Mid Year 2014 Portfolio Review

In my year end 2013 portfolio review,  I planned to do this quarterly, but I don't think I'll have enough commentary or trades to give a full update each quarter.  Going forward, I'll do a portfolio performance review semi-annually.  Onto the results (there were no deposits or withdrawals into the blog portfolio during the period):

The first half of 2014 has been great, just about all of my ideas have been working, but I don't have any visions of this continuing at the current pace.

However, a lot of value investors get too caught up in the macro picture, trying to outsmart the market by holding large cash positions, tweeting links to examples of excess in the market, and attempting to call a market top.  It always sounds clever to be bearish and pessimistic, but it's not productive unless you're trying to build followers.  I'd rather focus on finding a handful of mispriced securities than constantly worrying about when the next market correction is going to happen, it will at some point, but for smallish investors it leads to bad decision making.

Current Portfolio

 Positions Closed

You'll see I disposed of the thrift/mutual bank conversions, I still like the strategy and will continue to highlight conversions I find attractive, but for now I'm going to pass until I increase the size of the portfolio or macro conditions change.  I'm finding too many other opportunities available that don't have 2-3 year opportunity costs like a thrift conversion.  I also work for a large bank and I'm fully aware of the headwinds facing the entire industry, especially those highly weighted towards net interest margin like small community banks.

There are so many spinoffs happening right now it's hard to keep them all straight.  Despite the value creation being fairly well known at this point, spinoffs still outperform as a group.  I'm going to try to identify a few that I find interesting in the back half of the year.  Then exploiting them either by buying a call option if I believe the spinoff is actually the more attractive asset (like OIS/CVEO), or wait until regular trading occurs and buy the spinoff if its the orphaned business that gets sold indiscrimately.  I also like the REIT conversion trend, curious to see if these conversions and tax inversions acquisitions will finally spark some corporate tax reform in Washington.

Position Thoughts/Updates

Howard Hughes Corporation
Lots to like at Howard Hughes Corporation, they're aggressively investing in their "strategic assets" which will make their way into operating asset bucket over the next few years.  At some point in the future, it doesn't make sense to have these stabilized operating properties in a C-Corp structure, so another REIT spinoff could be in the offering once the NOLs are used up.  I like this company as a long term compounder, they have quite a few levers to pull and a capital allocation/shareholder focused management.  At a recent investor presentation, management quipped that an analyst's $200 price target was too low, I would agree.

MuniMae
It's balance sheet has uncovered most of the hidden real estate value due to accounting consolidation rules already creating a quick gain.  The question is what's next?  I like the share repurchase program, but that doesn't really help the fact that they're too small to be a public company, and they're only breaking even on an operating basis.  MuniMae has an incredible amount of NOLs, they should be initiating a rights offering and buying an operating business that throws off taxable income.  It's no longer a screaming buy, but I'm going to hold and let the situation play out more.  However, it's towards the top of the sell list if I need cash for a better idea.

Ultra Petroleum
The Uinta Basin purchase is a nice bridge asset, its going to be cash flow positive right away and gives management and analysts something to focus on while waiting for natural gas to resume its climb up.  There's still a huge spread between natural gas prices in the United States and what it fetches in foreign markets.  Given the recent news about oil exports being allowed for the first time in 40 years, more LNG export terminal approvals might be in the offering as well, long term this spread should narrow.

Disclosure: Table above is my blog/hobby portfolio, its a taxable account, and a relatively small slice of my overall asset allocation which follows a more diversified low-cost index approach.  The use of margin debt/options/concentration doesn't represent my true risk tolerance.

More Thoughts on Civeo Corporation

I gave an investment pitch at a CFA Society of Chicago roundtable today with a "Value investing in a not-so value world" topic theme, my idea was Civeo Corporation, below is the deck I used, been a great winner for me so far via a pre-spin call option that expired today.  I presented a pretty bullish view for the purposes of the pitch, but I think it has decent room to the upside as they pursue a REIT conversion.

Disclosure: I own shares of CVEO, sold my shares of OIS

Cadus Corporation: Flip this House with Icahn

Cadus Corporation (OTC:KDUS) might be familiar to a few value investors who enjoy having their patience tested.  Cadus is a former drug development company that sold essentially all their assets in 1999 to OSI Pharmaceuticals (which itself was purchased by Astellas Pharma in 2010).  Ever since Cadus has been more or less a shell company, with cash and some net operating loss carry forwards (zero revenues, no full time employees only a part time CEO earning $25,000 per year).

Carl Icahn has been a major shareholder of the company since the mid-1990s, and has resisted calls from investors to liquidate the company citing the $19,341,000 of NOLs.  It may seem tiny to a multi-billionaire, but Icahn is probably the type where it bothers him leaving any amount of money on the table.  In February, he finally got moving and Cadus announced "the company is currently seeking opportunities to profit from purchasing land and residential homes for construction or renovation and resale in the state of Florida."  He assigned his wife's son in law as the new CEO and as of 5/14/14, they have purchased 9 homes in Florida for $20.9 million, clearly targeting the upper end of the housing market.

Cadus Corporation's strategy sounds similar to David Einhorn's strategy with BioFuel Energy, however with BioFuel they're buying a larger operating company and have significantly more NOLs to monetize.  With Cadus, the house flipping venture appears short term in nature and maybe a simpler tactic to monetize the NOLs, and liquidate the company after the homes are sold?  Cadus should also be a less stomach churning ride as the retail day traders have likely long forgotten about Cadus.

To further fund the house flipping operation, the company went forward with a rights offering at $1.53 a share, one right for each share outstanding.  Icahn backstopped the rights offering and now owns 67.8% (40% prior) of the company after the rights offering, meaning almost all of the original shareholder base other than Icahn declined participating (I would expect a similar result in BIOF's upcoming rights offering).  The pro forma book value looks something like this:

3/31/14 Book Value = $22,314,215
Rights Offering Proceeds = $19,803,934
Proforma Book Value = $42,118,149
Shares Outstanding (after the rights offering) = 26,288,080
Book Value/Share = $1.60

The thesis is pretty simple with Cadus Corporation, it trades roughly at Icahn's recent cost basis and a liquid/current book value.  If the luxury flipping operation works out well, Cadus should be able to use up the net operating losses in the next year or two.  Due the short term nature of house flipping, I could see the company being liquidated once the tax asset is monetized.  It's not going to be a multi-bagger, but could provide an attractive return with minimal downside.

Disclosure: No Position

Civeo: a Spinoff and a REIT Conversion

Oil States International (OIS) is a oil services company that is spinning off its accommodation business, Civeo Corporation, later this month (it goes "when issued" Monday, and trades "regular way" on 6/2) after some nudging from activist investors last spring.  Civeo provides accommodation services for the resources industry in remote locations, think "man camps" that kind of look like portable prison complexes.  As apart of Oil States, Civeo is taxed as a C-Corp, but shortly after the spinoff Civeo's board intends to evaluate converting to a REIT structure, eliminating corporate level taxes, providing an immediate increase in the business's valuation.  This isn't a new idea, but despite JANA partners and Greenlight Capital being major shareholders, there's still a significant disconnect in the combined company's current valuation.

The company has laid out the typical reasons for the spinoff: management focus, optimize each unit's capital structure, cleaner for investors to value, acquisition currency, and aligning incentives.  Both businesses are attractive, it's not a classic spinoff where one of the businesses is orphaned and dumped in order to make the parent's results more appealing. However, the real value is the REIT conversion, REITs are valued more richly than C-Corps due to their tax advantaged status.  The pre-spin OIS trades for roughly 7x EBITDA, lodging/multi-family REITs trade in the 15-20x range, as long as the OIS stub remains priced at 7x EBITDA, a lot of value is going to be created through the spinoff and REIT conversion of Civeo. 

Civeo Corporation
Civeo is a pretty unique lodging company, they provide medium term (contracts are around 3 years) accommodations services to remote resource mining operations, a valuable service since infrastructure and labor supply is lacking in these far off locations.  Some of their lodges/villages can be quite large, for instance their Wapasu Creek Lodge has 5100 rooms, making it the second largest lodging property in North America behind the MGM Grand in Las Vegas.

Civeo Investor Presentation

Their operations are primarily located in the Canada oil sands region in Alberta, and around major metallurgical coal mines in Australia (as a result of the late 2010 acquisition of the MAC).  Being a US based company, this exposes Civeo to considerable currency risk, in particular Australia worries me being so closely tied to the Chinese economy.  Another unique feature of Civeo's business is the permanence of their real estate and how the market might value it?  They focus on providing accommodations to long lived resource assets, in the 30-50 year time frame, but their lodges (at least in Canada) are on leased land, and presumably depreciation expense is more real as a result.

Civeo Investor Presentation

Civeo sports a nice growth profile as seen above.  They "land bank" in growth areas like the west coast of British Columbia near potential LNG projects - their current lank bank pipeline could add another 15,000 rooms to their asset base over time.

One reason for the current discount might be due to a lack of pure comparables, do you value Civeo as a hotel REIT, multi-family/apartment REIT?  I blended the two below and threw in Extended Stay, which is not a REIT but is similar in that it tries to create a medium term apartment feel in a hotel.

Data via Bloomberg - Net Debt Includes Preferreds

As you can see, this peer group average is valued at approximately 17.5x EBITDA, I would place a little discount on Civeo as a result of its dependence on the cyclical resource industry as well as the more temporary nature (temporary in the 30 years sense) of its asset base.  Even putting a 15x EBITDA multiple on Civeo, backing out the $775 million in anticipated debt (and not accounting for any cash on hand) I come up with a $5.6 billion valuation, which is slightly more than the entire market cap of pre-spin OIS.  Even if you disagree with the comps, multiple, or discount the 2013 EBITDA for some anticipated slowdowns in Australia and corporate overhead, you're coming close to getting the remaining OIS for free.

Oil States International: Post-Spin
Post Spinoff, the Oil States stub will become a more focused energy services company with a TTM EBITDA of $435 million on $1.7 billion in revenue.  I haven't spent as much time on the remaining pieces of Oil States, but assuming it remains valued at a little over 7x EBITDA (which looks reasonable given peers trade for 9-10x EBITDA) the stub is worth roughly $3 billion.  Below is another list of comparables to give you an idea for where oil services companies are trading currently.

Data via Bloomberg

$5.6 billion for Civeo and $3 billion for Oil States gives you a pre-spin value of $160 per share.  I'm sure some of my numbers are a little optimistic, using EBITDA multiples obviously has its issues, and it will take some time for the REIT conversion to take place and for investors to fully value each component, but there's upside to be had here.

Risks
A few questions/risks that run through my mind:

• Will traditional oil service company investors dump Civeo after the spin?   Seems unlikely given that's what the investor base has been pushing for, but any blip due to selling pressure would be temporary.
• What about OIS, will that get dumped in favor of Civeo?  This appears more likely than Civeo being sold indiscriminately, however it's already cheap and would be a bite sized acquisition target for larger players in the industry.
• Australia - Civeo is heavily exposed to the country's met coal market and thus the Chinese growth story which we've seen is slowing a bit and potentially in a massive housing bubble.
• REIT conversion doesn't occur, it appears that the IRS is softening up its stance on these non-traditional REITs (like Iron Mountain), but with Civeo structures not being 100% permanent, I could see it being viewed with a skeptical eye.

My Strategy
Most value investors are aware of the spinoff strategy of buying the SpinCo after the initial wave of selling by unnatural holders or ones that don't want the orphan/bad business.  But in this instance, I think that Civeo could be the more appealing company for new investors to come in post-spin due to the planned value unlocking strategy to convert to a REIT.  So instead of waiting for the spin, I bought June expiration calls on OIS early last week, that way I have leveraged upside to the initial reaction to the spinoff which I expect to be positive, and the secondarily I plan to exercise the option, immediately sell OIS (unless it slumps) and hold CVEO until it converts to a REIT for that second leg up in valuation.

Disclosure: I own OIS calls

News Corp Buys Torstar's Harlequin

Last Friday, News Corp announced the purchase of Canadian media company Torstar's book business Harlequin, best known as a romance novel focused publisher, for C$455 million (or roughly 8x 2013 EBITDA of C$56 million).  I think its an interesting deal for both sides, more of an incremental move at News Corp and a transformational one at Torstar.

News Corp
News Corp was spun off of Twenty-First Century Fox last year (it was the spinoff but kept the name of the original parent) and unlike other recent spinoffs, the parent didn't saddle it with debt but instead let it go with $2.5 billion in excess cash.  Originally News Corp created a share repurchase plan and discussed initiating a dividend, but it seems like plans have changed as neither have been utilized and instead News Corp has made a couple small digital purchases in Storyful and a UK Luxury Shopping site.  Now comes a larger one in Harlequin, which is expected to be accretive to earnings and improve News Corp's free cash flow immediately.

Harlequin has a strong brand and a loyal repeat customer base but has experienced trouble making the transition from print to digital under Torstar, maybe under News Corp this trend will improve?  Romance novels initially seem like a great fit to be purchased and read digitally.  Books like 50 Shades of Gray are incredibly popular, yet no one likes to be seen reading a copy on the train, it's easier and more stigma free to read it on your morning commute on a Kindle.  Hopefully News Corp can implement some best practices learned from HarperCollins' move to digital at Harlequin, strip out some fixed costs, and cross sell HarperCollins books through Harlequin's much larger international distribution channel.  It seems like News Corp paid full price, but as a strategic buyer there are some efficiencies to be gained anyway. 

I still think News Corp is an interesting spinoff as I outlined in this earlier post, they have a collection of book publishing and Australian assets that together with their cash position roughly equal the market cap of the entire company.  The majority of their revenue actually comes from the remaining newspaper assets, which have strong valuable brands, but will take time to transition from print to digital.  In the meantime, Murdoch has hinted at even more deals in the works, he's probably not done yet for the year.

Torstar
From Torstar's angle, it was interesting to listen to their investor call on Friday, analysts were congratulating the company on getting a full valuation for Harlequin, sending the stock price up over 20% on the news.  The deal is more transformational for Torstar than it is for News Corp, Torstar will use the proceeds to pay down their debt and will be left with approximately C$260 million in net cash.  Initially it sounds like Torstar will be investing the proceeds into the business or making an acquisition versus returning it to shareholders.  Torstar's remaining businesses include the Toronto Star, 115 weekly community newspapers, and several joint venture holdings in other media assets.  Maybe they could roll-up additional community newspapers in a similar fashion to New Media's strategy?  It also sports a large dividend; on the surface it still looks pretty cheap.

Disclosure: I own shares of NWSA

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