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Housekeeping: RAD, NC and NYRT

Rite Aid (RAD)

When I first wrote about Rite Aid, Walgreens was still waiting for Justice Department approval to acquire the company at $6.50 a share (down from $8), an acquisition I gave a 50/50 chance of succeeding. Clearly I was overly optimistic, and when the deal was changed at the 11th hour (the acquisition was nixed in favor of a purchase of about half of Rite Aid stores by Walgreens) RAD shares tanked, losing close to a third of their value. I added 50% to my position at that point. Then, more recently as the share price continued to decline, I ‘doubled down’ at around $2.27 a share. This ‘doubling down’ has always been an issue for me; what ‘doubling down’ SHOULD mean is to double the INVESTED dollars not SHARE COUNT, yet I rarely end up doing that. What often happens, as it has this time, is that the share price drops, I buy another tranche of the SAME NUMBER of shares as I currently own with the intention of buying a further tranche when the share price falls more. Then, lo and behold, the share price never does fall further and instead begins to rise. Because I’m anchored to my most-recent purchase price I never end up purchasing the third tranche. It is totally illogical but I can’t seem to pull the trigger once the share price begins to rebound. Yet that’s EXACTLY the moment to buy… when the price is RISING not FALLING! The problem is that it’s not always easy to know when the price is really rebounding. In retrospect its easy to see this; a chart makes it obvious.  But in practice, well, you know what Yogi Bera said…

I find that one of the most difficult (read psychologically painful) moments is when one purchases  a final tranche of shares believing the share price is rebounding, only to have the price fall further. The way around this ‘purchase dilemma’ is to ignore short-term movements in the stock price and base purchases on your estimate of the company’s intrinsic value. Thus if you purchase with a discount to your intrinsic value (say a margin of safety of 30, 40 or 50%) it doesn’t matter if the share price goes down; in fact this is only an opportunity to purchase MORE of the company at an even GREATER discount. Of course this means that you have to do your homework and figure out your estimate of the company’s intrinsic value…

So where does that leave us with Rite Aid? Last post I outlined a bit of a heuristic valuation. I think you need a more complete in-depth valuation to feel comfortable in making an investment at current levels but I’m not going to provide that as I think each investor needs to make the effort on his or her own. I’m not expecting the share price to do much until the current deal with Walgreens is consummated (or not), so I think there is ample opportunity to pick up shares at levels slightly below where the shares are currently trading.


NACCO Industries (NC)

First, a hat tip to the Clark Street Value blog for bringing the Tropicana Entertainment opportunity to my attention; that was a cool 40% gain in less than 6 months! Thank you!

So now he’s mentioned the NACCO Industries (NC) spinoff. I love spinoffs (Thank you Joel Greenblatt), especially where there are two or more totally unrelated businesses within a holding company structure. ‘Conglomerates’ almost never get valued properly as investors have an easier time understanding ‘pure plays’ with the result that conglomerates seem to be assigned a ‘conglomerate discount’. NC is a perfect Greenblatt example; a coal mining business and Hamilton Beach, a small appliance maker. What do the two have in common? Not much, and apparently management has finally come to the same conclusion. This is a family controlled business (as will be the two surviving public companies) and so therefore everything is not strictly Wall Street rational. Family control can have significant advantages (long-term outlook and careful guarding of capital when shareholder and family interests are aligned) as well as disadvantages (like what are a coal company and small appliance maker doing together under the same corporate umbrella?).

I’ve taken an initial position and have yet to do a ‘deep dive’ into the financials. I’m hoping the market doesn’t pump up the value of the shares too much before I can get myself to look more closely at the two stand alone companies (already up 7+% since I purchased, ouch!)


New York REIT (NYRT)

Wow, what a ride! NYRT announced a transaction for their NYC Worldwide Plaza property last Thursday and the shares lost almost 10% in pre-market trading! What gives? Yes, this was a troubled REIT from the beginning; bad management (from a shareholder’s perspective, of course) slowly ground the value of this investment down considerably from its 2010 initial offering price of $10 per share. But with the decision to liquidate and a new management team heading the liquidation process since March of this year all the problems were supposed to be behind it. Why did the stock drop like it did? I’m not exactly sure but my guess is that the uncertainty that the Worldwide Plaza deal generated (a refinancing and sale of a portion of the equity rather than the sale of the entire equity position in the property) was the primary motive for the share price drop. On the conference call following the announcement, management DID affirm that the transaction will not negatively impact the liquidation NAV estimate that management will publish at the end of the 3rd quarter. As of the second quarter that NAV estimate was $9.21 per share. But management also made clear that the Worldwide Plaza deal will probably mean that at least the remaining interest in this property will probably not be sold within the two-year liquidation period, resulting in a continuing liquidation trust. As some institutional owners are not allowed to own non-tradeable securities this revelation could also have had a negative impact on the share price.

All that being said (and even before I heard the conference call) I added significantly to my position in NYRT at the opening yesterday. It seemed to me that a 10% haircut was far too much (actually it was more like a 15% haircut as the price had already begun to decline on Wednesday) and the market was overreacting. After listening to the conference call I am even more sure that the market over-reacted and now, of course, wish I had ‘backed up the truck’… but so it goes.


Portfolio update: BBX, TPCA, RAD and GLAE

Yes, I’ve been somewhat lax in updating my blog portfolio. The summer doldrums are here; with heat above 100 degrees my brain functions at half speed at best.

Last month I sold out my position in BBX Capital. I hadn’t really been following the vicissitudes of the company closely, but with the dismissal of the SEC charges against the former chairman and his return to the company once again as Chairman of the Board coupled with the declining share price over the previous 6 months I thought it time to take the money and run. I hung in there a bit to see if the NYSE listing would provide any renewed updraft in the share price, but it didn’t. I don’t like investing in companies where executives are even accused of wrongdoing (given the reticence of the SEC to go after ANY corporate executives I immediately assume that where there’s smoke there’s FIRE!). When I first invested in BBXT it was trading at less than half book value and the former Chairman (Levan) was ‘on sabbatical’. The shares are now trading over book value and he’s back in place… no need to say more. More than a 100% return, though I left money on the table by not being more attentive and selling out earlier.

The Tropicana Entertainment dutch tender terminated on 8/19. I tendered all my shares at the maximum, $45/share. Less than half the outstanding shares were tendered, meaning that the final price was the top end of the tender range and that a good number of investors thought the offer was too low. Knowing Icahn, it probably was! But for me a 45% return in less than 6 months was something I could live with, and to my mind there was more than some uncertainty as to the exit strategy and timing for those that continue to hold.

I have increased my positions in Rite Aid and Glassbridge. Selling in the wake of the 11th hour Rite Aid/Walgreen Boots deal change has sent the shares in Rite Aid down over 50%. I think this is a huge over-reaction. The company that Walgreens was willing to pay over $8/share for 24 months ago is now selling for 30% of that. Rite Aid is now a ‘disappointment’ stock and, to my mind, will bump along at current levels until a) the new slimmed down operations produces improved operating results or b) another company comes along and bids on the remaining Rite Aid (Amazon?). I plan to increase my position further if the shares continue to weaken.

Glassbridge delisted from the NYSE at the beginning of August.  There was a considerable spike in volume just before and after the delisting. I assume this was probably because some institutional holders didn’t want to or couldn’t hold the OTC shares, and that these ‘forced sellers’ have temporarily depressed the share price. In consequence I doubled my holdings at about $1.90/share. Insiders bought in June/July at more than $3.00/share, which would seem to corroborate my theory. The shares are still highly speculative and I’ll be closely watching the 2nd Quarter results which will be announced shortly.

Underperformance is UGLY

Over the past seven months I have added seven new positions, 6 long and 1 (ouch) short. Now, you know, I’m not one for looking at short-term performance but sometimes you have to look in the mirror and acknowledge just how ugly you are even in the short run… and that’s certainly the case here! Of the seven positions, two have positive returns, one is about even, and the remaining 4 are down between 8% and 40%. That’s not pretty when compared to the S&P 500; up some 11% since December 1, 2016. Undoubtedly throwing darts at a list of stock names would have resulted in better stock selection. So lets take a look what went wrong. As usual, I’ll ignore the investments with positive returns and focus on those that are down. There is no better way to improve your investing skills than dissecting your mistakes (if indeed they are mistakes!). So here goes.

Share Price
Company Purchase Current Change $2.09 $2.33 11%
Regency Affiliates $8.95 $6.95 -22%
Tropicana Entertainment $31.63 $42.60 35%
Glassbridge Enterprises $6.59 $3.96 -40%
Rite Aid Corp $4.70 $2.95 -37%
Awilco Drilling $3.76 $3.52 -6%
Netflix $138.00 $149.41 -8%

Regency Affiliates
Shares are down about 20% since I purchased. The story here is simple. One of the company’s three assets became irremediably impaired just after I invested; the company has a 50% interest in a cogeneration plant at a Kimberly-Clark facility in Alabama with a 15 year contract due to expire in 2019. The renewal was being renegotiated when I invested. With no forewarning (or at least none that I was aware of) it was announced in April that Kimberly Clark had decided to build their own cogeneration facility and thus not renew the contract! This rather surprised me as I don’t understand how it could be cheaper to build a new facility than renegotiate a better rate with the existing facility (but then again my engineering expertise is rather limited, I will admit). Furthermore Regency management gave no indication that the negotiations were going against them, or that, in fact, the decision would be made so soon. Once the existing contract expires in April of 2019 Regency will own an interest in a cogeneration plant that, from what I can understand, will have practically zero residual value. And this after management did a dog and pony show last Fall about how the company was so undervalued! So, either management was blindsided by the non-renewal or they were not quite honest with the investment community in their presentation. I’ll opt for the first, giving management the benefit of the doubt. But that still leaves me questioning the soundness of Regency management’s judgment. Did they underestimate the possibility that the contract would not be renewed and thus not dedicate enough effort to the renewal process or was it simply out of their control? We’ll likely never know.
So where does that leave us in terms of our investment? The Oct. 2016 management presentation put a ‘sum-of-the-parts’ valuation on the company of $14.63-$21.64 per share. Their value for the interest in the cogeneration plant was $10-$28 million, or $2.09-$5.86 per share. So a revised per share value might now be in the range of $12.54-$15.78 assuming no residual value for the cogeneration plant. It is interesting to note how much of the total upside the interest in the co-generation plant was in their Fall presentation! In any case, today’s price of $6.95/share is still a substantial discount to the company’s estimated ‘conservative value’; about a 45% discount to the conservative valuation. There remains another risk however; the company’s primary asset, a 50% interest in the buildings housing certain primary Social Security Administration offices, is under a lease that expires in 2018. Should the SSA not renew the lease this asset might have to be revalued downward. Notwithstanding this, I will continue to hold and see what happens during the lease negotiations. If the lease is renewed I expect that the underlying mortgage will be refinanced and the company should receive a large cash payment; how management handles this cash will determine whether I continue to hold thereafter or not.

Was it a mistake to buy when I did? or could I have made a better decision? The only thing I really fault myself for is being too optimistic about management. They did have some trouble with self-dealing about 10 years ago which I kind of ignored. Not sure, though, that my decision making was faulty as much as the timing inauspicious.

Glassbridge Enterprises
OK, I got this one ALL wrong. The transition from Imation as an operating company to Glassbridge as an asset manager sent the company’s financial statements into total turmoil. When I invested, the company was in the middle of the transition; financials were at best hard to interpret. It appeared to me that at my entry point of $6.59 per share I was getting more than the share price in cash on the balance sheet. However, when year-end 2016 financials were filed a couple of months later some of that cash and a good bit of book value had disappeared into the vortex; cash dropped from $50 million to $32 million, but more worrisome, book value dropped from ($.78) per share to ($5.29) per share. Just another case where I feel that management was somehow conspiring against us investors; new management also awarded itself 1.5 million shares against the right to invest funds in the now-parent company’s asset management business. And before you downplay this, remember that the company, after its January 10:1 reverse stock split, had only 5 million shares outstanding (including 5/6 of the grant). That 1.5 million shares represents more than 1/4 of the company!
It’s interesting to note how volatile the share price has been recently, trading down to almost $3.00 on basically no news, then popping back up to the $4-$5 range. I interpret this as investors having a rather disparate view of how the company should be valued. In fact, I’m a bit unclear myself as to how to value the business. With the share price down 40% from my entry point is it time to double down?
To a large extent I think the value of the Glassbridge’s asset management business is dependent on what The Clinton Group wants it to be worth. I’m assuming they want to do something with this ‘vehicle’. So if the shares dip into the $3.00 range again I’ll probably be doubling down.

In this case, I can clearly see that the investment process was faulty; I invested with incomplete information, knowing full well that it was incomplete. The hubris was in thinking that I could decipher what balance sheet information there was better than other investors WITH THE SAME INFORMATION! Note to self.. YOU’VE GOT TO BE KIDDING!

Rite Aid
What can I say here except that my belief was that management of Walgreens would tough it out and consummate the take-over? Well, they didn’t. At the 12th hour they struck a new, completely different deal; they agreed to purchase a little less than half of the Rite Aid locations for $5.8 billion, adjusted for working capital, and also give Rite Aid a $385 million breakup fee. From what I can garner, there are a number of varying opinions about what this means for Rite Aid shareholders. Will the stump company be able to make a go of it in their downsized form? or is there some other end game? It seems hard to understand the Rite Aid strategy in this new deal; most chains are trying to GROW and benefit from ECONOMIES OF SCALE. So what’s the scoop? I sure as heck don’t know. The new Rite Aid will be much less levered (the net $5.2 billion in cash they receive will go toward paying down LT debt of $7.2 billion). But savings of $300 million in interest payments doesn’t seem enough to ‘right the ship’, especially because they will be LOSING the effects of economies of scale on SG&A costs. We also have no idea WHICH locations they are selling to Walgreens; Are they selling the MOST profitable or the LEAST? So lets just take a step back and look at the big picture. Walgreens was willing to pay $6.9 billion for all of the Rite Aid equity ($6.50 a share), including the 4600 store locations and assumption of all liabilities (LT debt of $7.3 billion). Yes, they were going to have to sell off 1,000 or more locations to Freds but the compensation was still going to accrue to Walgreens. So, from a per store perspective, the buy-out deal valued each location at about $3 million ($14.2 billion/4,600 locations). Under the current store-purchase deal Rite Aid will be left with 2,400 locations. If we valued these locations based on the Walgreens revised buyout offer price of $6.50 a share they would be worth $7.4 billion. The shareholder equity would then be worth $5.2 billion (the $7.4 billion EV less the debt of $2.2 billion). With about 1.1 billion shares outstanding that would come to about $4.75/share. This is clearly worse for Rite Aid shareholders than the Walgreens original offer. But that simple calculation points out the several factors that WE DONT KNOW and which are ESSENTIAL for a more precise valuation; which store locations were sold off (the best or the worst?), whether SG&A can be shrunk commensurate with the shrinking of the store locations and what other efficiencies, in the form of sourcing benefits, the current store-purchase deal holds for Rite Aid.

I don’t think my (or anyone else’s) valuation of the post-deal Rite Aid can be very accurate with the information we currently have. I kind of laugh when Evercore comes out with a target price of $2.50 per Rite Aid share, but perhaps they know a lot more than I do. Instead, I want to focus on another aspect of the deal; Rite Aid management was in the mental mode of being ‘bought out’ over the past 18 months. I’m sure operations suffered because of the uncertainties surrounding the acquisition. I’ve worked for a company that was the target of an acquisition and I can assure you it’s not a pleasant experience; everyone is looking for their next job. So, transitioning from that mindset to one based on reorganizing a downsized corporate structure? good luck! My inclination here is to believe that some other deal is in the works or will be in the works shortly. It is difficult to move from one mindset to another so swiftly especially after such a long ‘gestation’ period. So my totally UNINFORMED prediction is that the stub company gets sold within the next 18 months as well. It may be that management will need the Walgreens purchase to be approved before another ‘deal’ can be announced, but I think those investors who wait it out will see a tender in the $5-7/share range sometime in the next two years. Of course, I could be totally off base; Rite Aid management might have an acquisition (like Freds?) in their sights instead. Or they could just be happy to maintain their high paying management jobs and run the company into the ground (never underestimate self-interest!); it’s not easy to ascribe intelligent asset allocation to management. In any case, I am hoping to double down on my position at around $2.50/share. I was surprised at the price resilience yesterday as it was the last day of the quarter and I thought there might be some ‘forced’ selling for those funds that didn’t want to show a position in Rite Aid at the end of the quarter.

On the investment process: the jury is still out. Need to see how this plays out over the next year or two.

Awilco Drilling
Shares of Awilco, after accounting for the $.20 dividend paid in June, are currently priced right about where I purchased them. I expect the share price to remain in a rather narrow range until we get closer to contract-end next April or oil prices make a significant move up (or down!). I think there is kind of binary outcome for these shares based on what happens to the price of oil.

Ditto as above: the thesis still has to play out.

OH BOY WAS I EARLY ON THIS! shares are now only 8% higher than when I sold short but in the meantime they have been as high as $165 (-20% on my position). My original investment thesis was that the shares were priced for perfection at $138, but, as someone once said, the market can stay irrational far longer than I can stay solvent. I almost bailed on this position several times but because it is small relative to the overall portfolio I ended up hanging in there. I still think Netflix shares should be priced in the $50-$75 range. Will they ever get there? I don’t know. But what I believe the general investing populace is forgetting is that this disrupter can get disrupted too! Who is to say that Amazon or Google won’t invest billions to create original programming? Then it would just be an ‘arms race’; who can spend the most and develop the biggest guns (the best programming). There really is no enduring moat in this race; just look at the broadcast networks! And they had a 30 year head start! New technology is the disrupter and Netflix just happens to be at the crest of the wave at this moment.
As I noted in my last post, I’m still about 50% in cash and look to stay that way until I can find a $.20 dollar. Given my slothful state I really don’t think that’s going to happen until the market corrects ever so slightly. In the meantime I’m trying to build up a wish list of great companies that I might be tempted by at 50%. 40% or, better yet, 25% of their current price.

The investment process: remember 2 things.. 1) do not short shares; trading is not your strength and 2) don’t forget… DO NOT SHORT NO MATTER WHAT! GOT THAT? This position may still play out positively, but it will just be pure dumb LUCK (something we hope for in investing but know not to count on).

Updates on TPCA and GYRO

A quick update on a couple of positions that are in the news.

Carl Icahn’s IEP and Tropicana Entertainment (TPCA) are offering to purchase up to 5.58 million shares of TPCA shares in a Dutch auction for a minimum of $38 and maximum of $45 per share with the tender running through August 2nd. The auction is contingent on at least 2 million shares being tendered. If the full 5.58 million shares are tendered IEP will control over 90% of the outstanding shares as it already owns 72.5%. My only thought about this tender is that the price range is rather odd since the stock is already trading at $42/share; why anyone would tender below the current market price is not clear to me. In any case, I will be tendering my shares at $45 since my original investment thesis was that Icahn would do something to bring the share price closer to HIS estimate of intrinsic value ($48/share per IEP’s balance sheet valuations), and here we are. A 45% gain in less than 6 months is nothing to be sneezed at. On the other hand, I also don’t mind if he doesn’t buy up my shares at $45 as I’m quite convinced he would come back at a later date with a potentially sweetened offer.

Gyro dyne Corp. (GYRO) has announced a distribution of $1.00 per share as part of  their long-term liquidation process. My thought here is that after the shellacking common shareholders (me, primarily!) took in the exchange a year and a half ago I’m a little peeved that the liquidation isn’t being moved along with a bit more urgency. I look at the slowness of the process and note that, as usual, management is reticent to liquidate in a timely manner since their compensation terminates with the full wind-down of the company.

On a similar note I’m also becoming less and less enthused with Winthrop management’s handling of their liquidation; its been almost a year now since the company’s remaining assets were put in a liquidating trust and we shareholders have seen little in the way of property sales and liquidating distributions. I was very positive about management when they first decided to put the REIT into liquidation almost 3 years ago but now I’m beginning to wonder if they are not just dragging out the liquidation process for their own benefit. Because of what’s happening with the Winthrop Liquidating Trust I’m beginning to get worried about my position in New York REIT (NYRT) as Winthrop’s management has taken over management of that liquidation as well. As part of Winthrop management’s pitch to replace the then-current management at NYRT they estimated the liquidating value of NYRT at over $11.00 per share. But the latest financials for the company, the first to be presented under liquidation accounting, show a liquidation value of just $9.25 per share. So where did that $1.75+ per share of value go? Difference between conservative liquidation value and real potential liquidating dividends? or perhaps difference between marketing (when you’re pitching something that will bring in $) and operations (when you actually have to perform!)….hmmmm. We’ll see. Maybe I’m just being a bit too anxious.

Just a note on my cash position. From the above you can see that I have invested in a number of situations that are self liquidating. My current portfolio remains about 50% equity, 50% cash, and with time (and no action on my part) I’m looking for the cash portion to increase. (Note that I wouldn’t mind if the equity portion increased too.. in both absolute and relative terms!) Yes, I’m nominally in the camp of ‘overvalued stock market’ but I have no idea when or even if this might be corrected. Unlike most market analysts, I’m willing to freely admit I have absolutely no predictive powers. My cash position is more reflective of the fact that I can’t find anything dirt cheap to buy (and that what I do buy doesn’t turn out to be as dirt cheap as I thought … but that’s the subject of my next post). I have to fight daily from keeping that cash from burning a hole in my pocket, especially since I’ve been wrong on the market direction for a couple of years. But better safe than sorry; I’m too old to go back to waiting on tables or being a Wal-mart greeter (ouch!) Selling apples on the corner (1930) no longer seems to be an option!

Sale of Aviat Networks (AVNW) and 3 purchases

I haven’t been posting much recently; I’m a little gun shy since shares in the companies I wrote about in my last 2 posts dropped 30%+ after I mentioned them. Today I’m updating my portfolio for a sale and 3 recent buys. First, the sale; I’ve finally sold out my small position in Aviat Networks. I initially purchased shares in the company because it was a holding of Steel Partners LP and they have a history taking a minority position in small companies, influencing (or replacing) management, turning the company around and taking out the public shareholders at a decent premium. However, Aviat had a few problems I did’t see when I first purchased my position, and after I purchased in 2014 losses continued and, in fact, began to grow. The shares, reflecting a 3:1 reverse split, fell from the mid teens down to almost $5 a share. Then, and only in the past 6 months, the price begun to climb. I don’t know exactly what’s behind this surge; there have been some recent  announcements about new products but earnings have certainly not been anything to write home about. Earnings are due out after the market close tonight (sorry, didn’t publish this until the day after!) but with the share price up some 50% since I purchased I’m happy to gracefully exit and put my funds to use in a more depressed sector (read CASH or perhaps natural resources).

OK, so where and why have I been putting funds to work since my last post in February? I’ve taken 3 small positions: Awilco Drilling (AWLCF), Rite Aide (RAD) and Tropicana Entertainment (TPCA). The first, Awilco Drilling, was a darling of the value investing community until 2 years ago when oil prices tanked and the stock cratered, dropping almost 90%. Awilco is a simple company; it owns and operates 2 semi submersible drilling rigs in the North Sea. That is, it owns 2 but operates one as the demand for drilling rigs in the North Sea is currently low or non existent. The one operating rig is under contract only until next April. What then? Either demand picks up and both rigs are put back into operation or the second rig could also be stacked like the first, and the company basically put on hold. Alternatively, the 2 rigs could be sold (for scrap or otherwise) and the proceeds distributed to shareholders. My bet here is that there is some recovery in oil prices or that at the very least there is some recovery in day rates for rigs in the North Sea. There should be at least $.60 in dividends before the end of the year from cash generated by the one operating rig.
My second new position is Rite Aid. I know, I know, merger arbitrage is generally a no win game for the non-professional. I’ll admit I have no edge here, but my thoughts on this long drawn out acquisition are simple: 1) the proposed acquisition has dragged on for so long it’s likely most arbitragers have given up and sold their position, 2) the terms of the acquisition have worsened since the initial offer by Walgreen creating further incentive to dump the shares and 3) even if the acquisition doesn’t go through (I give it a 50 50 chance) I think that the company is worth more than the current $4 and change a share based on operating results over the past 10 years.

And my final new position is Tropicana Entertainment (TPCA), an idea that I purloined from.. well, I can’t remember where. The narrative behind this is that Icahn, who owns a majority of shares, values the company on his LP’s balance sheet at $49/share. If its worth so much more than the market price might he not just step up and purchase all the remaining shares at even a 10% discount to his estimate of intrinsic value?

The above is just a shorthand narrative for these three new investments. I’ll try to put something together a little more in depth shortly.

The Company Previously Known as Imation: Glassbridge Enterprises (GLA)

I’ve been following the vicissitudes of Imation for a number of years, ever since it first showed up as a net-net on one of my screens. I have never been close to investing in it, primarily, I think, because the track record of management looked horrendous. Perhaps it was just a function of luck; by the time I became aware of the company management had established a multi-year track record of deplorable asset allocation. So I was surprised to read about their latest transformation in a recent post at Shadow Stock. Despite some misgivings about the nature of the transformation I decided it might be worthwhile to take a second look, and the Shadow Stock analysis further peaked my interest. I have to admit that the opaqueness surrounding the transformation really intrigued me. When deals are opaque, they usually are so for a reason; either the dealmakers create opaqueness to derive some benefit for themselves or the complexity of the deal, combined with reporting requirements, creates unintended opaqueness. In the former case, you want to stay as far as away as possible since the dealmakers are merely out to fleece  investors. In the latter case, the opaqueness of the deal can create an opportunity for those who are inquisitive as it may induce most investors to indiscriminately sell the offending company.

So what kind of ‘deal’ is the Imation transformation? On the face of it, one might think it is the former; Clinton Group, an activist investor, has taken the lead in transforming Imation from a data storage company to an alternative asset manager. “Huh?” you may say, “What do the two have in common?” or “How is the management expertise of the former supposed to transfer to expertise in the latter?” First I should remind the reader that the so-called management expertise in the former didn’t really produce favorable results did it? So, no loss there. OK, so now the company is to be transformed into an asset manager using the leftover cash that prior management didn’t have time to dissipate to seed the new company. Next step, issue Clinton Group  12.5 million shares of Imation (renamed Glassbridge Enterprises) stock for use of its investing platform for the next 5 years. “WHAT! That’s egregious self dealing.. shareholders getting ripped off!” or so was my first thought. Furthermore as part of the transformation, the last operating business, Nexsan, was to be ‘sold’ for a $25 million promissory note and 50% of the equity in a successor operating entity; Nexsanwould be combined with a similar company owned by a private equity firm. “Huh?” my thoughts exactly. So you spin-off the only operating entity, merge it with some other operating company owned by a private (read PIRATE) equity firm and you get an IOU and some ‘equity’ in the new entity? Great deal! So far it adds up to a lot of nothing, at least superficially. Oh, I forgot to add a 1 for 10 reverse stock split just to further complicate the financials.

Then I had a think about this. Clinton Group, while being the activist on this company, wasn’t by any means the largest institutional investor; Ariel Capital Management, Wells Fargo and Renaissance were much larger investors than Clinton Group. In fact, prior to the 12.5 million share issue, Clinton Group was only a 3% owner. So why were the other ‘sophisticated’ investors letting Clinton Group up their ownership to 28% without putting up a penny and diluting the other investors by almost 1/3? Hmm.. is there something I’m missing or are the other investors just making the best of a bad situation? After all, they had all invested in Imation at much higher levels.

Just to be sure about ‘invested at higher levels’, lets take a look at the price history of Imation stock. UGH! 10 years ago Imation shares were trading at around $40. Then, over the next two years they traded down to the $8-9 range, gradually trending down over the next 8 years to around $1/share a year ago. Not particularly good for long-term investors! Today, Glassbridge Enterprises is trading around $6-$7 (after the 1:10 reverse split). This means that almost every investor, unless very recent, is sitting on a significant loss in their position. This, of course, doesn’t rule out the ‘making the best of a bad situation’ mentioned above.

How to value Glassbridge? Not so easily as it turns out, at least not until the next quarter’s financials are filed. It is not clear to me how to break out the Nexsan operating business that has now been ‘sold’ from the Imation’s last consolidated balance sheet. Nor is it clear how to evaluate some of the assets and liabilities from discontinued operations on last quarter’s balance sheet. But let me take a stab at a liquidation valuation

Cash & marketable securities $10.00
Resricted cash A/P $2.18
A/R DO $0.36
Other Discontinued Ops $1.15
subtotal $13.69
Current liabilities $1.29
Disputed A/P $5.77
Pension Liabilities $4.82
Other non-current liabilities $0.60
Other Discontinued Ops $2.82
  subtotal liabilities $15.30
shareholder equity -$1.61
Disputed A/P $5.77
Nexsan Promissory Note $5.04
Reduction in other liabilities (50%) $0.95
Discontinued Ops (50%) $0.84
subtotal before equity $12.59

At the end of the 3rd Quarter 2016 Imation financials showed shareholder equity of about -$3 million. I estimate that Nexsan had a maximum of about $5 million in shareholder equity, leaving the balance of the company with about an $8 million equity deficit.  Pro forma, then we might expect Glassbridge to have an equity deficit of about $1.60 per share post reverse share split and Nexsan spinoff IF NOTHING ELSE HAPPENED IN THE 4TH QUARTER (which of course it did, but we’re not yet privy to this yet, so this is all a bit fictitious). Where’s the value then? It’s both in the potential balance sheet upsides listed above as well as the value of the ongoing asset management business and the equity interest in the new Nexsan. Right, the above analysis gives no value to the 50% interest in the new Nexsan entity nor does it ascribe value to what Clinton Group contributed for the 1.25 million shares it received.

Clearly from a balance sheet perspective we max out at an asset value of $10/share or so, and that’s not considering that Glassbridge will be using some of its cash to build a staff for its new asset management business. In other words don’t count on that cash being returned to shareholders or even invested in passive investments (private or public equity) for the benefit of shareholders; A liquidation valuation really isn’t of interest here as Glassbridge is set to be an ongoing business and I can see an operating cash bleed for 3-5 years depending on how long it takes the company to attract enough AUM to cover operating (read staffing) costs.

What makes this an interesting potential investment then? I think it’s because management and major institutional shareholder interests are aligned with the interests of us little shareholders. Yes, Clinton Group gets a ‘free’ equity ride for contributing its expertise; it’s a low-cost way to launch an alternative asset manager that will be valued in the stock market, but they have every incentive to make it work. After all, their name is attached to it! And to make it work they need to have some good initial investments. That’s why I think getting in early could have advantages. But it’s not to say that the share price will not go lower. Yes, I’d rather buy $10/share worth of company for $4 rather than the current $6. And the market may not recognize the potential for this asset manager until its results are proven so we do run that risk that shares could tank from here until the market sees results. That said, I do think this is an interesting investment opportunity for anyone looking at a publicly traded alternative manager (and there aren’t many out there).

Note that the above is simply my very approximate analysis of Glassbridge; asset managers are not really in my field of competence, so I would be quite happy if someone more knoweldgeable weighed in on this and pointed out where I am mistaken. Thanks!

Disclosure: I own a small position and may add to it if the share price drops further.

Regency Affiliates (RAFI)

I’ve recently picked up a small position in Regency Affiliates (RAFI), not an easy thing to do at the price I wanted to pay as the liquidity is almost zilch.

I first read about RAFI in a 2013 post over at OTC Adventures. At the time I remember thinking that the company looked interesting but the potential value recognition catalyst appeared to be about 5 years away, so I took a pass and put it on my ‘potential’ list that I file away (sometimes only mentally). As it happens, a few weeks ago I was browsing through Barrons weekly list of new annual highs and lows and I recognized the name Regency Affiliates (on the ‘new lows’ list of course, I rarely peruse the new highs). So I took a jog over to their website to see if there was any news that might have caused the stock to drop. I didn’t immediately see any, but that didn’t surprise me; illiquid stocks like Regency can make significant price swings on just a small amount of volume. Then I thought I might check to see if they had published any recent financials. Regency is a ‘dark’ company (no financials filed with the SEC) and so I didn’t expect to find much. But just when you least expect it! Yes, the company participated at a microcap conference in October of last year and made a presentation that was available on the website!

Basically the presentation was a valuation of the company. And while I found the presentation interesting, more interesting to me was why a CEO who owns almost 50% of a company would be making a presentation showing the company to be significantly undervalued by the market. But lets leave that till later.

The presentation confirmed the basic outline of OTC Adventure’s post. The only update was that between then and now the company made a rights offering (to qualified investors only… a bit of a caveat here that management can be self-serving) raising about $9 million last Spring and investing those funds in a self-storage facility in PA. This means the company now has 4 assets; Cash, a 50% interest in a Maryland property currently under lease to the Social Security Administration, a 50% interest in a co-generation plant serving a Kimberly Clarke manufacturing plant in Alabama and the new investment in a Pennsylvania self-storage facility. Per management’s calculation the shares are undervalued some 35-60% (upside of 60-135%). Take a look at their calculations. They don’t seem unreasonable. The two main risks are that the Social Security Administration doesn’t renew their lease in 2018, which I think is very unlikely, and that Kimberly Clark doesn’t renew their co-generation contract for the Alabama power plant, which I also view as somewhat unlikely. The other risk of course is that management does something stupid with the free cash flow or makes some self-serving investment. This is entirely possible because apparently in the early 2000s they did something similar, but more recently they have been using cash flow more judiciously, paying down borrowings in each of their investments.

The real question here is what is management’s game plan and is there an exit strategy. The CEO owns close to 50% of the equity and is 60 years old, i.e. heading towards retirement at some point in the next decade. This is not a company that is likely to be bought out given the diversity of the assets. Potentially, the assets could be sold off individually. But if that was management’s intent then why buy a the storage facility just 9 months ago? So I have to conclude that management’s short-term strategy is to opportunistically buy undervalued assets that will accrue in value over the long-term, but that their long-term game plan and/or exit strategy is still unclear, or possibly even unformulated. The question is why suddenly participate in a micro-cap conference? The most obvious response would be that Management is trying to boost the stock price. But if the stock price is so undervalued why doesn’t management simply buy more and eventually buy out all the public shareholders?  That would provide the most upside. Perhaps they don’t have the means. More likely is that they might want to use equity, combined with funds from refinancing the MD property (once the lease is renewed), to potentially make a large acquisition. If this is the case, then the current undervaluation of the shares is merited as there is some risk that the funds might not be effectively invested. For shareholders looking to close the value gap the best outcome, of course, would be for management to return any cash from a refinancing in the form of a dividend or share buyback . Ironically, returning the cash from a refinancing would probably do more than anything else to get the company’s share price up and the company’s market value closer to its intrinsic value.

For me, despite the risks, the shares represent an attractive investment in a basket of undervalued assets with the potential of a value-enhancing catalyst happening within the next two years. Yes, the attractiveness, is somewhat limited by the risk that management could poorly allocate future free cash flows, but, given the asset value, I see limited downside and I like investing alongside management where they have significant skin in the game. My hope is that the cash freed from refinancing the MD property will, at worst, highlight value of the company to the investment community and at best be returned to us patient shareholders.