Speculating on Iron Mountain's REIT Conversion

Many investors are well aware of record storage operator Iron Mountain's efforts to convert the company from a C-Corp to a REIT.  As a REIT, Iron Mountain (IRM) would be taxed only at the individual shareholder level and would likely reduce their cost of capital, both of which would cause the shares to be re-rated higher inline with storage/industrial REIT peers.  Iron Mountain's primary business is building large storage centers and "leasing" out space on their racking structures to store paper records.  In this business line they have over 67 million square feet of storage space across over 1,000 locations, so there's a good case to be made that Iron Mountain is indeed a real estate driven company.

However, last summer, the IRS initially pushed back on Iron Mountain stating they were "tentatively adverse" to classifying the racking structures as real estate.  The basic question is how permanent are they?  Are the racking structures more similar to walls in a house or removable display shelves in a grocery store?  The market reacted quickly selling off IRM shares from around $40 per share before the announcement.

Iron Mountain hosted an analyst day presentation in March (shares are trading in a similar $27-29 range since) where one of the main topics was the REIT conversion, listen to the whole call if you can, but the key REIT valuation slide is below:

It's fairly clear by these measures that Iron Mountain would be significantly undervalued as a REIT.  If approved, the stock should recapture much of the ground it has lost since the IRS's "tentatively adverse" push-back in the near term, and maybe more upside above $40 over the longer term. 

Management seems fairly confident in a positive outcome, they have been operating the company as a REIT since the beginning of the year in preparation of approval so they could file next year as a REIT.  The board initially announced plans to evaluate REIT status in April 2011 (after some activist pressure), and formally announced the desire to pursue the strategy in June 2012, if plans fail the board and management would face real credibility issues.  Additionally, the IRS recently has been approving non-traditional REITs in sectors such as outdoor advertising, cell phone towers, data storage centers, and casino properties.  There is some time pressure to get approval sooner than later, in order to qualify as a REIT, Iron Mountain would have to make a special dividend within the calendar year to distribute their accumulated earnings and profit (E&P) to investors.  In order to get this done, the company believes they need to initiate the process in October, if the IRS doesn't rule in their favor before, the REIT conversion gets pushed back to 2015.

I'm writing this on Wednesday (4/30) afternoon, earnings come out tomorrow (5/1) morning, if any negative REIT related news is released tomorrow I could end up with egg on my face pretty quickly.  But I couldn't resist a little special situation call option strategy, I bought some call option contracts, nothing big, basically just free rolling the small profit I made on BioFuel Energy earlier this month.

Disclosure: I own IRM calls

Momentum Traders and BioFuel Energy

That was quick!  My last post was on Greenlight Capital's proposed transaction to utilize BioFuel Energy's net operating losses (NOLs) in a reverse merger of sorts with a real estate developer/homebuilder the hedge fund controls (JBGL Capital).  I noted at the bottom that I expected a wild ride because it seems like the current crop of momentum day traders had taken notice to this small float stock with a sexy name and were driving up the price without understanding the Greenlight transaction or reading the details of how BioFuel Energy is going to meet the $275 million price tag for JBGL Capital.

On Thursday, BioFuel's share price jumped almost 30% with no news and well above the maximum range of the rights offering:

5. The Rights Offering. Prior to and contingent upon the closing of the Acquisition, the Company will conduct a rights offering for shares of its Common Stock (the “Rights Offering”) to raise at least $70 million. Each right will permit the holder thereof to purchase shares of Common Stock for a price per share equal to 80% of the average closing price per share of the Common Stock for the 10 trading days immediately following the date of filing of the Registration Statement relating to the Rights Offering (the “Filing Date”); provided, that in no event will the price per share of Common Stock be greater than $5.00 per share, or less than $1.50 per share. Subject to certain limitations, the Rights Offering will be backstopped by certain investors determined by Greenlight.

Based on the initial terms of the rights offering above, anyone buying BioFuel Energy above $6.25 (80% of which is the maximum $5.00 of the rights offering) is guaranteed to face massive dilution after the rights offering is completed.  In order to fund the acquisition, BioFuel is going to have to issue 4-5x as many shares as is currently outstanding, at a maximum price of $5 per share, that's going to force the fair market value considerably lower than where its trading currently.  I don't have the trading mindset to participate in this kind of pump and dump, so I exited this morning at $8.15.  Slightly disappointed that I won't be participating in the rights offering unless things change dramatically, but maybe I'll get an opportunity again once the transaction closes.

Disclosure: No Position

BioFuel Energy's Reverse Takeover

Greenlight Capital and developer James Brickman are proposing that BioFuel Energy (BIOF) purchase JBGL Capital, a residential developer and homebuilder controlled by the two, for $275 million in a reverse takeover transaction to take advantage of the failed ethanol producer's $178.2 million in net operating losses.

BioFuel Energy was founded in 2006 in the middle of the ethanol craze.  The company operated two ethanol plants, one in Nebraska and one in Minnesota, which produced ethanol and related products for the company until this past November when they turned their assets over to the lender in a foreclosure.  After the foreclosure, BioFuel Energy is now a shell company with two assets, $10.8 million in net cash and the aforementioned $178.2 million in NOLs.

At year end 2013, hedge funds Greenlight Capital and Third Point owned 35.4% and 17.4% respectively of the company, one that's a rare investing black eye for each.  The NOLs are clearly valuable, otherwise the company would be liquidated and the $10.8 million would be distributed to shareholders, but the NOLs are only valuable if they can construct a transaction where there isn't a change of control in the mind of the IRS.  In comes the home builder transaction where Greenlight is already the lead investor.  There isn't much available about JBGL Capital on their website, but Greenlight would only choose an asset that would throw off taxable income to utilize the NOLs, so its reasonable to assume its fairly profitable.   I tend to like the residential real estate sector right now and think home builders will have the wind at their back for some time as we're still far below historical new home starts in the US.  The millennials generation will one day move out of their parents basement and start buying homes, just might take longer than most expect due to the financial crisis hangover and student loan debt.

Transaction Details, $275 million for JBGL Capital, compensated by the follow ways:

1. $150 million in debt financing provided by Greenlight, 10% fixed interest rate for a 5 year term with a 1% prepayment penalty during the first two years.
2. A rights offering of at least $70 million, with each holder able to purchase shares at 80% of the 10 day average closing price following the official registration statement.  Maximum price is $5.00, minimum is $1.50.
3. Equity issuance to Greenlight/Brickman, this will ensure that Greenlight owns 49.9% of the shares following the rights offering and James Brickman will own 8.4% of the shares.
4. Cash of $10.8 million currently held by the company

The debt is the most concerning of the above; 10% is awfully high in such a low rate environment, but I view this as Greenlight's preferred return for choosing the asset and being the company sponsor.  But after a few quarters of profitability, you'd assume the company could refinance the loan, but with Greenlight/Brickman being the lenders, would they be conflicted in facilitating a refinancing?

However everything else sets up pretty nicely, post transaction, David Einhorn will become the Chairman of the Board and James Brickman will be the CEO and join the board as well.  So Greenlight will remain the sponsor and presumably a long term shareholder of BioFuel in order to retain the NOLs, any "change of ownership" would disqualify the NOLs in the eyes of the IRS.

At the current price of about $5.30, you get around $2 per share in cash and the market is valuing the NOLs at $3.30 per share or only ~$17 million.  That's a reasonable valuation without any specific details of JBGL Capital which should come with the rights offering and subsequent filings.  BioFuel Energy, probably due to its name, former industry and low float, seems to now be on the radar of unsophisticated momentum traders which could make for a wild ride until the transaction is completed, but I took a very small starter position in the name (with the intention to participate in the rights offering) as I think there could be substantial upside once the dust settles.

Disclosure: I own shares of BIOF

CLOs, Leverage Loan Funds, BDCs and Oxford Lane Capital

Last week I attended a panel discussion titled "CLOs in the Heartland" hosted by Mayer Brown and Fitch Ratings, while most of content was directed at the structured finance industry (my day job), I found a few of the topics applicable to the broader value investing universe that I thought I'd share. 

CLOs, Leveraged Loan Funds and Oxford Lane
For the uninitiated, Collateralized Loan Obligations (CLOs) are pools of leveraged loans that are then sliced (tranched) into different levels of risk and sold to institutional investors.  Unlike the ABS CDOs that were ground zero of the 2007-2009 financial crisis, CLOs experience few defaults as they were genuinely diversified among many different industries and weren't forced to sell assets that had dropped in value.  Contrastingly ABS CDOs ended up holding 100 securities that were virtually the same and all were impaired at the same time causing total losses in many deals up to the AAA tranche.  A good example of the collateral held in a CLO is Tropicana Entertainment's term loan they recently closed in connection with the Lumiere purchase.

CLOs are typically actively managed for a period of time by an asset manager, and those managers have begun facing considerable competition for loans from retail floating rate mutual funds and ETFs.  An interesting situation has the potential to play out in this space as a CLO represents essentially permanent capital for the manager for an extend period of time, during times of distress like 2007-2009, CLO managers were able to hold on to their assets and ride out the wave without investors demanding their money back.  CLO investors could only obtain liquidity by selling their CLO liabilities/equity holdings in the second market.  Whereas in a mutual fund or ETF, a manager would be forced to raise capital by liquidating their loan portfolio to meet redemption requests.

Retail investors have been pouring money into floating rate or bank loan funds as a safe haven from interest rate risk, the below slide from the conference shows the dramatic flows that occurred in 2013.  I would guess much of this happened after the spring when rates first began to start moving up.

What happens when flows reverse themselves?  Leveraged loans are not book entry securities and aren't completely liquid.  Loans that trade hands on the secondary market can take 1-2 weeks to settle, and if they're distressed that time frame can stretch out into months.  Retail investors are by nature hot money, and may pull their cash at the first sign of distress causing liquidity issues for the managers of leverage loan ETFs and mutual funds.  This rush to exit and forced selling of supposedly liquid assets is what caused trouble in the money market fund sector, and could cause similar issues for bank loan funds.  A fund's net asset value might not be what it appears in a quick liquidation.

One panelist, Levoyd Robinson (fantastic panelist BTW) of Chicago Fundamental Investment Partners, pointed out the CLOs are essentially long volatility in the bank loan space.  Because of their pseudo permanent capital funding structure they'll be in a position to take advantage of any volatility caused by the retail investor exiting the space.  CLO equity (first loss position, 8-10x leveraged) targets internal rates of returns in the mid-teens, and his thinking is if volatility picks up, these returns would only increase over the full cycle as managers in CLO could pick off good credits from forced sellers.

Where could individual investors potentially take advantage of this idea?  Many BDCs hold CLO equity, but I'm not a huge fan of those as I think they're primarily built for the benefit of the third party manager.  But there is one BDC-like investment company that invests almost completely in CLO equity and a little bit in the junior/mezzanine tranches, Oxford Lane Capital (OXFC).  While I haven't done a lot of work on Oxford Lane, a few things do jump out at me, they have been ramping up their equity base and buying a lot of the recent CLO issuances.  Is this because CLOs are a great deal now?  Eh, more likely the 3rd party management agreement that encourages asset growth over total returns.  But it is a pure play on CLO equity, and will likely perform better in a rising rate environment than the mortgage REITs. 

BDC's Continue to be Popular
The growth of BDCs and its potential issues is another area that concerns me and might be ripe for distressed investing situations in the future.  Their growth as been pretty incredible as retail investors continue to scoop up anything with a high yield, never mind the fact that they're taking incredible amounts of risk to secure that yield when they could take fractions of the risk for the same return if they had a total return mentality.

One hallmark of BDCs has been their limit on leverage to one times equity, however there's talk of that increasing to two times leverage by the end of the year.  Politicians are putting this forward as a way to increase lending to small businesses, but the fact remains that most of the loans that end up in BDCs are not to small businesses or venture capital like startups, they're the same stuff that finds their way into CLOs.  Continued low interest rates and competition for leveraged loans is making it more and more difficult for managers to grow their distributions, so one way to make that problem go away is more leverage.  Expect a few blow ups in this sector during the next recession.

Blog Note
I will be attending the 9th Annual Credit, Restructuring, Distressed Investing & Turnaround Conference next Friday (4/4) in Chicago, and would enjoy meeting up with any readers who are also attending, so if you are attending please send  me a note.  I doubt there are many attractive active distressed ideas out there currently, but it will be interesting to hear the panelist comments and hopefully come away with a few areas of interest to watch for as the business cycle unfolds.

Disclosure: No positions

Municipal Mortgage & Equity

So I was browsing around for new ideas when I stumbled across a post by Olmsted at the Corner of Berkshire & Fairfax message board who compared a new name to me, Municipal Mortgage & Equity ("MuniMae"), to blog favorite Gramercy Property Trust.  And after reading through quite a few complicated balance sheets, I can agree the parallels are definitely there.

Before the credit crisis, MuniMae originated and managed debt and equity investments collateralized by affordable housing that offered attractive tax incentives.  Things went very wrong for the company in 2007 when the market for tax-exempt debt securities sharply declined forcing the company to meet all sorts of collateral calls by selling their assets at distressed prices just to stay alive.  The situation was compounded by some accounting issues and their accountant's assessment that there was significant doubt they could continue as a going concern.

Fast forward a few years and the company has sold off most of their assets and derisked their balance sheet, the most recent example being the sale of a huge bond portfolio, "MuniMae TE Bond Subsidiary LLC" or TEB, to an affiliate of Bank of America Merrill Lynch.  As part of the sale, they were able to shed much of their short term floating rate debt that was financing the long term fixed rate bonds which was presenting the company with interest rate risk scenarios where a small increase in rates could effectively wipe out the equity.  Another key aspect of the TEB sale is it allows the company to convert from a partnership to a corporation for tax purposes.  As a partnership, the company was forced to pay a lot of phantom gains out to shareholders due to the company repurchasing their own debt at a discount.  Now going forward, they'll be able to utilize their huge NOLs and essentially never pay income tax again.

So the bond portfolio that remains is now only 55% leveraged and much of it is non-performing, so the risk of the company switches from mostly interest rate risk to underlying asset performance risk.  The TEB sale also will dramatically reduce the net interest income spread they receive, putting pressure on the company to either cut operating expenses or find a new profitable venture.

In relating MuniMae back to pre-net lease Gramercy, MuniMae historically sponsored Low Income Housing Tax Credit Funds ("LIHTC Funds") where they sourced capital for the development of tax advantaged affordable housing developments.  The developer of the affordable housing project would start out as the General Partner, however during the credit crisis many of these projects and developers ran into financial trouble, causing MuniMae to step in become the General Partner to protect their investors interests in the project (also because MuniMae guaranteed certain investor's investments).  So even though MuniMae has a limited (0.01-0.03%) equity investment in these LIHTC Funds, as the GP, they're deemed for GAAP accounting reasons to be in control and must consolidate these funds on their balance sheet causing all sorts of problems.  In their quarterly press releases, MuniMae makes adjustments for the non-economical consolidation adjustments for us:

The cash and restricted cash portion of the balance sheet is pretty straight forward, the restricted cash is mostly collateral held in total return swaps that will expire in the next year or two.  $45MM in free cash is a nice position to be in when they have a share repurchase plan in place to buy up to 4 million shares at the book value per share as of the last quarterly, or $1.22 currently.  That's a nice floor under the current market price, and management and the company have been recently purchasing shares at higher levels.

But the most relevant footnote to their financials is regarding their bond portfolio and effects of consolidation:

(2) Represents the carrying basis of the bonds eliminated in consolidation. This amount excludes net unrealized gains occurring since consolidation that have not been reflected in the Company’s common shareholders’ equity given that the Company is required to consolidate and account for the real estate, which prohibits an increase in value from its original cost basis until the real estate is sold ($32.5 million at September 30, 2013 and $10.7 million at December 31, 2012).

So the fair value of the bonds is closer to $321.4 million dollars, a $32.5 million increase is a big adjustment for a ~$50 million market cap.  The big question then... are the marks correct?  Well during Q3 2013, MuniMae foreclosed on and sold the underlying real estate on two bonds in their portfolio for virtually the same amount as the fair value of the bonds.  Small sample size, but it provides a little reassurance that the fair values are reasonable.

In addition to cash and bonds, there's a grab bag of other assets MuniMae has on its balance sheet:

• REO assets: They have a few parcels of undeveloped land and a multi-family property that they've foreclosed on in the past that they're holding as real estate held-for-use.  On a few recent conference calls these have been discussed as potentially having value a few years down the line, and that they were valued at 7-10x their current book value at the time the original bonds were issued.  
• Solar assets: There are some leftover solar assets from a failed business purchase just before the credit crisis, value here is probably minimal.
• Some potential GP incentive income from the LIHTC Funds that could materialize, but not for several more years.
• International Housing Solutions (IHS): 83% stake in a South African asset manager that has one private equity fund which invests in affordable housing in South Africa.  MuniMae's equity stake in the one private equity fund shows up on the balance sheet, but not the ownership stake in the asset manager doesn't.  IHS is looking to raise capital for another fund and MuniMae might use some of their free cash to invest here.

If you assume the rest of the balance sheet is properly marked, the adjusted book value per share of MuniMae is closer to $2.00/share (currently $1.25), with a lot of management optionality in how they deploy their free cash (more stock and debt repurchases), manage the remaining bond portfolio, and any upside from the REO and LIHTC assets.

The obvious risks here are (1) the bond portfolio loses value and (2) this has been a historically mismanaged company with the same management still in place.  As for the bond portfolio, it's mostly unleveraged at this point, removing most of the dangerous impact from rising short term rates, and the bonds are collateralized by affordable apartments.  There's lots of talk about the disappearing middle class and people falling behind, tax advantage affordable housing will probably play a role in addressing the problem.  As for management, in reading their filings and conference call transcripts, they strike me as very transparent and fully acknowledging their past mistakes.  They even let individual investors ask questions!  So I agree that MuniMae could be a good place for people who have taken gains in Gramercy and looking to roll that money into a similar theme.

I've added a smallish position to my portfolio.

Disclosure: I own shares of MMAB

The St. Joe Company

This one might be a little controversial, but I think it deserves a second look... the St. Joe Company has been in the news quite a bit the last few months with two large asset sales, one of their timberland assets, and the sale of their RiverTown community in Jacksonville.  I found both transactions pretty interesting as it begins to show the company's future direction and potential value.  With the recent transactions, I think St. Joe has the opportunity to follow a similar path as the Howard Hughes Company by selling acreage in their residential communities to home builders and eventually redeploying that capital into income producing industrial and commercial assets.  Post spinoff, Howard Hughes was much farther along than St. Joe is currently in the process, but I admire St. Joe's Chairman Bruce Berkowitz (manager of the Fairholme Fund) and there's no doubt he has seen friend Bill Ackman's playbook and will move to implement a similar strategy creating value at St. Joe.

History

The St. Joe Company was formed by Alfred du Pont and his brother-in-law Ed Ball in the early 1930s to hold a collection of assets they purchased in the early days of the Great Depression.  Included in St. Joe at the time was a sugar company, an interest in Florida National Bank, cardboard box plants, an interest in the Florida East Coast Railway Company and vast swaths of northwest Florida land.  St. Joe was rather conservatively managed for decades as primarily a timber and paper business until 1997 when they brought in Peter Rummell as CEO.  Rummell was a real estate developer, with previous stints at Avrida and the Disney Development Company before joining St. Joe.  Rummell took to St. Joe's real estate assets and repositioned the company as an upscale developer.

St. Joe's fortunes boomed and busted with the Florida real estate market in the mid 2000s.  One savy move management made during this period was to raise $570 million in equity during 2008, otherwise it might not have survived the financial crisis.  As a result, today the company has very little debt and plenty of balance sheet flexibility.

"Field of Schemes"
Fast forward a couple of years and St. Joe had basically shut down its operations as the real estate crash brought its business to a halt.  Despite being near ground zero of the crisis, St. Joe was slow to take material write-downs of its real estate assets.  This caught the attention of hedge fund manager David Einhorn and in October 2010 he presented a very detailed, well thought out short thesis on St. Joe (a must read if you're considering investing).  He also argued that after all the money and effort, St. Joe made very little money in the development of real estate and should be valued at roughly the value of their rural forestry land, or about $1,500 per acre.

St. Joe Today

Since David Einhorn's presentation, much has changed at St. Joe.  In March 2011, Bruce Berkowitz took control of the company becoming Chairman and brought in Park Brady (formerly of Leucadia National), eventually elevating him to CEO.  After Berkowitz came aboard, St. Joe took a large write down on the improvements and capital expenditures previous management made to their real estate of $375 million.  Much of these write downs were on the same properties Einhorn went into such great detail examining.

Fast forward again to late last year and the new St. Joe's story is starting to take shape with two big asset sales:

(1) AgReserves Timberland Sale

On November 7th, St. Joe sold 382,834 acres of its "non-strategic" timberland and rural land to AgReserves for $565 million, or for $1,475 an acre (which gave the appearance of a victory for the short thesis).  This sale represents substantially all of St. Joe's forestry land, so they'll be out of this commodity business once the deal closes.  The tricky part of the transaction will be structuring it to be as tax efficient as possible; the land has a cost basis of $54 million, creating a large taxable exposure.  St. Joe does have $76.8 million in Federal net operating loss carryforwards that will be exhausted after the sale, they're also exploring a combination of cash and timber notes that could reduce their tax liability.

(2) RiverTown Sale
On December 31st, St. Joe entered into an agreement to sell their RiverTown community to Mattamy Homes for $43.6 million, with an additional $20-$26 million coming at the end of 5 years associated with impact fees.   RiverTown is a community located outside of Jacksonville and was deemed as non-core to St. Joe's strategy of concentrating their time in Northwest Florida.  The net carrying amount of RiverTown was $16.7 million on the balance sheet, so there will be a small tax impact here as well.

I believe the more important transaction of the two is the RiverTown sale despite the smaller scale, this transaction received considerably less press coverage but is more telling of the potential value hidden in St. Joe.  RiverTown was one of David Einhorn's "ghost towns" that he prescribed very little value to, however this transaction works out to a sale price of roughly $10k per acre.  What other assets have recovered in a similar fashion?

What's Left?
After both sales, St. Joe will have roughly 180,000 acres concentrated in northwest Florida.  St. Joe has communities with very inspirational names like WaterSound Beach, Windmark Beach, and Rivercamps targeting both the baby boomer retirement market (will newly surging 401k accounts encourage baby boomers to splurge?) and second home buyers located in nearby southeastern states.  St. Joe has stated they intend to invest capital in these residential communities going forward and potentially building out a Villages like active adult community (with additional retail and commercial buildings).  I would prefer they invest in commercial and industrial properties (like they have built for Exelis), but the residential base isn't there yet to build commercial properties in scale, they need more residents to support it.

There is some potential for commercial properties that could generate meaningful operating income.  St. Joe donated land to build the Northwest Florida Beaches International Airport, which opened in 2010 and hasn't been a tremendous success.  A quick Google Map of the surrounding area shows minimal development, but this is where the value in St. Joe's is; long term operating income producing properties. 

Southwest Airlines is the main carrier with Delta also running a few flights back and forth to Atlanta, but this is a pretty empty airport at the moment.  Again, the area needs more residents before the more flights are added, additional carriers are added, and the eventual gain in property values in the surrounding area.  There's also the Port of Port of St. Joe, which with some additional investment could be the closest port to the renovated Panama Canal, and the Pier Park North project is another nice retail project to add recurring income to the St. Joe portfolio.

Cash & Investments

After the two asset sales close, St. Joe will be left with a lot of cash, but a pretty restrictive investment policy of 50% in cash and the rest mostly in government securities with a small bucket of corporate debt (which is in Sears and JC Penney).  Ideally, Berkowitz would have free reign allocating capital wherever he sees the best value, but St. Joe wants to avoid the burden of becoming an Investment Company.

With the recent asset sales, St. Joe now has approximately $700 million per share in excess cash (this is a guess, tax consequences for the asset sales is a little hazy) for Berkowitz to allocate.  Previous management was criticized for spending money on development with very little ROI, but I would imagine that will change considerably going forward with an investment focused Chairman and his hand picked management team.  That's really the crux of a long thesis in St. Joe, faith in management to no longer waste shareholder funds on low return opportunities.

Back of Envelope Valuation
A quick and dirty ex-cash valuation of St. Joe's remaining acreage is as follows (I'm ignoring debt, and cash due from the pension termination):

Current Market Capitalization = $1.75 billion
Proposed Asset Sales (minus capital gains) + Cash & Investments = $700 million
Current Acreage Holdings = 180,000 acres
Valuation Per Acre = $5,555

If the RiverTown assets were worth ~$10k an acre, and it was a legacy bust asset, how much is the remaining core real estate worth?  Yes, there's a lot of rural land surrounding the airport and other non-entitled land, but I believe the current market price provides a reasonable margin of safety with the opportunity to invest alongside a great investor.

Risks
I see a few big risks to the St. Joe thesis (there are few ideas in today's market without considerable risks):

1. St. Joe's land is highly concentrated in Northwest Florida, their fortunes will be tied directly to the development of the area, which historically has had little economic development and below average income growth. "Lower Alabama" or "Redneck Riviera". 
2. St. Joe's land is located in rural areas of Florida, the development time frame is long and will likely require a lot of capital.
3. High short interest, David Einhorn took a victory lap of sorts with the media after the AgReserves sale appeared to justify his per acre valuation of St. Joe, he remains short and more media coverage regarding his short could move the market price down in the short term.
4. A lot of my thesis revolves around Bruce Berkowitz being the Chairman and his asset allocation abilities, however his position in St. Joe is quite small for his fund and he likely doesn't devout much of his time to St. Joe given his competing interests (including starting up a hedge fund).

Conclusion

Overall, I see some loose parallels to Howard Hughes Corporation, although I think St. Joe's assets are farther out from being realized, its going to be a slower transformation.  Bill Ackman and Bruce Berkowitz are similar investors (Bruce was also an initial investor in HHC, but he has since sold his position); Ackman tends to be more of a pure activist, but both are willing to hold positions in the face of adversity and are concentrated long term holders of high conviction investments.

Disclosure: No position, but like New Media, strongly considering.

New Media Investment Group Spinoff

New Media Investment Group (NYSE: NEWM) is a recent local newspaper/media spinoff of Newcastle Investment Corp (NYSE: NCT).  It was formed as a result of Fortress/Newcastle's ownership in GateHouse Media debt prior to a prepackaged bankruptcy and their purchase of Dow Jones Local Media Group from News Corp in September 2013.  For me it hits several themes that I like, (1) it's an unwanted spinoff from an investor base that's likely to sell it off,  (2) it operates in an out of a favor industry, and (3) it is run by a capital allocation expert (although at a cost).

Local Newspapers

Berkshire Hathaway's Warren Buffett recently purchased 28 local newspapers for $344 million dollars.  It's a very small purchase for a $270B+ Berkshire Hathaway, and Warren has a soft spot for newspapers, but he still wouldn't make the purchase if it didn't make economic sense.  The industry has value.  Local newspapers have a connection to small communities who rely on their hometown newspapers for updates on local schools, sports teams, community politics, and local advertising that's hard to replicate for free.

Most people also assume that newspapers are in permanent decline, but I think it's a wrong assumption that the move to digital will permanently lower the revenue and profitability of the newspaper industry.  Owners of businesses demand a certain return on investment, and businesses are fairly organic, it may take time, but eventual newspapers will restructure, consolidate, and earn a respectable ROI.

Deal History
Prior to GateHouse Media's bankruptcy, the company had a total of $1.2 billion face amount of debt, majority of which was owned by Fortress/Newcastle.  GateHouse Media went into the credit crisis overleveraged and ran into trouble, Newcastle (externally managed by Fortress) grouped together with other debt holders and restructured the company this past November.  Newcastle basically dual tracked the purchase of Dow Jones Local Media Group from News Corp (another spinoff and one of my holdings) in September, together with GateHouse Media, to form a new local news media company.  Since Newcastle is a REIT, it makes little sense to hold a non real estate operating company like New Media within the restrictive REIT structure, so they decide to spin out the media assets into a new entity.

Post Spinoff
After the spinoff, New Media will have 435 community newspapers, related mobile sites, and 6 yellow page directories.  That appears to be just the start, as Fortress has identified nearly $1 billion in potential acquisitions they believe can be purchased at between 2x-5x EBITDA, and then presumably integrated with GateHouse/Local Media, costs cut, resulting in increasing operating leverage.  There is a track record here, as Newcastle/Fortress was able to buy Local Media from News Corp at roughly 3.4x EBITDA (after backing out the real estate value).  By doing this, Fortress projects they can earn 20-25% unleveraged returns, and 30-35% return on equity with leverage.  New Media will also get attention from investors as it plans to pay out a significant portion of their cash flow in the form of a dividend.

Investors post spinoff might get the chance at a better return as the price is likely to decline in the near term due to uneconomic sellers for the following reasons:

• New Media is unrelated to Newcastle's core business (senior housing REIT, and some legacy CDO debt), there's probably not a lot of shareholder overlap other than those who are loyal to Fortress Investment Group.
• Newspapers and yellow page directories are an out of favor business that are unpopular and unsexy to discuss at cocktail parties.
• Unfortunately, I thought there might be more index fund selling due to New Media not being a REIT, but as Newcastle is transitioning from a mortgage REIT to an equity REIT structure, it's not included in the MSCI US REIT Index.  But there still might be some REIT focused holders that will be forced to sell New Media in the coming weeks.

Valuation
While revenues have been stabilizing, they're still falling, New Media hopes to reverse the trend with their digital advertising business Propel.  I would encourage people to check out their slides on Propel in their recent presentations, but I don't put much value in it.

As for a current EV/EBITDA multiple, below are the actual/projected numbers for the two newspaper companies forming New Media, as reported in their initial investor presentation in the fall.

If you combine the two 2013 numbers, you come up with $105 million in EBITDA.  New Media has 30,000,000 shares outstanding, based on today's closing price of $12.20 you get a market capitalization of $366 million.  New Media took on $185 million in debt after the GateHouse restructuring and the purchase of Local Media Group, making an enterprise value of $551 million, and an EV/EBITDA multiple of a little over 5.2x, definitely cheap, but on the high end of what Fortress thinks they can pay for acquisitions in the industry.  I'd like to pay to a little below 5x and that's before the issue of the external management expenses.

External Management
New Media will be externally managed by Fortress Investment Group, a large private equity/alternative investment manager with little direct expertise with media companies.  Fortress is handsomely paid for this arrangement; it receives 1.5% of equity annually and 25% of adjusted profits (adding back depreciation and amortization, among other adjustments) above a 10% hurdle, so you're essentially investing in a cheap media company with a private equity fee wrapper.  The advantage of having a private equity fund manage an operating business is the capital allocation, Fortress says they have identified up to $1 billion in potential acquisition targets in the near term, which would almost quadruple the size of the company (and presumably add operating leverage along the way).

But external managers have their downsides, (1) the management fee is based on assets which essentially incentivizes them to increase the asset base irrespective of the price they pay for the assets, and (2) the incentive fee may cause the manager to take unnecessary risks as their payoff is skewed to the upside and they don't participate equally in the downside.

The benefit usually touted for externally managed REITs is the manager has greater scale and charges the REIT less than what they'd pay internal management.  But unlike other externally managed REITs which have limited staff that work directly for the company, New Media has its own operational management team, including a separate CEO, so I'm a little cautious on how this type of model will work in a non-REIT entity.   Will the additional costs outweigh the cheapness?

Another question I have is around the potential incentive alignments with an acquisition, to me New Media would best be run as a short term vehicle that would later be acquired by a true private equity investor or a larger media company.  But its unclear to me how that would benefit Fortress and if they'd really go for it?  Yes, they have a decent size equity position, but the fees they earn from keeping New Media as a separate entity far outweigh any premium they would get for their equity in a buyout scenario.  

Conclusion
New Media has a lot of attributes that I like in a potential investment, but I'm holding off for now to see if it will get cheaper and I'm still trying to get my arms around what discount it should have with an external manager.  I'd appreciate any thoughts or comments on New Media, especially around the external manager arrangement, feel free to leave a comment below or email me at clarkstreetvalue@gmail.com.

I have another 2-3 ideas that I'll post over the next few weeks, and will probably buy my favorite 1-2 of those.

(I'm not 100% positive on some of the numbers above as the financials are still settling, please do your own research)

Disclosure: No Position.. yet