Clark Street Value

Western Asset Mortgage Capital (WMC) ($56MM market cap) was one of the mortgage REITs caught up in the margin call wave of 2020 when otherwise safe mortgage back securities ("MBS") suddenly went no-bid.  Mortgage REITs often financed their MBS with daily mark-to-market short term financing, when MBS prices suddenly dropped (they would later recover), financing counterparties forced liquidations and significant shareholder value evaporated in the process.  WMC did survive, but in a wounded and subscale form.  Around the end of last year, they started to transition their portfolio away from commercial mortgages to residential mortgages, primarily in Non-QM loans (financed via RMBS under the Arroyo branded shelf).  Non-QM is short for non qualifying mortgages, those that aren't eligible to be purchased by the GSEs, most of these are actually to prime borrowers (746 average FICO) but those borrowers don't have regular W-2 income to meet tighter post-GFC mortgage underwriting standards.

Getting straight to the point, WMC trades for $9.35/share despite having an economic book value of $24.58/share, or WMC is trading at just 38% of book.  Their book value will likely come down a fair amount when they release Q3 earnings due to rates rising and spreads widening since 6/30, but it should still be very cheap to its net asset value.  WMC is managed by large fixed income specialist Western Asset Management, they've already cut their fees 25% for 2022, have no chance of raising additional capital to regain scale, and are thus waving the white flag by announcing they've commenced a strategic alternatives review process.  It is likely just not worth Western Asset's time at this size (their management fee is based on equity, not assets).

Here is WMC CEO Bonnie Wongtrakool discussing the rationale in their Q2 earnings call:

The primary way to achieve scale as a mortgage REIT is to issue additional common equity, but our philosophy and practice has been to conduct equity offerings only at such times when they have not been materially dilutive to existing shareholders. The last time we issued any meaningful amount of equity was in the second quarter of 2019, when we raised nearly $50 million, which was done at a modest discount to our book value at that time.

Unfortunately, when COVID hit the following spring, our portfolio experienced a significant decline in value and our stock price experienced an even greater decline relative to book value. Since then, our overarching goal has been to improve and stabilize our future earnings power.

Over the last two years, we have made significant progress by taking actions to improve our liquidity and balance sheet and by shifting our investment focus towards residential real estate. Nonetheless, we do not see these positive actions being reflected in our stock price. Therefore, we believe that yesterday's announcement regarding our decision to review strategic alternatives is the best path forward towards unlocking shareholder value, and we are committed to analyzing alternatives that may involve a sale, merger or other transaction involving the company.

I'm always a little skeptical of externally managed mREITs looking to sell themselves, sometimes it means they're simply selling the management contract to another asset manager that will just rebrand and the discount to NAV won't close much.  But here the discount is so wide and the language sounds slightly more focused on shareholders.  There is likely some middle ground in between the share price and book value to get a deal done that pleases all three parties: 1) WMC shareholders get some premium to current prices; 2) Western Asset rids themselves of the distraction and receives some value for their management contracts; 3) one of the countless potential acquirers gets a publicly traded permanent capital vehicle or a current mREIT gets some additional scale and fees for their manager.

Similar to LMPX, this is a completely commodity/fungible type business or balance sheet that trades hands regularly, even in this currently strained M&A market, a willing seller (which sounds like they are) should find no problem finding plenty of willing buyers.  Most likely this will be a stock-for-stock deal or reverse merger with a non-traded REIT, so the upside won't be as big as a liquidation or cash deal, but still an attractive risk/reward.  My best guess is $12-14/share in value.

Other thoughts:

• Their balance sheet is a mess and difficult to untangle.  For example, one of their legacy commercial investments is a mezz tranche of the Mall of America CMBS (CSMC Trust 2014-USA) and due to accounting rules, WMC actually consolidates the entire SPV.  WMC's economic exposure is $10.7MM, but they consolidate the $1.4B in liabilities on their balance sheet.  Mall of America's future is certainly cloudy, they did restructure the loan during the pandemic, but as an important tourist attraction for the Twin Cities MSA, I would expect it to get political support to survive as a destination/entertainment mall.  In 2020, alongside the restructuring, Trep did put a $1.9B value on the mall, for whatever that's worth.
• They also have one big problem CRE loan, "CRE 3" in their disclosures which is described as an entertainment/retail property in New Jersey.  I couldn't find it in their disclosures, but it wouldn't surprise me if that was the troubled American Dream mall as it shares ownership with Mall of America.  CRE 3 has been in non-payment status for about a year, if WMC needs to write down the full value of the loan, that knocks about $4/share off the book value.
• Their Non-QM loans are highly concentrated in California, about 2/3rds.  LTVs look good (originally 65% at the time of underwriting) at the current moment, but we're early in any housing correction and California typically exhibits higher price volatility than other markets.  WMC disclosed that about 15% of their Non-QM loans have near term rate resets (these are ARMs) that will slightly help offset the price pressure of higher rates.

Disclosure: I own shares of WMC

Back in the March 2019, I wrote up the merger between U.K. based Mereo BioPharma (MREO) (~$100MM current market cap) and OncoMed Pharmaceuticals (formerly traded as OMED) as a way to play the contingent value rights that were issued to OMED shareholders.  The CVR part of the thesis hasn't worked out, at least yet, there are still potential milestones on Navicixizumab in play before the CVR expire on 4/23/24.  Since closing out that trade (I received MREO shares in the merger but sold immediately at $5.30, shares trade for $0.95 today), I've checked in on the company occasionally as the CVRs naturally have Mereo counterparty risk.  On the most recent of those check ins, I came across two Seeking Alpha write-ups (here and here) by Dalius Taurus of SSI that piqued my interest.

Mereo BioPharma has six product candidates, four purchased from larger biopharmaceutical companies (Novartis and AstraZenca) that previously received considerable investment in the pre-clinical stage but were no longer strategic priorities and two product candidates inherited from the OncoMed acquisition.  MREO's market cap is approximately $100MM (MREO trades as an ADR, each MREO share equals 5 ordinary shares) and last reported a cash balance of $105MM (current conversion rate, MREO reports in GBP) as of 2021 year end, after some cash burn, it likely has a small positive enterprise value.  

Similar to most pre-revenue biotechs these days, Mereo's investors have lost their patience funding development pipelines, Rubric Capital (~14% owner) has stepped up as an activist to stop the cash burn by attempting to reconstitute the board of directors.  Rubric has its eyes on gaining control of the board, then monetizing assets and returning cash to shareholders in what amounts to a liquidation.  Rubric is run by David Rosen, who was a portfolio manager at SAC Capital (now Point72) before going on his own in 2016.  It just so happens that the second largest MREO shareholder is Point72 with 8.6%, likely friendly to Rubric, further increasing the likelihood that Rubric gains board seats in the proxy campaign as the current board/management owns an insignificant amount.

Below is the back of the envelope valuation math provided by Rubric in their 6/9/22 letter:

I have little way of confirming or refuting their valuation, but even if they're wrong by half the stock is approximately a double from here.  Mereo's most valuable asset according to Rubric is their partnership with Ultragenyx (RARE) on Setrusumab (originally purchased from Novartis) which is a treatment for a rare bone disease, osteogenesis imperfecta ("OI"), that currently has no approved therapies.  Mereo retained the commercial rights for Setrusumab in the UK and Europe, otherwise Rubric is ascribing no value to Mereo's other product candidates, including Alvelestat which is a treatment for a rare lung disease undergoing clinical trials.

Alvelestat is the one product candidate that came from AstraZenenca (AZN). In June, which to be fair is a lifetime ago in this market, The Times of London reported that AZN was considering a bid for MREO:

Word is that it is considering a bid for Mereo Biopharma, a specialist in cancer and rare diseases.

Mereo, which has developed a portfolio of six clinical-stage product candidates, is based in London but listed on the Nasdaq exchange in New York and lists AstraZeneca among its partners alongside Novartis, OncXerna and Ultragenyx. There are suggestions that at least one other suitor, possibly another partner, may also be on the prowl.

Shares in Mereo have been a stinker, shedding almost 80 per cent of their value in the past year, although they jumped by 8.5 per cent to 69 cents on Wednesday, valuing the company at $81 million. Analysts have an average target price of $7 and the talk is that Mereo would accept $5, equating to $500 million including American depositary receipts or ADRs. Evercore and Citigroup are said to be involved as advisers.

This article came out around the same time as the Rubric letter, they might be related, or it might be coincidence.  Even if the Setrusumab valuation is overstated, there might be other assets worth something here.  Rubric and Mereo's management have been going back forth on Rubric's request for a special meeting, Mereo seemingly was citing every technicality why Rubric's request was ineligible but eventually relented and the special meeting is now set to happen sometime in November.  It appears that a new board will be put in place shortly, we'll see what happens from there.  I bought a small position.

Disclosure: I own shares of MREO and some non-tradable OMED CVRs

Another quick idea -- hat tip to Writser again for pointing me in this direction -- Digital Media Solutions (DMS) ($135MM market cap) is a "technology-enabled digital performance advertising solutions" company that came public in July 2020 through a SPAC, Leo Holdings Corp (LHC).  From what I can gather, DMS gets allocated marketing spend from their clients, runs a digital campaign and then delivers warm leads or actual customers to their client depending on the arrangement.  DMS gets paid a percentage of that customer's lifetime value ("LTV") based on the advertising client's models.  While this isn't a great business, DMS is cyclical based on marketing spend (having a down year in 2022), it doesn't seem to be a scam or puffed up science fair project like other deSPACs of recent vintage, DMS is more a marginal-to-average business with potential long-term tailwinds.

Since all my speculative M&A ideas seem to be falling flat on their face in the current market environment, it is time to go back to a broken biotech that appears set to liquidate.  IMARA Inc (IMRA) ($43MM market cap) is a clinical stage biopharmaceutical company that announced back in April their decision to discontinue further development of their sickle sell disease treatment (IMR-687) and initiate a process to evaluate strategic options.  The stock then crashed and traded at about half net current asset value.  In 2022, that's nothing exciting on its face, there are lots of broken biotech stocks trading well below cash that it is difficult to parse between them for actionable ideas other than taking a basket approach.  

But IMARA is interesting because today they announced via an 8-K (no press release) that they've sold IMR-687 to Cardurion Pharmaceuticals for $35MM, plus some contingent payments if things go well.  Excluded from the asset sale is IMARA's cash pile:  

Excluded Assets. Notwithstanding the provisions of Section 2.1, no right, title or interest is being sold, assigned, transferred, conveyed or delivered to Cardurion in or to (a) any property and assets of Imara that are not Purchased Assets (including any and all amounts of cash and cash equivalents of Imara), (b) any rights or claims of Imara under this Agreement or any of the Ancillary Agreements, (c) all assets of Imara exclusively related to IMR-261 and (d) all assets of any Third Party with whom Imara enters into a transaction on or after the Execution Date pursuant to which it becomes (or will become) an Affiliate of such Third Party (collectively, the “Excluded Assets”).

Prior to this surprise asset sale (I normally assume a broken biotech's IP is worthless), IMARA had a net current asset value at 6/30 of ~$60MM and 26.3 million shares outstanding, or $2.30/share in net cash.  After the asset sale closes, that number jumps up to $3.65/share (pre-cash/expense burn), yet the shares only trade for $1.67 today.  Hidden in the 8-K, the company mentions the below:

In connection with stockholder approval of the Asset Sale and the plan of liquidation, the Company intends to file a proxy statement and other materials with the SEC. Stockholders of the Company are advised to read the proxy statement and any other relevant documents filed with the SEC when they become available because those documents will contain important information about the Asset Sale and the plan of liquidation.

They did a few other things that hint this it for the company, they amended their retention plans to pay 50% out now on the execution of the asset sale and 50% on the closing of the asset sale, versus paying out on any subsequent reverse merger or other action.  And it appears their advisors are done too.  The current price seems far too cheap if the company is going to return their cash to shareholders, I bought some shares today.

Disclosure: I own shares of IMRA

A quick update on one of the few ideas that worked for me this year, LMP Automotive (LMPX) ($80MM market cap) announced on Monday that they have sold most of their dealerships and will be asking shareholders to approve a plan of liquidation.  In the press release (oddly, no 8-K was filed), management put out an estimate of $115-$126MM, which on ~11 million shares outstanding equates to $10.49-$11.49 per share in distributions (liquidation estimates are typically conservative).  The asset sale is scheduled to close in October, yet as of today shares trade for just $7.50/share.  Following the asset sale, by my count, LMPX will have only one new car dealership (Bachman-Benard Chevrolet-Buick-GMC-Cadillac in TN, LMPX paid $7.5MM for it in 2021) plus less than a handful of unbranded used car dealerships remaining to sell, which should be a small part of the total enterprise value.  If approved, I'm guessing a large distribution could be made before year end that would return most if not all the current share price, leaving a stub that may take time to wind down.

There are still a number of red flags around LMPX, the company is restating earnings and behind on their financials, they recently fired their CFO, and they seem to have limited oversight (whether it be truly independent board members or strong shareholders) of CEO Sam Tawfik (who is also now the interim CFO).  On the other hand, Tawfik does own 35% of the shares and has been repeatedly emphasizing via business update press releases (here and also here) that the share price doesn't reflect the private market value of the company's assets.  Getting approval for the liquidation shouldn't be an issue, since Tawfik owns 35%, getting over the 50% mark shouldn't be a problem even with a largely retail shareholder base.  The major remaining risk is the asset sale closing, we don't have much disclosure about the buyer at this point, but going back to the original thesis, car dealerships are rather fungible and if the buyer falls through, I'm sure there's one behind them willing to transact at near similar terms.

Disclosure: I own shares of LMPX

Quick one today that I mentioned briefly in my Mid-Year post as a watchlist idea.

WideOpenWest (WOW) ($1.6B market cap) is a cable/broadband overbuilder primarily focused on secondary and tertiary markets in the southeast that trades for 7.5x EBITDA, while it sold assets last year for 10-11x EBITDA (here and here).  WOW is rumored to be in a late stage process to sell itself with both Morgan Stanley Infrastructure Partners and Global Infrastructure Partners reported as interested bidders (worth noting that the two asset sales were to strategic buyers, both of these firms would be financial buyers).  Fully acknowledge that we're not in the same 2021 M&A environment, but the PE bid and financing are still there for digital infrastructure like businesses.  Even a takeout at a 9.5x EBITDA multiple would equate to $24.30/share or 35% higher than today's $18.00/share price.  After the asset sales, WOW is currently under levered at 1.9x net debt/EBITDA (a PE buyer would likely lever a cable company up to 5-6x); taking WOW out at a cheapish price with a relatively small equity check due to the ability to lever it up further, this deal would likely be a home run for the buyer.

A bit more about the business, as an overbuilder, WOW is the "challenger" cable provider that enters established markets which typically already included either Comcast's (CMCSA) Xfinity brand or Charter's (CHTR) Spectrum brand (which I'm long via LBRDK).  In order to convince customers to switch from an incumbent provider, WOW has to offer some combination of faster speeds, lower prices and better customer service.  Additionally, WOW lacks the scale and purchasing power of a Comcast or Charter when it comes to negotiating with content providers, further squeezing margins in the already declining video business.  All adding up to an overbuilder like WOW having lower penetration rates (28% of homes passed), thus lower margins and generally viewed as an unfavorable business model compared to the incumbents.

However, times are changing, as more people cut the cord and move away from the broadband/video cable bundle to just seeking out a broadband internet provider, WOW's value oriented proposition starts to look pretty good, offering similar speeds at a lower price.  With a recession potentially on the horizon, WOW might also benefit from the cord cutting trend accelerating and their position as a value offering as consumers look to cut costs.  To provide some perspective, 90% of WOW's new customers are only buying broadband.  Cable valuations have come down recently, partially due to rising competition, new competition is less likely to join the fray into WOW's already competitive markets, rather fiber-to-the-home overbuilders are more likely to focus on markets where the incumbents are vulnerable to new competition.

On the downside, WOW is currently trading at only a slight discount to Charter and the struggling Altice USA (ATUS), where CHTR/ATUS have better business models as a incumbent cable providers.  So there is some deal premium baked into WOW, maybe a turn worth.  I pulled the above public comparables from TIKR, I realize each is a bit different, especially throwing DISH in there.  I don't love the idea of adding another speculative merger position to my portfolio, but this one just seems to make too much sense for a PE buyer to take private.

Disclosure: I own shares of WOW

Thanks to Writser for pointing me to this idea

Rubicon Technology (RBCN) ($36MM market cap) is primarily an NOL cash shell with a small $4MM revenue, roughly break-even, industrial sapphire business.  RBCN was previously trading below net current asset value until 7/5 when Janel Corporation (JANL) offered to tender for 45% of the shares at $20/share.  Following the tender, Rubicon will distribute a $11/share special dividend (approximately their excess cash) to all shareholders including Janel and also delist from the NASDAQ along with suspending their SEC reporting requirements ("go dark").  If everyone fully participates in the tender offer (which they should, but is unlikely, probably a few forgotten shares out there), RBCN shareholders will receive a total of $15.05 in cash per share (45% x $20 + 55% x $11) in the next couple months, plus a dark NOL stub.  The shares roughly trade for the $15.05 cash consideration number today.

To fully access the NOLs, Janel will then be incentivized to make another tender offer on that residual stub in three years (IRS required waiting period to preserve the NOL) to get their ownership level above 80% so they can consolidate the financial statements.  Janel spells out that potential second step in their schedule 13D:

The purpose of the offer is for Janel to acquire a significant ownership interest in Rubicon, together with representation on Rubicon’s Board, in an attempt to (i) rejuvenate, reposition and restructure Rubicon’s business and brand by focusing on its profitable business line and implementing a lower cost structure to achieve profitability and (ii) allow Janel to be in a position to potentially more easily acquire such number of additional Shares of Rubicon three or more years thereafter that would, after which, should such transaction occur, permit Janel to consolidate the financial statements of Rubicon’s with its own, thereby allowing Janel to benefit from Rubicon’s significant net operating loss (“NOL”) carry-forward assets. Under federal tax laws, Janel would then be able to carry forward and use these NOLs to reduce its future U.S. taxable income and tax liabilities until such NOLs expire in accordance with the Internal Revenue Code of 1986, as amended.

Since the company isn't cash flow positive, they currently have a full valuation allowance against the ~$65MM in tax assets:

While the total tax asset is $65MM, about $39.5MM is federal which is likely more valuable and easily transferrable than the $13.3MM in state taxes (IL and IN), I'm guessing Janel could also take full advantage of the $6.75MM of capital loss carryforwards too.  Let's remove the state tax assets and call it $46.25 in value or $19/share (plus whatever you value the remaining business for) that Janel is paying $9/share ($20 minus the $11 special dividend).  You've got some time value of money in there since they'll need to wait 3 years for the next tender, and during that time some of the NOL will expire (it started expiring in 2021, but I don't know the amortization schedule of the NOL).  Sounds like potentially a great deal for both sides given RBCN traded for $9.00-$9.25 prior to the announcement.

I don't know much about Janel Corp, it is a $37MM market cap company traded OTC that is 42% owned by Oaxaca Group.  It appears to be a holding company of smallish operations in logistics, manufacturing and some health care.  We are taking some counterparty risk here in both the deal being completed successfully and Janel ultimately being able and willing to buyout the remaining stub in 3+ years.  They have committed financing already from the expansion of their established credit line with Santander (don't need to go to the syndicated or private debt markets like FRG/KSS for example).  Santander is also providing them with a bridge loan while they wait for the special dividend to get paid out.  The other minimum condition is 35% of holders tendering, four major shareholders including names people reading this blog would recognize own 27% of the shares have already agreed to tender, so that should be no problem either.

I go back and forth in my head on what value to ascribe to the stub position.  Post tender it will still have the same $19/share (or approximately that, again not sure how much will expire) in tax assets, Janel will be situated as the only bidder but also they'll have a sunk cost of purchasing 45% of it, we might be under a different corporate tax regime, it will be immediately useable so no discount for the time value or risk from their perspective that they won't get access to the NOL.  I don't see why the base case shouldn't be $9 again, but I could be too optimistic in that view, the good thing here is it doesn't matter much as it's a free roll once the deal closes.

Other thoughts:

• Why is it cheap?  Post tender and special dividend, it will go dark and be a small stub with a catalyst 3+ years out, that doesn't appeal to many investors, particularly in the current environment when time horizons are shrinking as people are scared of the economy.  It is a CVR like asset, you've got some counterparty risk with JANL, it needs to have the ability and desire to acquire the remaining stub in 3 years.  Many investors are down for the year (me included!), potentially behind their benchmarks and don't want to invest in something where you're just going to get your money back in 2022, and have this illiquid hard to value dark security after that we won't know the true value for 3 years.
• I like this better than other NOL shells, it is a better structure for current shareholders, as it doesn't rely on new management to make acquisitions at a time when there's still plenty of SPACs and busted biotechs looking at reverse merger style deals.
• RBCN sold some raw land in Batavia, IL.  The sale hasn't closed yet, but the company expects to net $600k in cash, or roughly $0.25/share.  The company also owns their current industrial facility in Bensenville, IL which they bought for $2.3MM (or just under $1/share) in September 2018.  Even after the special dividend, there should be some residual liquidation value left in the operating business and possibly more if they can turn it around. 
• Not sure yet of the tax implications of this idea, might be best to play it in a tax deferred accounts or given it is 2022 and a lot of us have tax losses, might not be so bad in a taxable account either.
• There's currently not an odd-lot priority provision, I'm assuming that is on purpose by the four large fund shareholders, they do not want people piling in to the odd-lot provision and end up transferring value to small shareholders playing that arb game.  There's also no cancel provision based on a drop in the over market either like we've seen in other tender offers.
• If you have access to the expert market, might be worth watching this one after the special dividend, especially if I'm right that the second step won't be done at a huge discount.

Disclosure: I own shares of RBCN