Monthly Archives: November 2012

One year anniversary!

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Today exactly one year ago this blog saw daylight for the first time. I started the Alpha Vulture blog mainly as a way to receive feedback on my thinking process and stock valuation skills, and think this goal has been achieved quite successfully. I have received plenty of constructive comments, and also some new ideas, so thanks readers! Google Analytics also tells me that most of my visitors are returning visitors, so apparently what I write is not perceived as totally worthless. That’s of course what’s needed to make blogging work: it needs to be beneficial for both the writer and the readers. Hopefully next year the blog continues to be a win-win situation :-).

A birthday post isn’t complete without some fun facts as a present, so here you go:

  • Most comments that I receive are spam, 96% percent to be exact. Luckily the spam filter is quite good and managed to catch 99.95% automatically without my intervention :-).
  • The most popular post measured by page views was my write-up on AIG, a bit disappointing because it also has to be one of the more superficial write-up’s. Guess a well known company attracts more attention, too bad most of my investments are pretty obscure…
  • Measured by average time spend on page my write-up on Rella manages to reach the top spot.  Readers spend more than 16 minutes on average on this page, more than quadruple the average time spend on the AIG page.
  • More than 1,000 different search terms were used by visitors originating from a search engine. I have the feeling that the person searching for “ριαλασ ανδρεασ” didn’t find what he was looking for, although if Google thinks differently, who am I to argue?
  • The blog has received visitors from 102 different countries, but my popularity in Africa needs some work. The same can be said about my popularity in South Dakota: despite thousands of visitors originating from the U.S. not a single one came from South Dakota. What are the odds of that happening?

Alternative Asset Opportunities (TLI.L)

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An investment that promises high returns and almost no correlation with the market? Wexboy seems to have found it in Alternative Asset Opportunities PCC Ltd. This is a closed-end fund listed on the London stock exchange that has investments in traded life interests (hence the TLI ticker). I suggest you start out with reading Wexboy’s write-up on the fund, aptly titled “An Investment To Die For” since he has all important points solidly covered and I’am not going to reinvent the wheel.

Present value

The question that I do want to answer is how much should should TLI be worth today? The fund is currently trading at 44.5 pence per share while NAV at 31 October, pro-forma adjusted for the equity issue earlier this month, was 56.0 pence per share. This is already a nice 20% discount, but I think the NAV is significantly understated because the company uses a ridiculous 12% discount rate to value their assets. While the capital asset pricing model (CAPM) does have it flaws the general idea behind it is solid: an investor should not be compensated for idiosyncratic risk because you can eliminate it using diversification. What matters is systematic risk.

So how much systematic risk does an investment in TLI have? You can probable argue that there are some relations between the life expectancy of 89 year old’s and the general economy, but it’s going to be far fetched. The only major source of systematic risk is the credit risk from the insurance companies that have underwritten the insurance policies. As a policy holder I imagine that you have a pretty solid position in the capital structure of these companies, but not to make things overly complicated: what happens if we use the yield on investment grade US corporate bonds as a discount rate? At the moment this yield is 3.3% according to Bloomberg, and using Wexboy’s spreadsheet, you can easily figure out expected cash flows. This gives me a present value of 89 million dollar (55.8 million pound) or 77.5 pence per share. This is still a reasonable conservative estimate in my opinion. Wexboy is nice enough to add almost a year to the average life expectancy of the old folks in his spreadsheet, and I think the proper discount rate is probably even closer to the risk-free rate (near zero these days…) than the yield of investment grade bonds.

Return of capital

I don’t expect that the market is going to agree with me on that discount rate anytime soon, but the good news is that the fund is basically in liquidation mode (shareholders actually have to vote every year to extend it’s life!) and intends to return all capital to shareholders. The fund already has the authority to buyback shares, and with all debt eliminated this month it shouldn’t take very long before they get enough cash to start buying back shares. Given the big discount between ‘true NAV’ and the current market valuation this could enhance returns even more.

Conclusion

I think that TLI offers a truly remarkable opportunity. The performance of the policies should have almost zero correlation with the market, and yet at the same time potential returns are very attractive. The biggest risk is that the insured group lives longer than expected, but with an average age of 89 and a 4.7 years weighted average LE you can’t be off by a huge amount. Not a lot of people manage to hit the magical 100 number, and there isn’t a lot of time for things to change radically. The life expectancy of a new born is much more uncertain.

Rating: just before the first anniversary of this blog I’m going to give out my first five star rating. I believe an investment in TLI is very low risk while the expected return is more than respectable. Not only is the risk/reward ratio great, there is a reliable catalyst: no-one can escape death…

Disclosure

Long Alternative Asset Opportunities, and looking to increase my position.

ALJ Regional Holdings merger/tender offer arbitrage

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ALJ Regional Holdings (ALJJ) announced yesterday that the company has entered into a definitive merger agreement to sell their KES subsidary. After the merger is completed the company will basically be an empty shell with approximately $51 million in cash ($0.86/share) and large net operating losses. The company also announced that they will buy back more than 50% of the outstanding shares after the merger is completed at a price between $0.84 and $0.86 per share. For some background on the company I recommend checking out this post at OTC Adventures.

The company has 59,467,498 diluted shares outstanding as of yesterday, and Mr. Ravich, chairman of the board and owner of 13,142,221 shares (22.1%), has indicated that he will not tender his shares. This means that if everybody except Ravich tenders their shares you can sell 64.8% of your position to the company at $0.84/share. If you would buy $1000 worth of shares at $0.72 you would get back ~$750. What you keep are 490 shares with a $244 cost basis, or a 43% discount to the future net cash position of the company.

There are multiple ways to win here. I think it’s highly likely that not all shareholders will tender their shares. The current board, with Ravich as the leader, accomplished a lot the past years, and after the offer is completed the chairman will own almost 50% of the company. And while the tender offer is for roughly the cash value per share it ignores the valuable NOL assets. I imagine that there are investors who want to remain invested.

In a best case scenario the company will buy all or almost all your shares at $0.86/share and you make a quick 19%, but if the proration factor is for example not 64.8% but 85.7% you are already free rolling on your remaining position (assuming a $0.84/share price in this case).

A second way to win is if the discount to net cash value shrinks after the deal and tender offer are completed. If the discount for example would shrink from the current 43% to 20% it would mean that the share price post tender offer would only drop from the current $0.72/share to $0.70/share. Again using a hypothetical $1000 investment: you would own 1389 shares and sell 899 shares to the company at $0.84/share. The remaining 490 shares would be sold for $0.70/share for a total amount of ~$1100 or a 10% return.

The worst case scenario is obviously that the merger isn’t completed and the tender offer is cancelled. In general a very high percentage of definite merger agreements are successfully executed, and don’t think there are any special issues in this deal that makes this one above average risky. The acquirer has executed multiple successful deals in the past, and I don’t think there are potential regulatory or political issues with a small deal like this. A risk is financing since Optima has not yet closed the necessary arrangements, but with Jefferies as an advisor I would expect that they got this covered.

Conclusion

While it’s hard to know how this will exactly play out I think the odds are in my favor at the current prices. If the deal is completed successfully, and I think it will, the worst case scenario is that I bought a cash shell at a 43% discount to net cash value. I’m comfortable with that investment given the big discount and the fact that Mr. Ravich will be a major co-owner. And most likely I’ll effectively be buying less shares at an even higher discount if not all shareholders decide to tender.

Disclosure

Long ALJJ

More reading

Whopper had basically the same idea as me, and you can find his thought here.

Air Transport Services Group (ATSG)

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Air Transport Services Group (ATSG) supplies mid-size freighters, either providing a lease of the aircraft alone or on a packaged ACMI (Aircraft, Crew, Maintenance and Insurance) basis. They are the global market leader in their niche and the majority of their fleet are 46 Boeing 767-200/300 planes. For an overview of the company and their financials this presentation from the latest annual meeting of stockholders is a good start. Some quick valuations stats from Yahoo Finance:

Last Price: $3.46
Shares outstanding: $64.17M
Market Cap: $222M
Enterprise Value: $556M
Trailing P/E (ttm): 5.31
Price/Book (mrq): 0.74
EV/EBITDA (ttm): 3.30

Valuation

While the company is trading at a discount to book value the various metrics related to earnings are the biggest attraction. Especially if you look at free cash flow ATSG appears to be extremely cheap. See the table below for the numbers of the past few years:

Roughly $100M in FCF for a company with a $222M market cap looks amazing, right? Wrong! There is one big problem: the maintenance capex is not sufficient to maintain the earnings power of the business since planes have a limited life expectancy, mainly due to metal fatigue that develops in the fuselage and wings. Air Transport Services usually buys used passenger planes and converts them to a cargo plane. It’s currently in the process of converting a number of new planes and the company expects that it will be able to use these planes for 15 years after the conversions are done. This explains the high capex from the past years, but this is not all growth since old planes are replaced at the same time.

I think a better proxy for how much FCF the company is truly generating is to take CFO minus depreciation and amortization. If the estimates of the company with regards to the useful life of the planes are reasonable accurate this should provide a decent approximation of the ‘owner earnings’ of the business. This gets us the following picture:

Since the company reports a lot of D&A this measure paints a completely different picture. Instead of an almost 50% FCF yield we get a more normal yield of ~14,0% (based on the TTM, and the average based on the past 4 years would be almost the same). This even a bit lower than the earnings yield that is currently sitting at 18,8%.

These numbers still look pretty decent, but I think there are some other issues worth mentioning. The company has significant post-retirement liabilities on the balance sheet: there is a defined benefit pension plan that is underfunded for $161M (total assets ~$595M). I really dislike seeing a company with a big defined pension plan because if the plan is unable to meet the, in this case, 6.75% expected return on plan assets shareholders will have to make up the difference some time in the future.

Another issue is that the debt (currently $357.8M) of the company is understated. While they own most of their planes they also use operating leases for a small part of their fleet. They had $76M in minimum lease payments outstanding at the end of 2011, and if you would capitalize this the EV/EBITDA multiple is going to look (a bit) less attractive.

What I also don’t like is the extremely low insider ownership. All directors and executive officers as a group owned just 2.4% of the company at the date of the latest proxy statement. That means they own a bit more than $5 million worth of stock. The CEO earned more than $2 million last year while the other executive officers earned on average ~$0.7 million. I think people generally do what is in their best interest and maximizing shareholder value is probably not going to be on the top of the list for this group of people…

Conclusion

I think it’s obvious that I don’t really like ATSG so far, but that doesn’t mean that it is necessarily  overvalued or a bad investment. Maybe the company deserves to trade closer to book value, or maybe the current PE-multiple is on the low side. I don’t think there is a big margin of safety though at current prices. There is a lot of leverage at work, and the company is quite sensitive to changes in the economy. As an equity investor you would need a relative high expected return to compensate for these risks, so I don’t think that the company is significantly undervalued at the current price levels.

What do you think?

Disclosure

None

Conrad Q3 2012 results

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Conrad reported results for the third quarter of 2012 yesterday. Results are pretty good: income is up and the backlog is growing. The amount of cash on the balance sheet is also growing while the share count is shrinking. But what I found really interesting was the following disclosure:

We are preparing to submit claims to the BP Settlement Fund in accordance with the Deepwater Horizon Court–Supervised Settlement Program. We plan to submit these claims to the BP Settlement Fund by November 30, 2012, and estimate a response before the end of the first half of 2013. Certain of our businesses are located within the economic zones included in the class settlement and we believe that the damage calculations have been made in accordance with the guidelines established for the BP Settlement Fund. The cumulative amount of the claims is anticipated to be approximately $22 million to $23 million.

While it’s uncertain if they will in fact receive this money this could be a pretty significant event, even after accounting for taxes. The company has at the moment just a ~115M market cap and it has already 43.7M in cash on the balance sheet. It looks like they are not planning to let it sit idle and waste value:

Management is currently engaged in a detailed business planning process to identify potential uses of the Company’s cash.

There is of course always a risk that money will be wasted on something stupid, but given the fact that management owns more than 50% of the company I think they have a strong incentive to do something smart with it. Maybe it would make sense for them to issue a big special dividend and try to take Conrad private? That’s what I probably would try to do if I would be in their shoes.

Disclosure

Long Conrad