent troll type NOL shell.  Mario Gabelli is a significant shareholder, not via his GAMCO mutual funds but directly in his/his family's names and his son Marc is on the board.  LGL is a very small holding in comparison to his net worth in GAMCO but like Carl Icahn's involvement similarly small companies, Gabelli has a lot of energy, loves the investment game and especially taking advantage of tax assets.  I think its clear based on the type of business this isn't a vanity project, he owns LGL to make money even if it's small in comparison to his net worth.  I've seen him speak on several occasions and he's always mentioning the tax disadvantages faced by old fashion open ended mutual funds compared to ETFs or especially real estate held for investment.  Plus he loves boring small industrial companies (where he started his career as an analyst), so his investment in LGL Group makes perfect sense.

This is another simple thesis with a near term catalyst, LGL announced a rights offering beginning on 9/5/17 to raise a little more than $11MM to pursue acquisitions, likely to monetize their NOLs without creating an "ownership change", the offering was expected to close on 10/10/17.  The rights offering was a little unconventional because it was announced at a small premium ($5.50 exercise price) to the share price at the time of the announcement and it was going to be tradeable, at a premium, what value would the rights have if you could just buy the shares directly for cheaper?  I looked at it then, as I try to look at all rights offerings, and passed.  But on 10/5, they issued a press release announcing the rights offering would be pushed back until 10/25 because they received a non-binding cash offer for their two operating businesses making the situation a lot more interesting.  Then on 10/23 they pushed the rights offering expiration back again to 11/13, likely to give both sides more time to agree on a deal?

The shares today trade for $5.66, we know that Gabelli was a buyer at the rights offering price of $5.50 as he's essentially backstopping the rights offering and along with the current CEO will have effective control of the company after the rights offering settles.  With the potential cash offer on the table, I think it significantly de-risks the situation:

• On the upside, we could either get straight taken out at a premium or receive a significant cash infusion to the holding company.
• On the downside, the two sides can't come to a deal, you still have an improving operating business, the rights offering closes and the company receives a cash infusion for additional acquisitions knowing that a proven capital allocator is effectively in control of the company.

The company has $6MM in cash and marketable securities on the balance sheet, no debt, and the operating businesses did about $1MM in EBITDA over the trailing twelve months ended 6/30 (but EBITDA for the first six months of '17 was about double '16, so there's some ramp to the business happening), putting the EV/EBITDA at approximately ~10x, not on the surface particularly cheap.  But several things strike me:

1. The investment group submitted their bid after the rights offering was announced so they must believe their offer is the superior path and has some urgency to it; 
2. Gabelli likely can't buy significant amounts of shares on the public market, either for liquidity reasons, or because he has non-public material information, but he can have the company conduct a rights offering and acquire shares that way, oversubscribe, and gain control of the company; 
3. The company is run by a 40+ year industry veteran in Michael Ferrantino, however he came to LGL in 2014 to spark a turnaround, he's 74 years old, the business trajectory is turning for the better, is now the time to cash out and retire?

It's worth noting that the company did receive a similar offer for parts of their operating business in June 2013 and turned it down, but the offer spurred strategic review that led them down their current positive path, so it's certainly possible the same thing happens again and a short term catalyst speculation turns into a longer term bet on the jockey type investment.

Disclosure: I own shares of LGL

Inotek Pharmaceuticals: Selling Below NCAV, Exploring Strategic Options

Inotek (ITEK) is a rather simple and small idea that adds to my recent theme of buying up the scraps of busted biotech companies.  Inotek was focused primarily on the treatment of glaucoma, an eye disease with a high unmet need, however their only drug, Trabodenoson, failed recent trials and it appears to be the end of the road for Inotek.  They've suspended research and development, hired Perella Weinberg Partners to pursue strategic options, and now sell below net current asset value.

Their balance sheet is now mostly cash and short term investments, offset by some convertible notes:

The current market cap is around $27MM, they'll burn ~$4MM a quarter on G&A and interest costs, and NCAV is ~$57MM.  Inotek does also have $105MM in NOLs, but the company should probably just call it a day and liquidate, hopefully we know more soon, but this seems like a fairly straightforward bet.  The biggest risks are the burn rate being higher than anticipated and/or a bad reverse merger transaction happening, both are more likely than I'm probably baking into the situation.

Disclosure: I own shares of ITEK

iStar: Non-Dividend Paying REIT with Significant Development Assets

iStar (STAR), f/k/a iStar Financial, is an internally managed former commercial mortgage REIT that ended up foreclosing on a variety of land, development projects, and operating assets (office, hotel, condo projects) across the country following the financial crisis.  Over the last several years iStar has poured money into these foreclosed assets to reposition them for an eventual exit, much of that investment should start showing up in asset sales over the next 1-3 years.  Cash from the sales could then be recycled into their core commercial mortgage and net lease business making the company easier to understand and value.

iStar is an odd REIT that doesn't pay a dividend, REITs are generally under-invested in by institutional investors (although that may change now that REITs have recently been carved out of financials into their own S&P sector) but are generally favored by retail investors because of their high dividends.  iStar misses both investor bases.  iStar is a unique pass-through entity that has NOLs from the financial crisis (similar to ACAS in the BDC industry) and are using their tax asset to shield taxable income (bypassing the 90% distribution rule) in order to reinvest in their business and repurchase shares.  They're not getting credit for this strategy as it doesn't immediately result in higher dividends or in a clearly articulated higher NAV value.  Instead, iStar uses a gross book value metric in their press releases which adds back depreciation on their real estate but does not give any credit to the increase in real estate values since they acquired the development assets via foreclosure or the additional value created above cost as they've deployed capital into those properties.

iStar breaks out their business into four main buckets: 1) Real Estate Finance, 2) Net Lease, 3) Operating Properties, and 4) Land and Development.  Real Estate Finance and Net Lease are complementary businesses as a triple net lease property is essentially a financing transaction.  The Operating Properties and Land and Development segments are the assets iStar acquired through foreclosure, over time these segments should shrink from 36% of assets to become a smaller part of the pie.

2015 10-K

Their asset base is pretty well diversified across geography and real estate subsectors, although the public market likes clean pure-play REITs, diversification still reduces risk, especially in the land and development asset class.  If one area of the country is seeing a slowdown, they can pull back their development plans and focus on other opportunities (seeing this with HHC shifting capital away from their Houston assets).

Q2 16 10-Q

There's a lot of noise in their Operating Properties and Land and Development businesses as earnings are lumpy based on when assets are sold.  iStar breaks out their commercial Operating Properties between stabilized, those that are leased up at prevailing market rents, and transitional, those that have low occupancy and need to be re-positioned.  I think it makes the most sense to value iStar's core Real Estate Finance, Net Lease business lines and the stabilized Operating Properties as if it were a typical straightforward REIT that pays a dividend.  The below is a bit of a crude back of the envelope valuation, but it shows that the market is giving little credit to the value in iStar's transitional operating properties and in their land and development holdings.

On an FFO basis:

iStar has quite a bit of leverage, so a pure FFO multiple probably isn't appropriate but still shows the value embedded in iStar's complicated structure as the shares currently trade for $11.00, less than 14x FFO of just the core Real Estate Finance and Net Lease portfolios.

On an NAV basis:

The above analysis assumes a 6.5% cap rate for the net lease and stabilized operating property assets and values the rest of iStar's assets at book value despite many of the land and development assets being valued at 2010-2012 cost basis on the balance sheet.  One way to look at iStar's valuation, the market is hair-cutting the foreclosed assets by 70% despite significant progress made in recent years to entitle and further develop these assets.  It's likely that these assets could be worth 1.5-2.0x what they're carried at as value is realized over the next 1-3 years.

Land and Development Assets
iStar's Land and Development assets are quite extensive but there's not a lot of disclosure around the specifics of each asset in the 10-K, maybe something for the new CFO to implement?  In total they control land that will eventually contain over 30,000 residential units, not an insignificant number.  Management expects the back half of 2016 and into 2017 to be big realization years, with $500MM in exits targeted from the Land and Development and Operating Properties segments.  Below are a few projects that are currently in production or under development:

• 1000 South Clark: 29 story, 469 unit luxury apartment complex located in Chicago's South Loop.  iStar partnered with a local builder in a JV, its both an equity investor and a lender in the deal, it will likely be sold after stabilization early next year.
• Asbury Park Waterfront: iStar recently opened an "adult playground" hotel, The Asbury, in Asbury Park, NJ (Jersey Shore), the hotel/entertainment venue is meant to spur additional development in the surrounding 35 acres of land iStar owns that will eventually support over 2,700 residential units.  iStar is currently finishing up a small condo project, called Monroe, which is 40% sold and has plans to revive an uncompleted high rise construction project called Esperanza that was abandoned after the financial crisis.
• Ford Amphitheater at Coney Island: iStar just recently completed construction on a 5,000 seat amphitheater along the boardwalk in Coney Island, the amphitheater was built to spur additional development around it, which iStar has 5.5 acres and plans for 565 residential units.
• Grand Vista: 5,500 acres of mostly raw land on the outskirts of Phoenix that has plans for 15,000 residential units, this was a large failed project before the financial crisis and it may take a while before Phoenix builds out to this site.
• Highpark: Formerly known as Ponte Vista, Highpark is a 62 acre former naval shipyard in San Pedro, California which will house 700 new residences.
• Magnolia Green: A classic master planned communities outside of Richmond, VA with a golf course and room for 3,500 residential units.  It has an estimated sellout date of 2026 and another 2.400 units remaining to be sold.  Richmond is becoming a hot market, the city itself is pretty vibrant and it's in a good geographic weather location, it should attract both millenials and retiring baby boomers.
• Marina Palms:  Two luxury towers along with a marina in North Miami Beach, the second tower is currently under construction and slated to be finished in December 2016.  The company partnered with a local builder and contributed the land for a 47.5% interest in the JV.
• Spring Mountain Ranch Place: 785-acre master planned community located in the Inland Empire.  For the first phase of the development, iStar partnered with KB Homes and retained a 75.6% interest in the JV, the first phase calls for 435 homes, 200 of which had been sold as of 12/31/15.  Additional phases of the MPC will bring a total of 1,400 home sites.

NOLs
iStar has $856MM of net operating loss carry-forwards at the REIT level that can be used to offset taxable income and don't expire until 2034.  The NOL allows iStar to utilize retained earnings to grow rather than tap the capital markets constantly like traditional REITs.  This is a plus for iStar as they trade for a significant discount to my estimate of NAV, if forced to pay out market rate dividends they might not be able to access enough capital to fully realize the value of their development assets.  Additionally, they have more available free cash flow to buyback shares which should ultimately be a better use of cash at these prices than paying out a dividend.

Share Repurchases
The company is a large net seller of real estate, they will be selling down their portfolio as time goes on using the proceeds to pay down debt and repurchase more shares.  In the past twelve months iStar has repurchased 19% of their shares outstanding, after the second quarter they approved another $50MM increase to their repurchase program.  The combination of selling their non-core assets above book value and buying back shares below NAV is powerful and could lead to some substantial returns.

Risks

• Jay Sugarman is the CEO of iStar, he's been in that position since the late 1990s and thus led iStar into the financial crisis, he has a lot of the trappings of a NYC real estate guy (owns a sports team, Philadephia Union of the MLS, and a massive home in the Hamptons).  But like Michael Falcone at MMAC, sometimes you need the guy who led you into the abyss to lead you out because they know each asset intimately and where the bodies are buried.
• Does iStar go back to the "boring" business of real estate finance and net lease after diving into the glamorous development world?  Their website and headshots don't look like your typical REIT or credit shop, I worry the management team has fallen in love with real estate development and the portfolio won't ever resemble a clean REIT until iStar exhausts its NOLs.
• Timing of asset sales, a few of iStar's land and development assets have long tails (10+ years), if they intend to do the development themselves versus selling to a local builder it could push out the value realization time frame.
• Leverage, convertible bonds/preferreds, development assets all make iStar more vulnerable to a recession and a downturn in real estate prices.  They have some near term debt maturities and are generally dependent on the capital markets on an ongoing basis for both debt refinancing and asset sales.

iStar reminds me of a combination of HHC (hard to value development assets, atypical for a public vehicle), MMAC (real estate acquired through foreclosure that's difficult to piece out, cannibal of its own shares), and ACAS (pass through entity that doesn't pay a dividend due to its NOL assets).  Over time I think can generate similar gains as those previous ideas.  Thanks to the reader who pointed it out in a previous comment section.

Disclosure: I own shares of STAR

Par Pacific Holdings: Wyoming Refining Acquisition, Rights Offering

I wrote a poorly timed update of Par Pacific Holdings about six weeks ago, since then the shares have dropped over 20% as crack spreads continued to tighten at the same time as Par Pacific's principle refinery asset in Hawaii is shutting down for a period to undergo significant maintenance.  Crack spreads are of course volatile, however management has guided to the Hawaiian business generating $100MM in mid-cycle EBITDA keeping the valuation thesis largely intact.  The growth story relies on Sam Zell's handpicked team making additional acquisitions in the currently distressed energy sector in order to finally start making a dent in the large tax asset.

This past week, Par Pacific announced the acquisition of Wyoming Refining, it operates a small refinery (18,000 bpd) and related logistics assets in Newcastle, WY which supplies the Rapid City, SD market and nearby Ellsworth Air Force Base.  The refinery is in the attractive Rocky Mountain region (PADD IV) where oil supply outstrips local refining capacity and where demand is growing due to the increased industrial activity (although much of it is oil and gas related) in the region, this creates wider average crack spreads.

Par Pacific is paying $271MM for Wyoming Refining from a private equity owner and its expected to generate $50MM in EBITDA, or a 5.4x multiple, which unfortunately doesn't appear like a particularly distressed asset.  The previous owners have invested significant capital recently to increase the capacity of the refinery which should minimize near term capex needs, but I was hoping the next deal would be a fire sale asset from a distressed E&P company, but onto the deal details and resulting change to the valuation.

Note the rights offering and quick July 15th close, more details will follow on the structure of the rights offering but any current shareholders should be prepared to fully participate or face dilution.

The crack spreads for this niche refinery are pretty huge, at least in comparison to the high single digits seen at Par's Hawaiian refinery, much of that can be attributed to difference in the supply chain, Hawaii has to source crude oil from at least half an ocean away whereas the Wyoming refinery is close to new fracking supply that's come online in recent years.

Proforma Valuation
Using the same basic frame work from a couple months back and updating for the recent Q1 results and Wyoming Refining acquisition:

The market is roughly assigning no value to Par Pacific's ownership in Laramie Energy (which is maybe right? I'm not smart enough to value an E&P) and no value to the NOL as well (which could be right as well, quickly finding out its not easy to generate taxable income in the energy sector).

Disclosure: I own shares of PARR

Par Pacific Holdings: Update, Distressed Energy M&A Thesis

I received the Par Pacific Holdings (PARR) annual report in the mail this week and thought it made sense to revisit my initial thesis in an updated post now that I've spent more time on the company in the past 20 months I've owned it.  Last fall Par Pacific changed the holding company's name from Par Petroleum, and renamed their Hawaiian operations Par Petroleum, which coincided with Bill Pate being appointed CEO and signaling the future direction of the company.  Par Pacific traces its roots back to 2012 when it was known as Delta Petroleum, a failed natural gas producer that went through bankruptcy and ended up in the hands of creditors, the largest of which was Sam Zell's organization through the Zell Credit Opportunities Fund.  In the reorg, $265MM in debt was converted to equity and the $1.4B in net operating losses were preserved giving Par a significant tax shield as they pursue an acquisition strategy.

Sam Zell built his reputation and wealth as a distressed investor, and with much of the energy industry in distress, Par Pacific Holdings is a way to invest alongside him and his management team in an environment that should see plenty of attractive deal opportunities.  The bulk of Par Pacific today was created through two acquisitions of refining and retail assets in Hawaii.  In 2013, they bought Tesoro's Hawaiian operations for $75MM plus a $40MM earn out and in 2015 they paid $120MM for Mid Pac Petroleum (primarily retail locations).  Last year alone these assets generated $110MM in EBITDA.  Distress in the upstream oil and gas sector is migrating down to pipeline and retail players, Par Pacific's main focus going forward.

In current form, the company has three primary assets: Par Petroleum (Hawaiian downstream business), Laramie Energy (Colorado based natural gas E&P), and the tax assets.

Par Petroleum: Refinery, retail distribution network and related logistics assets located in Hawaii.

• Tesoro had mothballed their Hawaiian refinery and related assets, running them as an import, storage and distribution terminal while running an asset sale.  Most everyone passed, Tesoro wrote down the refinery to nothing, and then eventually Par came along and scooped it up for $75MM plus working capital/inventory.  Why did Par get a deal?  Tesoro made the strategic decision to exit Hawaii and focus on a new large acquisition it made with BP's old refinery in Southern California that could be operationally leveraged with Tesoro's in the same vicinity.  The Hawaiian business provided limited operational synergies and was a small piece of Tesoro's overall refinery business.  With no other buyers, Tesoro was able to effectively reallocate $325MM of net working capital to a more productive project for them with Par as the beneficiary.
• Being isolated in the Pacific Ocean, in order to drive profitability Par needed to increase it's on island sales otherwise it's expensive to ship refined product to either the west coast or Asia ($6 per barrel).  In 2014/2015 Par announced and closed on the acquisition of Mid-Pac Petroleum - 80 retail sites throughout the Hawaiian Islands.  The Mid Pac deal helps Par sell their refined product locally and internalizes consumption allowing Par to get both retail and refinery margins.  On a standalone basis the price wasn't outstanding, but the operational synergies Par will be able to squeeze out of their refinery makes it a transformational one.  They also own the land under 20 of the retail locations, so they have the ability to do a sale leaseback in the future.  With the Mid Pac retail locations, Par currently has 91 locations under the Tesoro and 76 brands, about 20% of the overall Hawaiian market.
• Management still believes there are acquisition opportunities in Hawaii, most likely additional retail to further drive the on island sales to match the output at the refinery, limiting the need to export.
• Later this year they will need to spend $30-35MM in maintenance capex at the refinery.  I assume/hope they will do their best to run at peak capacity around the scheduled down time in order to minimize impact.  Management has guided that the refinery will run at 1/2-2/3 capacity in the 3rd and 4th quarters.
• The refinery competes with one other in Hawaii, also located on Oahu, it was previously owned by Chevron and had shopped extensively until it was recently acquired by a private equity firm this month.  It's about half the size and Par was optimistically thought to potentially be a buyer of some Chevron assets, but regulators probably wouldn't have it.  The sale is likely just neutral for Par until we know more about the new owner's intentions.
• Par recently started breaking out their logistics assets as a separate reporting segment even though all sales are inter-company transactions and consolidated for reporting purposes.  But this change potentially signals further midstream acquisitions and in a distant future where MLPs make sense again they could sponsor their own and drop assets down.
• The combined Par Petroleum segment did about $110MM in 2015 EBITDA, which will probably come down some in 2016 with crack spreads coming in and the planned downtime at the refinery.

Laramie Energy: A minority interest in a privately own natural gas exploration and production company located in the Piceance Basin in Colorado.  This started as a legacy asset of Par's predecessor Delta Petroleum.

• In March, Laramie Energy completed a bolt on acquisition of nearby acreage for $157.5MM with Par contributing $55MM.  As a result of the deal, Par Pacific now owns 42% of the common equity and accounts for the position using the equity method.  Par's additional investment essentially created their own balance sheet write-down as of 12/31/15, the better the deal for Par the larger the write-down they needed to take.  But proforma for the acquisition, Laramie has a book value of $131MM.
• The timing of when the new acreage came up for sale wasn't ideal, management had been out in the investor community discussing mid and downstream acquisition targets but since this was adjacent to their existing JV the deal had a lot of strategic/operational value similar to what Mid Pac accomplished in Hawaii.  They know the area, and can spread their overhead costs over a larger asset base giving them additional leverage if the natural gas market recovers.
• Bob Boswell runs Laramie Energy, he's an industry veteran, currently serves on the board of Cabot Oil & Gas and has a history of starting and selling oil and gas producers.  In 2007, the first iteration of Laramie Energy was sold to Plains Exploration and Production for $1B, three years after the company was setup for $200MM (plus bank loan debt).
• Management seems realistic about this asset and has limited drilling planned for the near future.  They've also hedged much of Laramie's production through 2018, giving it the ability to wait out the cycle for a few more years.  It's mostly an upside option on natural gas prices.

NOL Tax Asset: $1.4B in net operating losses that can be used to offset future taxable income.

• Why do I like NOLs?  They attract long term investors that understand the importance of capital allocation and generally create an incentive to purchase cheap free cash flow businesses in order to monetize the NOL quickly.  The sooner the NOL is used up, the more valuable it becomes.
• Having the NOL reduces Par Pacific's cost of capital allowing them to be more competitive (pay a higher price) for acquisitions.  It also gives them additional flexibility in an asset sale (Laramie Energy for instance) where they could be more agreeable to a deal well above their cost basis knowing they have an NOL in place to shield capital gains.
• It is slightly tough having energy assets in an NOL heavy corporate structure, many energy businesses have built in tax shields to their business.  Par hasn't made much, if any, progress yet in monetizing the NOL, they're going to need a couple sizable acquisitions in coming years to start making a dent.

Valuation:

Below is a quick and dirty valuation for Par Pacific, refiners trade for 4-6x EBITDA, midstream trades 12-15x EBITDA, and retail seems to trade around 8x EBITDA.  For Laramie Energy, it's probably simplest to use the equity method book value; I'm thoroughly ignorant to how oil and gas companies are valued.  If anyone has any specific thoughts on Laramie's value, I'd love to hear them. 

At current prices, you're paying a cheap to fair price for the current assets and you get the acquisition runway/management as an upside option.  But I understand if non-shareholders would want to wait to see the next acquisition, it could create a better buying opportunity especially if it's paired with a rights offering.

Additionally, it seems like once a year the stock tanks for no apparent reason, in the summer of 2015 the company filed a shelf registration per the Shareholder Rights Agreement with Zell and other large shareholders which gave them the option to sell, but didn't actually mean they were going to, the stock sold off as if everyone was exiting and it went on to recover fairly quickly.  Shareholder Rights Agreements are one of those filing events to look for as some people sell first and ask questions later.

Risks:

• Hawaii - The state is a difficult place to do business, its heavily regulated and communal, they don't like outsiders running critical businesses in their state as can be seen with the Hawaiian Electric - NextEra merger drama.  Politically the state has a long term plan to move away from fossil fuels and have their energy needs provided 100% by renewable energy sources by 2045.  I would assume its safe to say that the military, tourism and other industries will still require refined products but there might not be room for two refineries long term if Hawaii meets its renewable energy mandate.
• Roll-up/Acquisition Strategy - Par Pacific describes itself as a growth company and most of that growth will come from repeated acquisitions funded through repeated capital raises.  The serial acquisition platform companies of the recent cycle have made roll-ups a dirty word as cheap debt and giddy equity markets led to some questionable deals and following meltdowns.  With Par Pacific you must believe in management's ability to identify attractive deals and not overpay for them.
• Equity Raises - Par Pacific will be a serial issuer of private placements or stapled rights offerings to fund its larger acquisitions in order to maintain the NOL asset.  Rights offerings are usually done at a discount, so shareholders will need to participate in them or be diluted.  I don't have any evidence to back this up, but it also seems to create a ceiling on the share price as investors become concerned that as the share price rises that management will use it as an opportunity to issue more equity.
• Natural Gas - After the recent bolt on acquisition, Laramie Energy is now a larger part of the company at a time when natural gas is as cheap and abundant as it has been in a long time.  Many oil and gas companies are going bankrupt, others have pulled way back on production, maybe at some point in the distant future natural gas prices will rise again, but they're likely to stay low for the foreseeable future.

Disclosure: I own shares of PARR

MMA Capital: Update, Balance Sheet Revealing Itself

Another update on a big position I haven't mentioned in 2015, quick background:

• MMA Capital Management (MMAC) is essentially a pile of assets (mostly tax advantaged low income housing bonds) selling well below their true net asset value.
• In 2015, the company has been recognizing large gains by selling off low basis real estate acquired during the financial crisis via foreclosure and then starting up a solar energy lending business with a JV partner where they'll ultimately park $50MM dollars while also earning a management fee.
• Cost accounting, consolidation rules, and it's inability to recognize the sale of the LIHTC business for GAAP purposes has artificially reduced the reported book value of the company.
• Some of my earlier posts from 2014: http://clarkstreetvalue.blogspot.com/2014/10/mma-capital-update-new-name-up-listing.html, http://clarkstreetvalue.blogspot.com/2014/03/municipal-mortgage-equity.html

MMA Capital released their Q3 results on Friday (11/13), they're hosting a call on Thursday (11/19) so if there's anything new that comes out of that I'll update this post as well.  The company's reported book value is up to $15.55/share, this time last year it was $9.25/share, the increase is mostly a result of monetizing low basis real estate, but if you take the time to read the 10-Q (not an easy read), there are two additional items that happened after 9/30 that increase their book value even higher making the current share price a bargain even after an impressive run this year.

Preferred Stock Investment

MMA Capital owned $36.6MM in preferred shares in a mortgage servicer, it had been held on the books for $31.4MM, but in the 10-Q, MMAC revealed that it been redeemed at par:

On October 30, 2015, the Company's investment in preferred stock were fully redeemed by the issuer at par value of $36.6 million and, as a result, the Company terminated the two aforementioned total return swaps and will recognize a gain of $5.2 million during the fourth quarter of 2015.  Refer to Note 6, "Debt", for more information.

Now $5.2MM might not seem like a lot, but on an $89MM market cap it's pretty significant, it's an additional $0.79/share in book value and also reduces the company's debt, and confusing TRS arrangements.

IHS Bankruptcy Estate
International Housing Solutions is MMAC's South African investment/property manager arm, up until recently there was a small minority ownership that was collapsed and wrapped up into MMAC during the second quarter.  In the latest 10-Q, another sizable gain occurred:

On November 12, 2015, the Company reached an agreement to acquire at a significant discount from the bankruptcy estate of one of the co-founders of IHS, all interests held by such estate in the Company's subsidiaries or affiliates, including notes payable and other debt obligations of the Company that had a carrying value in the Consolidated Balance Sheets of approximately $4.4 million as of September 30, 2015.  Among other provisions, such purchase agreement provides for the release and discharge of the company from its payment obligations associated with such deb instruments.  As a result, and based on all consideration to be exchanged under the agreement, the Company will recognize during the fourth quarter of 2015 a net gain in its Consolidated Statements of Operations that is estimated to be between $3.0 million and $3.5 million.

Let's call it $3MM on the low side, or another $0.45 per share in book value.  So without anything additional, and assuming no big market disruptions/losses, we know the year book value will be at least $16.79 per share.  It's trading at $13.79 or 82% of that adjusted/current book value.

Additional Items Not Included in GAAP Book Value:

• $418.2MM in NOLs, at a 35% tax rate that could be worth ~$145MM, more than the entire company. It's hard to imagine them utilizing in current form, but on previous conference calls they've emphasized their understanding of its potential value and back in May adopted a Rights Plan to reduce the change of control risk.
• In 2014, they sold their LIHTC asset management business to Morrison Grove Management, but retained the yield guarantee and included an option to purchase Morrison Grove starting in 2019. They provided seller financing to Morrison Grove, the balance of which is now $13 million, but that's off balance sheet (I forget the reason, either the yield guarantee or the option to buy). The option to buy the company in 2019 could be valuable in itself and another operating business to generate taxable income.
• The carrying amount of their remaining real estate is $25.1 million, they estimate it to be worth $29.2 million, it could be worth more as they've put some of their real estate into JV's with developers who are re-purposing the assets and hopefully generating more value.

The MGM seller financing and the real estate at fair value would add another $2.61/share to the BV above the two post quarter adjustments we made earlier for an all-in value of $19.40/share.

The same management that created all this mess is still in place, MMA Capital seems to be the one example of management knowing where all the bodies were buried and actually being able to extract significant value out for shareholders.  There's still a lot to be done, the ongoing businesses are basically break even, they still need to develop a sustainable business plan to move from being valued as an NAV pile to more of an operating business.  The new MMA Energy Capital business might be a step in that direction.

Disclosure: I own shares of MMAC

Green Brick Partners: Update, Guide Down, Shares Look Cheap Again

Update time, I haven't discussed Green Brick for about a year - quick background:

• Green Brick Partners (GRBK) is a former NOL shell (BIOF) which David Einhorn engineered an interesting reverse merger in 2014 with a home-building operation founded by Jim Brickman.  David Einhorn came to know Jim Brickman on the old Yahoo message boards discussing Allied Capital, Brickman's analysis helped fuel Einhorn's short crusade against the company and afterwards they became close friends/partners.  Einhorn is now the Chairman of Board and Brickman is the CEO of Green Brick.
• The company has an $83MM deferred asset as a result of the old BioFuel Energy net operating losses, meaning it won't pay income taxes for the next several years.
• The low float (Greenlight owns 49%, Third Point 16.5%), initial rights offering, secondary raise, and other events have led to a lot of stock price volatility.
• Some of my earlier posts from 2014: http://clarkstreetvalue.blogspot.com/2014/11/follow-up-on-green-brick-partners.html, http://clarkstreetvalue.blogspot.com/2014/09/biofuel-energy-green-brick-partners.html
• On 7/1/15, the company completed a secondary offering of 17.45 million shares at a price of $10.00, with Greenlight and Third Point fully participating in the offering to maintain their ownership percentages (important to keep the NOLs in place), the cash raised fully paid off the expensive 10% term loan the company had in place with Greenlight when it completed the reverse merger with the old BioFuel Energy.

On October 30th, Green Brick Partners fired their COO and took down their 2015 pre-tax income guidance from the $29-32MM range to $22-24MM, since then about $210MM in market cap (stock price was as high as $14.94 this summer, now $6.60) has been sliced off the company leaving the shares trading at a discount to book value (which includes the DTA).  The Q3 conference call held on 11/13 didn't provide much reassurance as the company admitted to misjudging their customers in Atlanta and building too high-specification homes that just weren't selling (fixable).  Combined that with their labor shortage issues in their Dallas communities (fixable) and the stock market has harshly penalized management who made the mistake of just reaffirming their original guidance in a mid-September investor presentation.  Where does that leave us now?

Homes aren't a fad product like say a GoPro camera or a FitBit wearable device where a guide down in the later half of the year could signal much larger demand problems.  We knew that Green Brick's revenue was going to be back loaded this year with the opening of two large communities (Twin Creek in Dallas and Bellmoore Park in Atlanta) happening in the fall.  While it's disappointing that both of these developments are facing issues at the same time, I get the sense that the revenue will simply get pushed back into 2016 and the current washout is a buying opportunity.  Both Dallas and Atlanta are high demand, growing, sun belt markets, and the housing market seems to have finally burned off most of the excess supply built leading up to the financial crisis.

With their unlevered balanced sheet, Green Brick should be in a position to additionally make acquisitions, there was a hint of that in the Q3 press release below, but I didn't catch any further commentary during the conference call. 

"We are continuing to find attractive "A" location land investments that should translate into profitable growth for years to come. Since the summer of 2014, we have quietly been finalizing entitlements and planning on numerous land development opportunities. In the coming weeks and months, we expect to utilize our strong balance sheet to opportunistically pursue attractive land purchases and other prospects to improve long term shareholder value and accelerate our growth in 2016 and beyond." - Jim Brickman

These land investments would presumably be above and beyond what they already have projected to open in 2016 and 2017, including a "~30%" increase in communities next year:

Net income figures below are projections pulled from Bloomberg and then Green Brick's own lower guidance, if I'm right about profits being pushed out to 2016 the shares look very cheap at just 13.5x 2015 pre-tax earnings, 90% of book value, and essentially a clean balance sheet.

I listened to people smarter than me and sold down some of my position around $12, but still held quite a bit through this slide and today bought back in at $7.00 most of what I sold.  Green Brick is of course partially a jockey play on David Einhorn (who is having a self admitted terrible year) and Jim Brickman, both remain impressive to me, and the structure of the company keeps them involved and encourages them to create long term shareholder value.  I wouldn't lose faith in either just yet off of a $~8MM drop in near-term guidance.

Disclosure: I own shares of GRBK

Sycamore Networks: Activists Pursuing NOL Shell

This is a small opportunity that's not suitable for everyone, but it has significant upside if recent activists get their way and could be interesting as a small addition to an NOL shell basket. Sycamore Networks (OTC: SCMR) is a former dot-com optical networking darling that at one point was valued at $44.8B before the bottom fell out as late 90s internet traffic estimates ended up being wildly optimistic.  In 2013, the company sold the last of its operating businesses, shareholders voted to dissolve the company and commenced a liquidation.  Today, Sycamore's market capitalization hovers around $15MM.

Sycamore uses liquidation accounting and estimates the potential payout to investors each quarter.  The main sticking point to wrapping up the company is the 102 acres they own in Tyngsborough, MA that's under contract but the closing date keeps getting pushed back.

Companies in liquidation tend to overestimate their expenses, so it's likely that the final outcome will be slightly higher than $0.33 per share, maybe something closer to $0.40 per share.  It's trading for around $0.50, so why is it interesting?  It has a large NOL in comparison to it's market cap, from the 10-K:

As of July 31, 2014, the Company had federal and state net operating loss ("NOL") carryforwards of approximately $856.46 million and $34.9 million, respectively.  The federal and state net operating loss carryforwards will expire at various dates through 2034.  The Company also has federal and state research and development credit carryforwards of approximately $11.31 million and $9.98 million, respectively, which begin to expire in 2020 and 2015, respectively.  The occurrence of ownership changes, as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the "Code"), is not controlled by the Company, and could significantly limit the amount of net operating loss carryforwards and research and development credits that can be utilized annually to offset future taxable income.  The Company completed an updated Section 382 study through July 31, 2011 and the results of this study showed that no ownership change within the meaning of the Code had occurred through July 31, 2011 that would limit the annual utilization of available tax attributes.  The Company has evaluated the positive and negative evidence bearing upon the realization of its deferred tax assets and has established a valuation allowance of $325.56 million and $330.43 million as of July 31, 2014 and July 31, 2013, respectively, for such assets, which are comprised principally of net operating loss carryforwards, research and development credits and stock based compensation.

Recently two different investors have filed 13Ds pushing for the company to withdraw the liquidation plans and instead raise equity, buy an operating business, and monetize the NOLs.  Lloyd Miller, who fishes in many of these Ben Graham like microcap securities recently disclosed a position and then General Holdings came into the picture too, below is the language General Holdings used in their recent 13D:

The Reporting Persons have engaged, and intend to continue to engage, in discussions with the Issuer’s management and members of the Issuer’s Board of Directors (the “Board”) on multiple topics, including the Reporting Persons’ suggestion that the Issuer should revoke its Certificate of Dissolution filed with the Secretary of State of Delaware on March 7, 2013.  Such discussions have also touched on corporate governance and corporate finance matters, including but not limited to the potential adoption of a shareholder rights plan, additional equity issuances, the use of net operating losses and other suggestions for maximizing shareholder value.  The Issuer has not taken any action with respect to the Reporting Persons’ suggestions described above.

The manager of General Holdings is Andrew Bellas, who was a partner at "Tiger Cub" firm Tiger Global Management where he specialized in technology stocks but left in January 2015 to start his own fund according to the Wall Street Journal.  Some light Googling found that he had been rumored to take a job at Latimer Light Capital, but it's unclear if he took the job or if he just went solo with General Holdings.  My guess is he could be looking to take control of Sycamore, put himself in charge and could use the shell as an acquisition vehicle.

It's difficult to value NOLs, but even after the recent excitement in SCMR shares, the NOLs are only being valued at a $5-6MM, if the company were to switch strategies and somehow utilize the NOL, the company would be worth multiples of it's current value ($5-7 wouldn't be out of the question).  Similar to WMIH, it's hard to point to a specific valuation as a shell, but with a 20% downside to $0.40 if the liquidation continues and a 10 bagger upside if it's reversed, the risk/reward seems worthy of a small position.

Risks
NOL rules are fairly complex, Section 382 of the IRS code stipulates change of ownership rules around net operating loss carryforwards.  I'm not a tax accountant, but I'd be curious if Andrew Bellas and his 14+% stake will limit the use of the NOLs going forward?  Even if the NOLs were limited annually, it wouldn't be the end of the world, the $856MM NOL is so large that it would be difficult for Sycamore to utilize it quickly without a huge equity raise in the first place.

Andrew Bellas and Lloyd Miller aren't the first investors to spot Sycamore's net operating losses, there have been others since it was clear the company was going down the liquidation path to push for a different strategy to utilize the valuable tax assets.  I can't be certain if there are other roadblocks pushing the company toward liquidation versus NOL monetization, but at today's prices its worth a small tracker position that can be added to as the situation becomes clearer.

Disclosure: I own shares of SCMR

WMIH Corp: KKR Controlled NOL Shell

A simple and brief investment idea today, it's been teased and mentioned a few times in earlier posts on other NOL companies.  WMIH Corp (WMIH) is the remaining shell of the former subprime lender Washington Mutual which became the largest bank failure before most of its assets were sold via the FDIC to JPMorgan Chase in September 2008.  What remains in the old corporate shell is approximately $6B in net operating losses, a small reinsurance business that's in runoff, and $600+MM in cash set aside for a future acquisition.

KKR is effectively in control of the company via the $600MM convertible series B preferred stock issued in January of this year, the proceeds of which are in an escrow account.  KKR is one of the original leveraged buyout shops and gives WMIH Corp access to deal flow and an experience management team.  SPACs and "platform companies" are a current rage, add that with the M&A reputation of KKR and any WMIH acquisition could be met with investor enthusiasm.

Valuation

WMIH Corp has cash of $670MM to use for an acquisition, $600MM in escrow and $70MM at the corporate level (I'm ignoring the cash and investments inside the runoff reinsurance company).

Let's assume KKR will just use the escrow funds and leave the $70MM for liquidity, they could make an acquisition using half equity, half debt for a $1.2B operating company generating $200MM in pre-tax earnings.  Using a 10% discount rate and assuming 3% annual growth rate in the pre-tax earnings the NOL could be worth an NPV of ~$750MM.  That's probably on the low side, 1) KKR will likely make a larger initial acquisition and raise capital via a rights offering (similar to GRBK, PARR, RELY) to bring forward the NOL value, and 2) there will be additional bolt-on acquisitions over time that will increase earnings at a faster clip than 3%.  But to be conservative, let's use the $750MM value for the NOL.

Assumes 3% earnings growth rate

WMIH Corp has also granted warrants for 61.4 million shares at an average exercise price of $1.38 per share which will raise nearly $85MM.  Add that with the $670MM in cash, plus the $750MM NPV of the NOL, totals $1.5B for WMIH.

The current share count doesn't include the dilution of the various warrants and convertibles in WMIH Corp's capital structure.  KKR's series B preferred stock will convert to equity at the time of an acquisition at a price of $2.25 creating 266,666,666 shares, add in the 1 million shares of Series A convertible preferred stock and the warrants will add another 61.4 million shares to the current outstanding 202.3 million, or a total of 531.4 million shares.  Using the $1.5B valuation number, that works out to $2.82 per share versus about $2.50 today.  So you're merely getting an okay deal today for the shell, but the incentives and potential leverage in an acquisition are such that there could be substantial value creation once a deal is commenced.

Risks/Other:

• KKR is unable to find a suitable acquisition, pays the wrong price, or just simply takes too long creating an opportunity cost for investors.
• At the time of an acquisition, there will probably a rights offering, so keep that in mind when sizing a position.  Trading around deal announcement, rights offering, and deal closings have been extremely volatile in these NOL shells, so even when there is good news, could be a wild ride.

Disclosure: I own shares of WMIH

American Capital: Complicated Structure, NOLs, Pending AM Spinoff

Expanding on the externalizing management theme, American Capital (ACAS) is a business development company ("BDC") that was an epic disaster during the financial crisis, it has somewhat recovered, but due to their NOLs the company has elected to not resume their dividend payments making it out of favor with the traditional BDC investor (muppet retail, dividend focused).  On 11/4/2014, the company announced a long awaited plan to separate their asset management division (American Capital Asset Management, or "ACAM") from their traditional BDC assets by creating and spinning off two new BDCs with the remaining parent company, ACAM, becoming a pure play permanent capital asset management company.  The two BDCs will then turn on the dividends making them more attractive to retail investors and ACAM will enter into highly valuable asset management agreements with the spinoffs.  American Capital's shares trade for $14.50, a significant discount to their self-reported NAV of $20.50 (as of 9/30), which doesn't include the incremental value of the two new BDC asset management agreements to ACAM.

The idea is well known among special situation investors and the separation of the asset management company from the BDCs has been well telegraphed, so why is it still trading at such a significant discount to it's NAV?  I believe the many blowups in popular event-driven names in 2014 has caused managers to reduce exposure and the spinoff of two new BDCs is extremely complicated and has required more patience than many short term focused traders have been willing to give American Capital.

For this situation to work out two questions need to be answered positively: 1) What will be the normalized run rate EBITDA for ACAM including fees received from the two new BDCs? and 2) Will the BDC spinoffs trade near NAV?  And of course, this situation needs time to play out before another recession takes a bite out of American Capital's risky assets.

Background
American Capital was founded in 1996 and went public in 1997, ACAS is based out of the DC area and like other BDCs traditionally invests primarily in debt and equity of small and middle market companies who can't access capital through traditional bank loans or the corporate debt markets.

BDCs like REITs are pass-through structures for tax purposes, if the BDC passes along 90% of its taxable income to shareholders its exempt from paying corporate income tax and instead the earnings are only taxed at the individual level (although at ordinary rates).  Since BDCs have limited retained earnings, they need access to the capital markets in order to grow their asset base and increase fees to the management company.  The ability to arbitrage their cost of capital against that of the assets they're purchasing can add value as the BDC turns illiquid risky assets into a liquid asset that appeals to retail investors reaching for yield.  This arbitrage only works if the company's shares trade for above net asset value (NAV), otherwise equity issuances will dilute current shareholders and destroy value.

Back to American Capital, from their 1997 IPO until the second quarter of 2008 the company's shares traded above NAV allowing the company to continually issue shares and grow their asset base.  The great recession brought American Capital to the brink as their risky loans to mediocre businesses took significant losses (creating its net operating loss carry-forwards).  The company turned off the dividends and sealed their fate with dividend focused retail investors as a toxic dump (that's still somewhat fair).  American Capital's management knew they could no longer issue shares to grow and now had a valuable tax asset to monetize, so in 2011 they changed corporate structures switching from a regulated investment company (RIC) to a traditional c-corp allowing the company to retain its earnings.  Retaining their earnings allowed them to repurchase shares in the years since the crisis at significant discounts to NAV and utilize their NOL position.

American Capital Asset Management
Back to the current situation, after the proposed spinoff ACAS (ACAM) will become a valuable permanent capital asset manager with external management agreements with 5 publicly traded BDCs or mortgage-REITs, 3 private equity funds, and 5 collateralized loan obligations (CLOs).  The management agreements with the 5 publicly traded vehicles are particularly valuable as they represent the holy grail of permanent capital, unlike open end funds investors can't withdraw their funds directly from the manager, they must sell their shares to another holder.

In a previous post on another permanent capital asset manager, Ashford Inc, I was likely too conservative by backing into a 10x EBITDA valuation, this multiple is more accurate for a traditional open-end manager but the new breed of permanent capital managers are trading at higher multiples, closer to 14-16x as their fees are nearly annuities.  Additionally, managers typically have a wide ability to push their expenses directly onto their captive vehicles and get fully reimbursed at full cost. Questionable?  Yes, but in this low rate environment, many retail investors continue to pile into dividend focused vehicles as a bond substitute allowing managers to get away with exorbitant fees.

So what is ACAM worth?  Below are their externally managed vehicles with the earning assets under management of each:

 

A couple of assumptions here, there are some moving parts with the two new BDCs and what the ultimate fee agreements will be, but I'm assuming a 1.5% fee on assets and ACAM only adding a little bit of leverage (when they'll probably add a lot more).  Additionally, most of their vehicles have incentive fees, so you can layer that on top as well, and then I'm using a 15x EBITDA multiple, which one can argue is high but the permanent nature of their AUM deserves a premium over the typical fund manager.  ACAM also has shown the ability to raise capital in different credit segments and aren't as concentrated to the shaky middle market as recent BDC manager IPOs have been.

Additional Assets: ACAM will also be structured as a c-corp and will keep the $620MM in NOLs that were created by the poor investments within the BDC portfolio but will now be applied to the earnings stream of the asset management company, a nice bit of financial engineering and tax avoidance.  In the investor presentation, ACAS guided to $1B in equity being available to the company, this appears to include the European Capital business ($680MM at NAV) which could be an additional spinoff in the future and also allows ACAM to seed new strategies before placing them in new public vehicles like they've done with American Capital Senior Floating (ACSF) in early 2014.

Value of ACAM = $2.5B (including European Capital, but giving you the NOLs for free)

American Capital Growth & Income and American Capital Income - BDC Spinoffs
The other key to this situation is determining what the new BDCs will trade at once the dividends are turned on and Seeking Alpha articles start getting circulated.  BDCs are pretty terrible investments, they charge high fees and mask those fees with risky loans and high leverage, most retail BDC investors would be better off investing in a low cost stock/bond mix and peeling off their own "dividend" by selling shares.  There is a noticeable bifurcation in valuation between internally and externally managed BDCs with the internal ones selling a sizable premium to NAV where the external BDCs are lucky to trade at NAV.

I don't have a lot to add specifically regarding the new BDCs.  American Capital Growth & Income will include the operating companies (thus able to be a tax-free spinoff) paired with the syndicated bank loan/CLO equity portfolio where they'll use all their available leverage and pile on debt.  Bank loans generally held up during the great recession and belong in a permanent capital vehicle instead of a traditional open end fund or ETF.   I could see this larger BDC transforming into something like their ACSF vehicle, syndicated bank loans are more transparent and easier for ACAM has a manager to service.  American Capital Income will have their third party middle market type loans, nothing particularly interesting about it, but the key is both of these BDCs will start paying "market rate" dividends.  In a record low interest rate environment, retail investors will continue to flock to BDCs as a fixed income replacement, once American Capital's BDCs start paying dividends they should trade near NAV or just below.

Value of the BDCs = $3.6B ($4B with a 10% haircut)

Adding up ACAM and the BDCs, I come up with a total valuation of $6.1B, or $23 per share, above the $20.50 estimated NAV because of the two new asset management contracts and a higher permanent capital manager multiple assigned to ACAM.  It should be noted that ACAS has over 54 million in options outstanding at an average exercise price above $9 per share,  ACAS will probably cover some of this dilution with share repurchases, but that will knock the $23 estimate down a notch or two.
 
Risks

• Breaking apart the tangled corporate web is complicated and could take longer than anticipated, American Capital hasn't guided to a specific transaction date yet which is likely holding back some event-driven investors
• If American Capital's publicly traded vehicles don't trade above NAV, AUM growth will be stunted and it will be more difficult to "cover up" bad assets with new assets potentially spiraling the discount to NAV problem
• In 2014, a few BDC managers went public (ARES, FSAM, MDLY) and haven't fared well, mostly due to BDC market specific concerns and in FSAM's case, questionable corporate governance and management
• If you think a recession is around the corner, this is not the situation for you, BDC assets are typically made to shaky middle market companies that can't get financing through traditional channels.  The syndicated loan book and CLO equity should be okay in a recession (relatively minimal losses there in 2008-2009), but I'd be more concerned with the middle market loans and operating companies that will be in the BDCs
• Management pays themselves lavishly, at ACAS and in the BDC industry in general, eventually if BDC managers don't add value for their clients the industry is going to suffer and some of that sentiment is already in BDC market values

American Capital is a combination of a few themes that I like right now: (1) it has a complicated structure and balance sheet that doesn't screen well and requires some work to dig through; (2) the remaining asset management company will be a c-corp (versus a partnership, no K-1s, widens the investor base) with a significant NOL tax asset; (3) it's a company that currently doesn't pay a dividend in a dividend focused sector, essentially getting punished for displaying rational capital allocation; (4) and of course it's about to embark on a break-up/spinoff which will force the market to value it on a sum of the parts basis (and create AM agreements with two new BDC vehicles).

I'm more interested in the asset management company for obvious reasons, but one might need to hold onto the BDCs for a quarter or two after the spinoffs to give time for the market to re-rate them inline with peers.  I bought a mid-sized position this week around $14.40, will look to potentially supplement my shares with LEAPs as well. 

Disclosure: I own shares of ACAS

Signature Holdings Group: NOLs, Aluminum, and a little Promotion

An investment theme I continue to like is companies with significant net operating loss carry-forwards (NOLs), they are typically small and have ownership restrictions in order to stay in compliance with IRS NOL rules making them out of reach for larger institutional funds (meaning less competition).  Signature Holdings Group (SGGH) is an NOL shell company formed in 2010 after one of the worst sub-prime operators Fremont General emerged from bankruptcy.  Since emerging as Signature, the company has been through two different proxy contests, the second one ending in the summer of 2013 with Craig Bouchard taking the CEO and Chairman roles with the backing of Sam Zell's distressed debt fund (same one as Par Petroleum).  It's main asset is roughly $890MM in NOLs which should keep it from paying income taxes for the better part of a decade in the most optimistic scenarios.

Signature Holdings aims to be an acquisition platform targeting the transportation, food, water and energy sectors to utilize the company's NOLs which begin to expire in 2027.  In order to fund these acquisitions, they plan to use the Covanta (CVA) playbook of raising equity through serial rights offerings in order to stay within NOL ownership restrictions.

GRSA Acquisition
In October 2014, the Bouchard led management team landed their first large scale acquisition (after bidding and losing 6 deals previously) with the purchase of the Global Recycling and Specifications Alloys ("GRSA") business of Aleris Corporation for $525MM.  GRSA is the largest aluminum recycling business in North America and Europe (largely fragmented industry), with this purchase Signature is hoping to ride the trend of auto companies using more aluminum over steel in order to meet their government mandated fuel efficiency standards.  The Ford F-150 is just one high profile example of this but expect more makes and models to start switching in the coming years.

The headline acquisition multiple was 6.5x EBITDA, but how did they arrive at this figure and how many adjustments were made to an already non-GAAP figure?  The below table is from page S-22 of the company's recent prospectus:
That's a long list of EBITDA adjustments!  Including even a line item for extreme weather as last winter's polar vortex drove up the company's natural gas energy costs.  There's also a little deception stripping out some SG&A above the GRSA business unit at Aleris, some of that overhead is necessary to run a business even if it's not directly related.  Signature has about a $9.5MM SG&A run rate, so I'm going to subtract that from their adjusted number and come up with about $72.5MM (after also adding back weather and other adjustments) in EBITDA; maintenance capex is pegged at around $35MM annually, so free cash flow is around $37MM.

One look at Signature's balance sheet before the acquisition announcement would make it clear that they don't have the $525MM necessary to close this transaction.  With only $44MM in cash, the plan is to take out significant debt, tap their asset-backed credit line, conduct both an equity issuance and rights offering, and a $30MM in non-convertible preferred note to Aleris in order to pay for GRSA.  Additionally, Signature sold its only small operating business NABCO for $78MM to raise cash, with a net of $56MM after paying off the debt associated with the business (NABCO was purchased for $37MM in 2011 by prior management).

The bond issuance ended up being fairly expensive, $305MM sold at a discount of 97.2% at a 10% coupon rate, and well in junk bond range with a B3/B rating by Moody's and S&P respectively.  I think the aluminum recycling business might be a little more cyclical than Signature lets on in their presentation materials.  Without knowing too much about the aluminum industry, it just strikes me as being heavily tied to capital spending, a heated automobile market (we've all seen the subprime auto loan numbers) and potentially the Chinese economy too which scares me.

So what does the proforma EBITDA, earnings, and free cash flow look like?  Below are my back of the envelope numbers:

There are a number of moving parts in this acquisition, so please double check my numbers, the main assumption is around the upcoming rights offering happening in the next month.  I'm assuming the NABCO net proceeds are coming out of the original $125MM Signature intended to raise via both the rights offering and the stock offering that's already been completed.

It certainly looks cheap on the surface, the current price is around $8 per share which is in between the prices paid in the two equity offerings ($10.00 and $6.50).  Signature has also stated they want to do roughly one acquisition of similar size a year which should provide some additional operating leverage as some of that corporate level SG&A can be spread over a larger base.  Plus it sounds like they see some increase in GRSA's EBITDA through both organic growth and bolt on acquisitions.  But I'm on the fence on whether it deserves a spot in my portfolio, on top of the cyclical nature of the business and the potential for further declines in their earnings, something just doesn't feel authentic about management.

Promotional Management
CEO Craig Bouchard is a charismatic serial entrepreneur who has run several successful companies in a variety of industrial sectors (Shale-Inland, Esmark, NumeriX) and written two books, including a children's book for charity.  Clearly he's a talented individual, but I can't shake the feeling that his individual brand comes before all else.  He has his own personal website that reads very promotional, including a quote that he seems shy about when he's saying it, but continues to throw it out there that "one outcome (of Signature Holdings) would be to become a mini-mini Berkshire Hathaway."  That's one cringe worthy goal that I'm sure has gotten some his investor base excited.  Then there's his LinkedIn profile, it's rare that someone of his accomplishments flat out brags, such as the line about becoming the 3rd fastest to SVP at First Chicago (regional bank that is now part of JPMorgan), who keeps track of that and then who brags about it 20 years after the fact? And how Esmark was the highest appreciating stock in 2008; hopefully he didn't write is own profile.

Additionally, smaller things like their cheesy PowerPoint templates and use of overly promotional language like "the World's Largest" are picky, but still strike as questionable.  Sure, Signature needed/needs to raise a lot of capital and other companies have done much worse, but it seems to be in the DNA.

There is still quite a bit to like here, curious to see how the rights offering shakes out and what others have to say.

Disclosure: No position