Tejoori finally liquidating

In the beginnen of this year I bought a small low-conviction position in Tejoori. The company had substantially sold all their assets at that point in time, and my guess was that it would soon fully liquidate. Tejoori took their sweet time though on making this decision, and if you would have asked me in the past couple of months if I would have wished I never invested in the company I would have said yes. “Luckily” trading stock on the SEAQ segment of the AIM market isn’t possible without incurring huge frictional costs, so I never bought or sold any shares after establishing my initial position. Last week the company announced that it would fully liquidate and return to shareholders its cash balance of approximately $17.6 million.

The company doesn’t provide an estimate of liquidation proceeds, and while knowing the cash balance is nice it doesn’t tell us how many liabilities are remaining on the balance sheet and how much costs will be incurred to finalize the liquidation. However, I suspect that there are no meaningful liabilities left. At the end of 2016 the company had $19.0 million in cash (and Wakala deposits) with total liabilities of $1.4 million for a net equity of $17.6 million. Since the company has a minimal amount of cash burn (less than $200,000 annually) I would conclude that most liabilities should have been extinguished given that the remaining cash balance is now close to the previous net equity number.

With the stock trading at $0.50/share the potential upside is significant. If we would budget half a million to wind down the company, net assets value per share would be $0.62 for an upside potential of 23.5%. For a liquidation that’s a pretty big spread, and I couldn’t resist increasing my position. At the same time I’m still not willing to bet too big on this. I deeply distrust the average AIM listed company, and so far Tejoori hasn’t done a lot to stand out positively.

I also wonder how the liquidation will be executed. The company is planning to hold a vote on delisting the company later this month, followed by a second vote at a date to be determined to authorize the liquidation. There should be no problem with passing the first vote. They need a 75% majority to approve it, but only from the votes present. If 51% of the shares vote that is sufficient, and if this threshold isn’t reached the meeting is delayed by one day and the threshold is lowered to 33%. Management owns 16.42% of the outstanding shares, and will vote in favor of the delisting, so this really shouldn’t be a problem.

After the delisting the company is planning to cancel their CREST facility (electronic depository), and I’m not sure what exactly the impact is of this move. I own my stock through CREST, so I’m wondering how liquidation distributions will be made if this facility is cancelled. Secondly I’m wondering if this will impact the second vote required for starting the liquidation. Shareholders who own shares in uncertificated form also vote through the CREST system.

Disclosure

Author is long Tejoori

A bit more on the Ocera Therapeutics merger

Yesterday Mallinckrodt officially launched the tender offer for Ocera Therapeutics with a deadline on the 8th of December while the merger should be concluded shortly after. Concurrently with the tender offer document Ocera also filed a “solicitation/recommendation statement” that has some interesting information that can be used to value the CVR. The document contains some tables with managements estimates of the probabilities of passing the various hurdles that need to be taken to commercialize OCR-002, and what kind of revenue it expect to generate. Management’s estimates of the probabilities are as follows:

The two most important milestones for the CVRs are those related to successfully starting Phase 3 trials. As you might remember from my previous post, I estimated a 80% probability for an intravenously version of the drug entering Phase 3 trials and a 20% probability for the oral version. It’s nice to see that as a total pharma nitwit I managed to guesstimate something in the right direction. Ocera management is going with 75% and 35.7% respectively. This would value the first two milestones at $0.43/share, pretty close to the number I was getting.

There is a big difference between my estimate of the probability of commercial success versus Ocera’s, but since my estimate was a super low 1%, that’s not really a surprise. They estimate a 34.6% probability of getting FDA approval combined with a 60% probability of commercial succes which implies a 20.8% probability of hitting the last CVR with just the intravenously version. How this probability increases with adding the oral version to the mix is a bit unclear. Presumably all outcomes here are highly correlated with each other, and adding the oral version to the mix will not meaningfully increase the probability of hitting the last milestone. Hitting it stand alone has a 16.5% times 80% probability of success which is a 13.2% probability, and presumably most of the outcomes overlap with those in the 20.8% pie of hitting commercial succes with the intravenously version. If we simply go for the 20.8% probability the third milestone is worth $0.34/share, although this number does need to be discounted significantly. Payment will not only be very far away in the future, a Mallinckrodt receivable might also carry a significant amount of credit risk

The tables with projected revenues also give some hints with regards to the timing of the various milestones. With the intravenously version possibly hitting the market in 2022 and the oral version possibly hitting the market in 2023 I guess we should expect the milestones related to entering Phase 3 trials to payout relatively soon. That good, not just because of the time value of money, but also so we don’t have to worry too much about credit risk since most of Mallinckrodt $5.9 billion in debt is due between 2022 and 2025.

Clear is that we don’t have to expect a quick payment on the last milestone. Using these projections cumulatieve revenue would hit the $500 million somewhere in 2027 while the oral formulation only hits it in 2030. And we shouldn’t forget the reason why this deal is partly financed using a CVR: presumably Mallinckrodt didn’t agree with all those projections and they certainly could be too optimistic. On the other hand a CVR can also simply be a way to share risk and borrow money. Given the highly leveraged nature of Mallinckrodt not spending too much hard cash on a deal must be attractive to them.

Disclosure

Author is long Ocera Therapeutics

Ocera Therapeutics: merger arbitrage with CVR

Earlier this month Ocera Therapeutics (NASDAQ:OCRX) announced that it would be acquired by Mallinckrodt (NYSE:MNK) for $1.52/share in cash plus a CVR that could be worth up to $2.58/share. In general I like mergers with CVRs because I think market participants are often conservative with valuing them. I especially like gettings CVRs for free, but unfortunately that is not the case here since the stock is trading at $1.70/share.

The CVR has three milestones on which it will payout:

  • $0.34/share if the first patient is enrolled in a Phase 3 trial for an intravenous formulation of OCR-002 (before 2029).
  • $0.52/share if the first patient is enrolled in a Phase 3 trial for an oral formulation of OCR-002 (also before 2029)
  • $1.72/share if cumulatieve sales of OCR-002 worldwide exceed $500 million before 2029

So to make this merger arbitrage a succes you basically need to hit the first CVR milestone. With a share price of $1.70 you are effectively paying $0.18 for the CVR, and if it returns $0.34/share at some point in the next couple of years it should generate a nice internal rate of return. The merger will be structured as a tender offer that is scheduled to be launched no later than November 16, 2017 and should be concluded before the end of the year. So with most of the cash being returned soon the only thing that really matters is how much are we paying for the CVR, and how much it’s expected to payout.

I know basically nothing about medicine, so take that in mind reading this post, but when reading the press release it’s clear that OCR-002 is not a sure thing to make it to a Phase 3 trial. It was unable to meet statistical significance in its primary endpoint in its Phase 2 trial, but it appears to be that this was caused by using a too low dosage of the drugs. That’s something that’s easy to correct, and Mallinckrodt is paying $42 million for Ocera Therapeutics so they must have a decent amount of confidence that they will not only be able to progress to Phase 3, but also get the product to the market. And I guess if you can make OCR-002 work intravenously there is also a decent probability of making it work orally.

I wouldn’t ascribe to much value to the sales milestone though. It not only requires OCR-002 to become a big success, you also have the problem that for a sales milestone your interests aren’t very well aligned with the company. If they are close to the deadline and close to hitting that $500 million milestone they will have a big incentive to stay below that number in order to avoid the $75 million milestone payment. You don’t have this problem with the two milestones connected to starting Phase 3 trials. Their whole purchase of Ocera Therapeutics will be a waste of money if they cannot start those trials.

To be honest I’m a bit surprised that there is no milestone related to successfully concluding a Phase 3 trial, but I guess that’s a good thing for investors here. Just starting Phase 3 trials is a milestone that is a lot easier to reach than successfully finishing them.

Attaching numbers to the various probabilities is a huge guess, but in my mind something like the following doesn’t sounds unreasonable. Maybe there is a 80% probability of starting a Phase 3 trial, maybe a 20% probability of also doing it for an oral formulation and maybe just a 1% probability of hitting the $500 million sales milestone. This would value the CVR at $0.39/share compared to a market price of $0.18/share, so as long that is roughly in the right direction it would be a good bet. I think it is.

Disclosure

Author is long OCRX

My take on TABS Holland

Last week a fellow Dutch value investing blogger wrote-up TABS Holland. The company supplies wood and building products to the Dutch market, and is traded on the obscure NPEX platform. The platform will actually cease all trading next month because its software doesn’t comply with the latest regulations. They have implemented a weird auction system without a central order book that makes it possible that different lots of shares are simultaneously sold and bought for different prices. An obscure illiquid stock on a weird exchange sounds like the rights ingredients for a cheap valuation, and on the surface that seems to be the case for TABS Holland as well. It’s trading at a 6.6x P/E-ratio while the other valuation metrics are as follows:

Last price: €28.76
Shares outstanding: 6,768,303
Market cap: €194.7 million
Net debt: €63.4 million
Enterprise Value: €258.0 million
P/E (ttm): 6.6x
P/B (mrq): 1.56x
EV/EBITDA (ttm): 5.23x
EV/EBIT (ttm): 6.12x

Based on market cap and enterprise value Timber and Building Supplies Holland (TABS Holland) is actually not that tiny and obscure. Most of the stocks I own are smaller, but in this case the float is ridiculously small. According to VIB.net the free float is roughly 3% which translates to less than €6 million. Most of the shares are held by HAL Holding while management and some other “big” shareholder own the rest.

Financials

Before trying to figure out how much this business is worth it’s a good idea to start with a look at the historical financials, even though that might not be that useful in this case. In 2015 PontMeyer NV acquired Deli Building Supplies and the combined company continued as TABS Holland. The acquisition basically doubled the size of the company. The transaction was completed the 1st of September, so in the financials for the year 2015 the last four months include the results of Deli Building Supplies while 2016 was the first full year of the combined company.

When looking at the historical results it is clear that TABS Holland isn’t a great business. Revenues didn’t grow at all in the 2011-2014 period while profitability was around breakeven. Only in 2015 and 2016 things started to turn around in a big way. While the acquisition of a big competitor can’t have hurt, I think the main reason is simply the fact that the Dutch housing market has rebounded after the crisis and is now running white hot again. The low for the Dutch housing market was in 2012 and 2013, while now things are pretty crazy again. I live in Groningen, which isn’t as hot as Amsterdam, but I  have never seen so many houses being renovated or just being torn down and rebuild in my neighbourhood as in this year. So it’s not a surprise that the more recent results are pretty good, and presumably the full year results for 2017 will be even better. The timing of the acquisition was certainly excellent!

It was a big acquisition, and to finance it TABS Holland issued a bunch of new shares while the amount of debt outstanding also exploded. They have been paying down the debt rapidly, and last year they even found some money to pay out a decent dividend.

Valuation

How much is TABS Holland worth? it’s a good question. It’s a cyclical business that probably is near the top of the cycle. The housing market in the Netherlands isn’t showing signs of slowing down yet, but when you play a game of musical chairs the music always continues playing until it doesn’t. Based on current earnings the business is clearly cheap, but a lesson about cyclical businesses that stuck with me is that they are best bought when they appear expensive, not when they appear cheap. But maybe a 6.6x P/E ratio is cheap enough to overcome this risk.

A reasonable base-case scenario is perhaps to assume a couple of years like this year, followed by more average results (adjusted for the doubling in size of the company). This gives some credit to the current good results, while also building a bit of mean reversion into the valuation.

In the valuation I have doubled the operating profit numbers from 2011 till 2014 to account for the fact that the business is now roughly twice as big. Since 2015 already included 4 months of the combined company I multiplied those results by a factor 1.5. This gives us an average operating profit of €21.2 million. Deduct €1.4 million in interest costs (assuming they keep operating with the current debt load), deduct 25% in taxes and normalised net income is €14.9 million. Slap a 10x multiple on that and we have a €149 million terminal value. Additionally I will assume that the next 3 years will be great, and the company will earn €30 million in each of these years. Discount this with a 10% rate and we get a valuation of €182 million.

The current market cap is actually a bit higher than that, so to me the market price seems pretty reasonable. A P/E-ratio of 6.6x sounds pretty cheap, but at the same time I don’t want to be paying a 10x ratio if it’s indeed near a cyclical top.

Conclusion

When I read about TABS Holland I thought that it was a pretty interesting situation, and I already had opened a NPEX account and transferred some money. After doing a little bit of research I’m less convinced. The company doesn’t appear particularly expensive, especially compared to other publicly traded equities, but at the same time it isn’t obvious cheap either. I think a conservative valuation needs to take into account a bit of mean reversion at this point in time, and because of that it should be looking cheap from the outside. You could come up with some reasons why looking at the past results is too pessimistic or why a 10% discount rate is too high though. The combined company probably has realised some synergies while the market has become less competitive.

I have to admit that I would have loved to buy something on such an obscure platform as NPEX, but I think I’m going to pass on this opportunity… TABS Holland is probably a bit undervalued, but not enough for me.

Disclosure

Author has no position in TABS Holland

The curious case of the BINDQ liquidation trust

If you are looking for an actionable idea you can quit right away, because the BIND Therapeutics stock has been cancelled months ago so there is nothing that can be bought or sold anymore. But if you like reading something about a bizarre situation you are at the right address here.

History

For those who don’t know anything about the story, a little bit of background information. BIND Therapeutics filed for chapter 11 bankruptcy protection in early 2016. It managed to sell its assets to Pfizer for enough money to pay back all creditors with some money left over for equity holders. So far all pretty straightforward, but the liquidation plan came with an interesting twist. The company picked a sort of random date (August 30, 2016) as the record date of which shareholders would be eligible to receive all future liquidation distributions. As a result the stock became basically worthless after that date, but since the stock continued to be traded for some time it offered shareholders a nice way to profit twice. I sold my position for something like $0.30/share which was a substantial windfall since I estimated liquidation distributions to be roughly $1.20/share while I bought the stock around $1.00/share.

Part of the reason that the stock continued trading at an elevated level was probably the involvement of a fund that apparently bought approximately one million shares after the record date. They have been, and still are involved in litigation, against the trustee (and FINRA as well I believe) trying to change the liquidation plan/the record date for future liquidation payments. So far they have been unsuccessful, but they haven’t given up yet. Their latest move is an attempt to convert the liquidation from chapter 11 to chapter 7, presumably to make it possible to work around the the record date confirmed in the chapter 11 plan.

Equity distribution form

While this is already weird, it got even weirder this year. After paying an initial liquidation distribution last year the trustee sent a letter to shareholders that they would be required to fill out an equity distribution form and a form W8/W9 in 180 days in order to be eligible for future distributions. This piece of paperwork proved a bit tricky to complete. You needed to provide the signed tax form to your broker, and your broker needed to sign-off on the number of shares you owned on the record date. A process like this has a lot of points where things can go wrong. Your broker might not notify you of the requirement to do the paperwork,  is unable or unwilling to do the paperwork, or things simply get lost in the mail.

As a result shareholders owning 75.05% of the company provided tax forms and equity certification forms. This means that a relative large part of the shareholder base isn’t getting any money from future distributions, either because of their own inattention or the inability of their broker to process the form. Based on some unhappy shareholder letters in the docket not all brokers were willing to do this. Luckily for me Interactive Brokers proved to be quite capable in handeling this weird situation. As a result the second liquidation payment contains a nice windfall profit for those who did manage to do all the paperwork. The first liquidation payment of approximately $8.0 million resulted in a distribution of~$0.38/share while the second liquidation payment of $8.0 million resulted in a distribution of ~$0.51/share.

As an added twist, because the payment wasn’t made to all shareholders it couldn’t be processed by the Depository Trust Company (DTC) and instead shareholders got a paper check. In the Netherlands checks haven’t been used in decades, and this was the first time ever in my life to receive one, but luckily my bank is able to handle them for a nice fee… It also creates a nice tax headache for those owning the stock in for example an IRA account since you are effectively doing a withdrawal from your account.

What about short sellers

Directly distribution money to shareholders while bypassing the depository raises an interesting question: how the hell do you handle this if people have lend out shares and other people have sold stock short. I think it’s mostly a theoretical question. As far as I know I didn’t lend out any shares on the record date, and I got the full payment per share. There are no issues for me. But imagine how messy it would be there would be a lot of people short. A potential scenario:

  1. I own 100 shares.
  2. I lend them out to a short seller
  3. He sells them to person X.

So how to deal with this situation? If I would claim ownership of 100 shares, and person X would claim ownership of 100 shares the liquidation trust is going to pay money to the same shares twice. If I couldn’t claim ownership of the shares, but only person X (I think this is the most correct implementation) I wouldn’t be able to fill out the equity distribution form. Maybe person X doesn’t fill out the equity distribution form. So there is no payment to X, and the short seller could claim that there should also be no payment to me. But lets say that I owned another 100 shares that I did successfully fill out the paperwork on. Now it’s clear that I got a certain payment per share. The short seller is supposed to pay me whatever I would have gotten on the shares if I would not have lend them out. So he would be on the hook for the $0.51/share payment. But how would that money get to my account? I know I got the payment, but it’s a paper check. My broker doesn’t know how much if any money I got and the same goes for the depository. And even if they would know, can they fix it on an account by account basis?

If this is not yet messy enough, if I would have owned all the shares and done the paperwork the distribution/share would have been a little bit lower for everybody (still assuming X didn’t do the paperwork). So maybe the short seller shouldn’t pay the full $0.51/share? Or what about the case when the short seller closed his brokerage account in the time between the cancellation of the stock and this liquidation payment. Is his broker then on the hook for it?

If anyone has anything intelligent about this to say I’m interested. Did you lend out any shares? Did you get paid on these shares? Someone who has been short this stock on the record date? Lending out shares to short sellers is supposed to be sort of risk-less. But I’m pretty sure the process breaks down in this obscure case. My guess is that either some people lend out a few shares, and simply didn’t get paid on those, or the trustee paid twice (or more) for some shares “screwing” everybody else by a tiny amount.

Disclosure

No position in BINDQ, yet still have the right to remain all future liquidation payments