Monthly Archives: February 2012

Sandstorm Metals & Energy (SND.V)

The Above Average Odds Investing blog published a few days ago a lengthy write-up on Sandstorm Metals & Energy, a merchant bank that provides financing to resource companies in return for a percentage of future production (the so called streaming model). The company currently owns nine resource streams, and AAOI makes a compelling case that the value of these streams is significantly more than the current market cap of the company (140M with 40M in cash) as just the gas stream could in an optimistic scenario be worth roughly that much.

There are however two major problems: the company wants to grow, and is diluting existing share holders to achieve that goal. For example: the company increased last year the share count from 222M to 318M on the following terms:

On August 3, 2011, Sandstorm completed a public offering of 88,650,000 units at a price of C$0.55 per unit, for gross proceeds of C$48.8 million ($51.4 million). Each unit was comprised of one common share of the Company and one-half of one common share purchase warrant. Each whole warrant entitles the holder to purchase one common share at a price of $0.70 until December 23, 2012. In connection with this offering, the Company paid agent fees of C$2.9 million ($3.1 million), representing 6% of the gross proceeds.

It is for me almost impossible to see how this can be a good allocation of capital for existing share holders, because if the assets of the company are indeed significantly undervalued this is a very expensive way to raise capital, especially if warrants are also given away. Some quick math to show the point:

Assume for example that the intrinsic value of the resource streams is 300M instead of the 100M that the market is currently implying. With 222M shares outstanding this would imply an intrinsic value of CA$1.35/share. Issue 88.65M shares for net proceeds of 45.7M and the value per share drops to CA$1.11/share. If we now account for the dilution that would occur if the warrants are exercised the per share intrinsic value drops further to CA$1.06/share. That’s more than a 20% drop in value per share! The best investment the company could make is in it’s own shares, while it is doing the opposite.

The second problem I see is that I don’t think that the streaming model offers a true competitive advantage above other types of financing available to resource companies. Sandstorm might be unique with the exclusive focus on the streaming model, but it’s simply a type of financing that sits somewhere between pure debt and pure equity. No reason to believe that on average this part of the capital structure offers abnormal risk/adjusted returns, and if that’s the case raising expensive capital is really inexcusable. You need to be able to redeploy the cash at very high rates if you want to make a case for dilution.


In my mind there are basically two conclusions possible: either SND.V is currently not undervalued and it prudently raising capital, or it is undervalued but it is not interested in maximizing shareholder value. Whatever the case: I’m not willing to invest.



Further Reading

The bookbookfund blog lists some additional concerns.

SALM reading material

Thanks to Google I managed to find a restructuring plan that was created in the beginning of 2009 when SALM was facing a liquidity crisis due to the maturing bonds. The document contains background on the company, operational and strategic analysis, a comparison with competitors and also a liquidation analysis. The plan proposed in the document (divestitures, debt for equity swap) was not executed because SALM managed to refinance it’s debt, but it’s worth reading anyway.


Author is long SALM

Salem Communications (SALM)

Salem Communications is the largest commercial US radio broadcasting company that provides programming targeted at audiences interested in Christian and family-themed radio content. The company owns 95 different radio stations all over the US, and also generates revenue with internet sites, books and magazines with a Christian theme. The company attracted my attention because according to a VIC write-up it has a FCF yield of 35%, and that’s worth investigating. Some statistics from Yahoo finance:

Last Price: $2.65
Shares outstanding: 24.28M
Market Cap: 64.3M
Trailing P/E (ttm): 10.7
Price/Book (mrq): 0.32
Total Debt: 277M

The company is very leveraged, and while it is trading at a significant discount to book value, that discount doesn’t directly offer a margin of safety. Almost all the assets that the company owns are broadcast licenses, and there are all kinds of FFC regulations with regards to buying and selling. The value of the licenses is also related to the income the company is able to generate, and if that drops, the value of these assets would drop just as fast. Combine that with the leverage, and it’s easy to see how the equity can go to zero.

Leverage & Valuation

The company has been reducing leverage the past five years, reducing the amount of outstanding debt from 361M in 2006 to 277M at the latest quarter. Unfortunately for the company they had to refinance their debt in 2009 at unfavorable terms (300M of notes @ 9.625%, and at a slight discount to par). The result of this is that the interest expense increased from 20M in 2009 to 30M in 2010. Since then the company has been paying down debt, and currently has 246M of the 9.625% notes outstanding and 31M on “The Revolver” credit facility that has a lower interest rate (3.73%). This means that the company needs to pay a little bit less than 25M in interest with the current debt load.

So the big question is: how easy can the company service this debt load, and how stable are the earnings? The earnings aren’t very stable: the company reported losses in 2008 and 2009 because it wrote down intangible assets (the broadcast licenses), but the underlying cashflow that is generated by the business is remarkable stable if we believe this company presentation. Adjusted EBITDA numbers from 2004 till 2011 vary between 52M and 58M. Strangely enough the company doesn’t disclose how it is exactly calculated, while they do use it in various documents (not in the 10K/Q’s), but usually Adjusted EBITDA is something along the lines of results from continuing operations minus stock based compensation. Charlie Munger called EBITDA bullshit earnings, so wonder what he would think of Adjusted EBITDA…

I have spend some time thinking what would be a reasonable way to calculate the earning potential of the company, and thought that taking net cash provided by continuing operating activities, subtracting capital expenditures and subtracting amortization related to bond issue costs and bank loan fees would be appropriate. This last item is a very real and recurring economic cost because the company needs to refinance every few years. I have created the table below with some key financial statistics. Adj. EBITDA is how I would calculate it by adding back D&A to Operating Income, and the row below shows what the company reported. Not included in this picture are the costs of stock based compensation.

So it seems that the company is indeed able to generate significant cash flows compared to the market cap. 18M in cash flow on a 64M market cap would translate to a 28% yield, and with the deleveraging of the company the free cash flow is growing thanks to reduced interest payments. A return half of that would probably be more reasonable, so that would imply that the equity should be worth twice the current price.

An Optimistic View

An alternative method to look at SALM is to imagine how the balance sheet could look like at the end of 2016 when they need to refinance. I’am assuming that the cash flow stays as it is, and it would mostly be used to pay down debt. The first assumption is in my opinion reasonable: it’s below the historic average and while new technologies are invading the radio space, the numbers of radio listeners have actually been growing every year, and the internet part of the business is growing fast. The second assumption is not reasonable, because they historically have used significant amounts of cash flow to buy new radio stations, buy back shares or pay dividends (they paid 4.8M in dividends in 2010). The alternatives don’t have to be a bad allocation of capital.

In the first year the company would be generating 18M in cashflow, and with the debt of the company trading at 108% of par they would be able to buy back 16.7M of debt: resulting in an additional cash flow of 1.6M a year due to reduced interest. Compound this 5 years long and the company would have 187M in debt left and be generating 26M in cashflow/year. If a 12.5% FCF yield would be fair that would imply an equity value of 208M, more than a triple compared to the current market cap.

But when the company would arrive at this point in time they would most likely be able to refinance at a significant lower interest rate: the debt is already trading above par. If they manage to reduce the interest rate from 9.625% to, for example, 7% that would shave an additional 5M off the interest expenses, and translate to 31M in FCF and a potential equity value of 248M. The company has a lot of leverage, but when things would develop favourably, gains can be huge. It also works in the opposite direction…


Insider ownership of SALM is very high. The CEO and chairman own combined 56% of the company, and because of a dual class share structure they have even more voting power. The shares traded on the Nasdaq are the Class A shares with 18.7M shares outstanding while the 5.5M Class B shares have 10x the voting rights per share. High insider ownership can be a problem, but being a co-owner with management that has a long term business view is actually a good thing. The current chairman of the board, Stuart W. Epperson, started his first radio station in 1961 and joined a partnership with the current CEO, Edward G Atsinger III, in 1972, and the company IPO’ed in 1999. They also have a history of paying dividends and buying back shares, and I also liked to read that they aggressively cut costs in the beginning of 2007, including suspending the management bonus program and reducing the base salary for employees by 5% and management pay with 10%.


SALM risky, and is maybe better viewed as an option since there is a lot of leverage, but I think that at the current prices the risk/reward ratio is very favorable. The company managed to survive the financial crisis, has pretty stable cash flows, is getting less risky every quarter, and the FCF yield is very high. Management also seems to be acting with long term share holder interests in mind.

I’m not going to make this a huge position in my portfolio, and I’m certainly not going to put too much companies with high leverage in my portfolio since that would introduce systematic risk, but I do like a cheap option. On a scale from 1 to 10 I give the stock a 8.


Author is long SALM.

Asta Funding Q1 2012 results

Asta Funding (ASFI) announced it’s results for the first quarter of fiscal 2012 today, making it the second time the company released earnings information since I have initiated my position in November. The stock is down 12 percent since, so a good idea to review my original investment thesis and see if it’s indeed playing out as expected.

Quick valuation review

The company reported having 111 million in cash and securities as of December 31, 2011, and during the conference call the CEO mentioned that as of today they have 113 million in cash. This translates to $7.79 in cash/share while the current share price is 7.55: making ASFI officially a net-net. And not only is the company a net-net, most of it’s assets are cash, cash equivalents and securities: not the often lower quality accounts receivables or inventory. The company is also remaining profitable ($0.20 EPS for the quarter, up from 0.18 for the comparable period previous year). So ASFI seems to be cheaper than ever, but is it also growing value at the originally projected speed?

The company started with 104M in cash a half year ago, and managed to grow that amount to 111M while at the same time investing 2M in new debts, 4.4M in personal injury financing and 0.6M in paying out dividends. If we add this all up the company  created roughly 14M in value in the past six months. If we would extrapolate those results for the next two and a half years we would arrive at a 188M valuation for ASFI at the end of 2014, not the 230M I originally estimated. The previous quarter included a one time 1.3 million charge though, so while it seems that my previous calculations were a bit too optimistic, it’s not that far off.

In the second quarter of fiscal year 2012 the growth of intrinsic value seems to be continuing at roughly the same speed. The company has grown the cash balance with another 2 million while at the same time investing 2 million more in Pegasus: generating roughly 4 million in half a quarter.

Personal injury financing

One major development for ASFI is Pegasus, the new joint venture in personal injury financing. The company has invested 6.4M so far in this business and has announced that they are willing to invest up to 21.8 million dollar annually. While this will transform ASFI from the safe super easy to value company based on it’s cash balance to something more unknown and risky, I don’t think it’s a bad development. You’re not investing in a company to let them sit on the cash: it needs to be returned to share holders or it should be used in financing business activities.

The CEO of ASFI is optimistic over the potential returns of this new business (but would you ever expect anything else?), and the press release contains the following sentence:

While the over-all returns to the joint venture are currently estimated to be in excess of 20% per annum, APH reserves the right to terminate Pegasus if returns to APH, for any rolling twelve (12) month period, after the first year of operations do not exceed 15%.

If they are indeed able to hit those targets I would be very happy, but it’s not a crucial part of the investment thesis. The value of the current cash balance and future cash flows is significantly higher than the current market value of the company, and as long as the new investments are not destroying too much value I should be able to come out ahead in the long run. With insiders owning a significant part of the company there is actually a strong incentive for them to create shareholder value.

Share buybacks

The company was very quiet about the 20M share repurchase program that it announced a half year ago, and for good reason: they didn’t buy back any shares, but the explanation given by the company actually sounded reasonable. The company stated that it couldn’t trade it’s own stock due to a blackout period while it was setting up the new joint venture, information that didn’t became public until the end of the quarter.


The investment thesis for ASFI seems to remain intact, although my initial valuation was probably on the high side and the continuing lack of share repurchases are a bit worrying. The next few quarters are going to be interesting, since it should start to show how good or bad the move in personal injury financing is going to be.


Author is long ASFI.

A speculative idea: Greek debt

This week the focus of the world is once again on Greece since it has to strike a deal with private creditors to voluntary write down a big part of the outstanding debt, and at the same time it needs to strike a deal with the “troika” to receive a €130B bailout. If these talks fail Greece would almost certainly default next month when a €14.5B bond payment is due. Both negotiations are progressing slowly and the odds of a country leaving the eurozone have never been higher.

There are some interesting dynamics at work. The ECB is trying very hard to keep a formal default off the table, and is pushing for a voluntary debt restructuring. The motivations of the ECB are questionable as Nobel laureate Joseph E. Stiglitz argues in this column, but if it is indeed successful it would create a market dynamic where the value of the same security could be very different for different parties. The value of the bonds for what are traditionally the largest holders such as banks and pension funds would be cut significantly (currently talks are about a 70%+ reduction in NPV) while other buyers cannot be forced in accepting the deal without triggering a default.

At the same time the group of holdouts cannot grow too big, otherwise a deal with sufficient participation would be impossible to make (the IMF wants at least 88% PSI), and that might at the moment already be the case given the slow progress of the talks. If Greece manages to avoid a default the upside for small bondholders that do not participate in the restructuring could be very big. The bonds due on March 20 are trading for 39% of par while most bonds with longer maturities are trading around 20% of par. If you would calculate a potential IRR for the March bonds it would be some crazy high number (couldn’t resist doing the math: it’s actually a 26 million percent IRR).

But even a formal default might not be all bad. It would also force the ECB to take losses on its debt holdings, making it easier to reduce the Greece debt load to a sustainable level (current goal is 120% of GDP in 2020: still high). Greece has currently 347B in debt (139% of GDP) and it is estimated that the ECB currently owns 50B euros.

While the default risk of Greece is extremely high (just look at the 5 year CDS), a default doesn’t mean that the bonds will be worthless. I haven’t been able to find estimated recovery rates that are based on more than some very general assumptions, but if we look at historic recovery rates we see that Russia offered 18% of par in 1998 and Argentina 27% in 2001. If Greece is somewhat in the same ballpark losses won’t be astronomical if you buy the bonds at 20% of par today.


If Greece manages to strike a deal between the private sector and with the troika there could be a possible opportunity to exploit the decision of policy makers to pursue a voluntary debt restructuring. It would be a predatory strategy at the expense of participating debt holders, and not without risks: especially if Greece defaults after performing the debt exchange you will presumably get screwed over if you hold the original bonds, even though you would technically be in the same ship as the ECB.

Another attraction of Greek debt that it must be one of the most hated asset classes of this moment, and the following quote from Buffet might apply:

Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.


None, but might initiate a position.

More reading

A relevant piece from Felix Salmon: “Greece: What happens if bondholders hold out?”