The Rational Cloning: Weekly Ideas #23
Emeth Value on Burford Capital; Laughing Water on Aimia, Transact, Cannabis and Countryside Partnerships'; Plus Ideas From Mittleman Global, Clark Street Value
Welcome to the 23rd edition of the Rational Cloning Newsletter (Weekly Ideas Series).
Helping you discover the best ideas of others.
Happy cloning.
Weekly Investment Ideas
(1) Emeth Value Capital 2021 H2 Letter
a. Burford Capital Limited (BUR)
Burford Capital is the world’s largest funder of litigation assets. The group has an unmatched team of internal lawyers and more than a decade long track record of partnering with ninety-two of the largest one hundred law firms globally. Burford was co-founded in 2009 by Chris Bogart and Jon Molot, who collectively own more than eight percent of the outstanding share capital. Since inception, Burford has deployed more than $3 billion in legal claims and has achieved a thirty percent IRR on realized investments.
A Brief History of Legal Finance
Litigation finance involves a third party investing in the asset value of commercial litigation or arbitration. While transaction structures are often bespoke, in its most common form litigation funding is provided to cover the expenses of pursuing a claim in exchange for a share of the ultimate damages.
Burford By The Numbers
Since 2009, Burford has made 339 litigation finance investments that showcase a variety of deal structures, are broadly diversified by claim type, industry, and geography, and are supported by several thousand underlying legal claims. At a high level, more than two hundred of these investments have been fully or partially concluded, which generated a multiple on capital of 1.95x with an average investment duration of 2.3 years.
Third Party Asset Management
In addition to investing its own capital, Burford is the largest asset manager in the litigation finance industry with $2.6 billion in client AUM across seven funds. Allocators such as pension funds, endowments, and sovereign wealth funds invest in a broad spectrum of asset classes, and litigation finance offers an exposure that increases diversification and provides an attractive return profile.
Valuation
Let’s assume that Burford wanted to run this book of investments into liquidation…. if we use Burford’s historical investment multiple of 1.95x as a midpoint, we arrive at an average expected recovery of eightyfive percent based on the year end share price of $10.56. In other words, an investor can expect to recoup the large majority of their investment, even if zero value is ascribed to the ongoing operations of the company. Furthermore, an investor would have a second layer of recovery in liquidation driven by the YPF claims, which if successful are likely to return more than Burford’s entire market capitalization.
While the thought exercise above is helpful to form a concrete assessment of impairment risk, Burford today has a thriving operating business. Litigation finance is a rapidly growing industry characterized by large and uncorrelated returns, and Burford is the largest and most respected competitor. The group has grown its book value per share at twenty-five percent per annum over the last four years and has a clear roadmap for longterm sustainable growth.
To borrow a phrase from Jeffrey Ubben of ValueAct Capital, Burford has built a “competitively advantaged human-capital franchise.” This franchise is worth far more than liquidation value.
The base case scenario modeled above factors in a compression of future returns from thirty percent to twenty percent, a lengthening of average case duration from 2.3 years to three years, a modest level of management and performance fees, and it ascribes zero value to the YPF claims. In addition, the base case scenario assumes only a modest level of growth in new investment originations and an eighteen percent annual growth rate in operating expenses driven by both an increase in headcount and employee carry. Finally, a terminal multiple of 18x is applied (less than a market multiple) even though Burford would expect to exit the forecast period growing at double digit rates. The analysis indicates a share price of $16.68, or 57.9 percent upside to intrinsic value.
The bull case assumes the YPF claims result in an after tax net entitlement of $2.5 billion and that investment returns persist near levels achieved historically. In addition, a moderately higher level of performance fees and originations are expected, as well as a twenty-five percent annual growth rate in operating expenses. Lastly, a terminal multiple of 20x is applied, as Burford would expect to exit the forecast period growing in the high teens. The result is a share price of $41.56, or 293.6 percent upside to intrinsic value.
(2) Laughing Water Capital 2021 Q4 Letter
a. Aimia
Long term holding Aimia continues to move closer to the date that Aeromexico exits bankruptcy. When that happens, I believe that Aeromexico will purchase the ~49% of PLM (Aeromexico’s loyalty program) that is owned by Aimia. The bankruptcy documents suggest that a price of $375M is in the offing, but I believe there will be additional consideration for balance sheet adjustments. Inclusive of these adjustments, I believe Aimia could walk away from this transaction with more than C$6 per share of additional cash on its balance sheet. Furthermore, over the next few quarters I expect that Aimia will increase disclosure around investments in Kognitiv and Trade X, potentially including plans to force the market to recognize value through a public offering of shares in these subsidiaries, or through a sale.
b. Transact (TACT)
Transact, our niche printer company that also houses a fast growing C-store/restaurant back of house SAAS product (BOHA!), was first introduced as Company #1 in our Q1’2021 letter. The company has been executing well, but shares plummeted in the 2nd half of 2021. I believe the sell-off was related to three factors, all of which are temporary. First, management has indicated that due to supply chain problems, they have had trouble securing inventory, and installs have been further slowed by customers’ inability to find labor. This is of course frustrating, but will take care of itself with time. Second, as Covid cases began to spike when the weather turned cold, management filed a shelf offering, which the market took as a sign that the company would be raising dilutive equity capital. I believe the shelf was filed for emergency use only, because if the world re-entered Covid lockdowns, the company could run into liquidity problems. As it has become clear that there is enormous hesitancy around renewed wide scale lockdowns, I think the risk of an additional capital raise hassubsided. Lastly, as shares declined ~40% from earlier highs, the stock became an attractive tax loss sale candidate. Looking forward, with gentle prodding from 3 activist investors I think it is likely that the company begins to explore a sale of its cash-cow slot machine printer business in the coming year. I believe that this sale could generate proceeds that would cover most of the company’s market cap. This cash would then be used to continue to fuel the 100+% growth of BOHA!, which could ultimately be worth multiples of Transact’s current enterprise value.
c. Cannabis Basket
At present, cannabis is still illegal at the federal level in the United States, despite a growing tide of state legalizations and growing evidence that cannabis has clear medical and social benefits. As such, U.S. based cannabis businesses that touch the plant are typically publicly traded in Canada, and most U.S. based financial institutions will not custody these Canadian stocks. We are fortunate that our custodian allows us to hold the Canadian listed U.S. cannabis companies, as they are growing like weeds (pun intended) and appear objectively cheap vs. their growth potential. It is increasingly clear to me that within the next year or three Cannabis will be legalized at the Federal level in the U.S., or at the very least the perception that legality is around the corner will grow.
When that happens, what is essentially one giant special situation will be put in motion.
While there are enormous structural tailwinds, it is also not clear to me what the ultimate margin structure in this industry will look like, or which companies will wind up as winners. As such, I am taking a basket approach, choosing to own smaller positions in several businesses, each of which has multiple pathways to success.
However, in the near term, I expect that the cannabis space will be extremely volatile. To paraphrase one industry executive who recently noted that over the last few years they have only met with the same 20 or so investors over and over with no new faces, if one large investor in the space chooses to sell or needs to sell, there aren’t incremental buyers absent legalization. The inverse of this dynamic is of course that these 20 or so investors will not be willing sellers when legalization happens, so the stocks should go much higher. As always, I am willing to trade short term uncertainty for intermediate to longer term success.
If you are interested in more direct exposure to the cannabis space, I would suggest contacting Aaron Edelheit of Mindset Capital, as he manages a dedicated cannabis fund. I have known Aaron for almost a decade, and he has an impressive track record as an investor, operator, and author. He has also become an expert in the cannabis space over the last few years.
d. Countryside Partnerships (CSP-LN)
Countryside Partnerships, until recently known as Countryside Properties, is a U.K. based homebuilder that is in the midst of transitioning from a model that was one part asset light and one part asset intensive, to a pure play asset light model.
Countryside’s Partnership business rhymes with NVR’s approach in that it is asset light. Unlike NVR where land is optioned, Countryside’s Partnership business enters into joint ventures with local housing authorities, where the Local Authority contributes the land (which has already been permitted) to the JV, and Countryside contributes their housebuilding and community development know-how. Also of note, Countryside typically only takes sales risk for 30-40% of the homes in a development, with ~20% being pre-sold to financial backers that intend to place these homes in the rental market, and ~40% of homes being earmarked as “affordable” and owned by the Local Authority. The fact that 60-70% of homes developed by Countryside are effectively pre-sold greatly reduces the cyclical aspects of homebuilding for Countryside.
Note that the company has eliminated its dividend, which I believe led to forced selling by dividend focused legacy shareholders, which allowed us to purchase our shares at favorable prices. Additionally, the company has indicated that the proceeds from running off their traditional homebuilding business will be used to repurchase £450M of stock, which at the time of our purchase approximated 25% of the effective float.
The combination of buying from forced sellers and a massive buyback create a favorable backdrop where any sustained downside seems unlikely. At the same time, the company is primed to benefit from a favorable macro backdrop, and exciting opportunities to improve its business.
(3) Mittleman Global Value Equity Fund
a. Aimia
Aimia continues to make progress on its strategy to invest in public and private companies to yield superior returns for its shareholders. In Q4 2021, Aimia’s share price was up 14.3% and for the year it was up 19.9% (all on a CAD basis). Since MIM’s first purchases of Aimia’s shares in late May 2017 much has changed, and those changes have yielded significant benefits to all of Aimia’s shareholders.
While MIM are insiders now and cannot comment much anymore on the stock, suffice it to say that it believes significant value remains to be realised at Aimia, from both the market valuation getting closer to fair value as confidence grows in its performance, and from the fair value rising in the businesses in which Aimia has invested as they grow in value over time.
In October 2021, Aimia confirmed it was in discussions with Aeromexico regarding a potential PLM transaction which, if successfully consummated, would deliver substantial proceeds to the company. In December 2021, Aimia announced an additional investment of C$31.6 million in TRADE X, a global B2B cross-border automotive trading platform. Trade X is growing at a remarkable rate as they expand their market reach via acquisitions and grow their trading platform to other countries. Aimia remains a very large position for MIM, however the concentration risk is mitigated by the diversity of assets inside of Aimia and its net cash balance sheet. For more about Aimia please see their website: https://www.aimia.com/about-us/
b. Revlon
Revlon, while creeping up enough to make it the 2nd best performer last quarter, was still essentially wallowing around the $10 level where it began the quarter, despite a brief run-up to $17.65 in early November on seemingly speculative activity (the meme stock/Reddit mob have taken a liking to Revlon’s illiquid shares and periodically toy with it).
The company remains over-leveraged although it has been making progress on improving sales and margins and thus deleveraging. MIM started buying Revlon at around $10 in December 2010 and enjoyed a nice run over the first five years, a period during which the business performed well. MIM sold some shares at around $40 in 2015 (only about 20% of MIM’s position, thinking the stock was worth $60+ then), but 2015 marked the last year in which it exhibited what MIM considers normal economics for this business (65% gross margin, 20% EBITDA margin, 3% maintenance cap-ex).
So while it has been six years since that interim peak in business performance and stock price, and some hugely disappointing and abnormal results in the interim period, MIM thinks the quality of the business remains largely intact, with Q3 2021 results creeping back towards normal economics (58% gross margin, 17% EBITDA margin). ,A sale of part or all of the company also remains a good possibility. MIM sees Revlon as worth $27, 2.4x its year-end price of $11.34, at 14x EBITDA of $350M for 2022.
c. International Game Technology
For the third consecutive quarter, International Game Technology was among the top three contributors to portfolio results. The company reinstated a cash dividend and announced its first ever share buyback program in Q4. While both initiatives are modest in amount they are a good start given how cheap the shares remain at 7.7x EBITDA and 11x FCF. IGT’s lottery business proved its resilience through the pandemic and continues to see strong growth. The slot machine business has also stabilised and sports gambling provides a tailwind of a large secular growth story that is underappreciated with IGT. Their “PlaySports” technology is the backbone of 50 U.S. sports betting operations in 17 states, including the retail and mobile sportsbook for Resort World Las Vegas, and they are behind the scenes on many other high profile operators. MIM increased its estimate of IGT’s fair value to $39 during Q4 from $38 per share in Q3 (previously $29), which applies the same targeted EV/EBITDA multiple of 9x on estimate of 2022 EBITDA at $1.6B, and market cap. to FCF multiple of 14x estimated $550M in FCF for 2022, but with slightly lower net debt.
MIM believes its estimate is conservative as IGT’s closest peer, Scientific Games’ (SGMS) lottery business was recently sold to Brookfield Asset Management for 12x EBITDA ($6B / $500M EBITDA), and does not appear to be a better business than IGT’s lottery business (which is 80% of IGT’s overall EBITDA) (article link). Applying the same 12x multiple to IGT’s lottery EBITDA would boost the value of IGT’s stock to about $55 per share, well above MIM’s $39 target and the $29 year-end price.
(4) Clark Street Value
a. Regional Health Properties: Revised Pref Exchange Offer
Last June, Regional Health Properties (struggling skilled nursing real estate company) proposed an exchange offer where the company's Series A preferred stock holders (RHE-A) would receive 0.5 shares of common stock (RHE) for each share of preferred stock. At the time of my post, RHE was trading at $12/share, today it trades sub-$5 as all speculative trading sardines have generally come down substantially over the past several months. Last Friday after hours, with no corresponding press release this time, Regional Health snuck in a new exchange proposal whereby Series A preferred stock holders could exchange their shares for new Series B preferred stock. The Series A preferred stock trades for $4.50/share.
Regional Health's plan following this exchange is to grow their way out of this mess, issue new stock, attempt to take advantage of the distress following covid (similar to SNDA, but without the creditable board/support) in the senior housing sector and redeem the preferred over time along the way. My initial thoughts are this is a pretty attractive deal for the Series A owners, certainly better than the initial offer. In my typical fashion, just penciling out what the returns might look like if Regional Health actually kept to that redemption schedule.
Now this is far too simplistic, but assuming that everyone exchanges (unlikely given that this hasn't paid a dividend in many years and is probably sitting in the forgotten corners of retail brokerage accounts), and Regional Health keeps that redemption schedule at the liquidation value (I had to average the liquidation value table since they don't line up perfectly) pro-rata for all shareholders which they probably won't and instead try to repurchase shares or tender at a discount, then they orphan it again afterwards and its worthless (which it wouldn't be). The cash flows won't look like this, it is just a sketch out of the redemption schedule, but I get a 30+% IRR if all works out.
The biggest assumption is management can actually get out from under this, raise equity, gain creditability, etc. and that's pretty unclear, but it is a situation that deserves a second look.
Tweets That Make You Go… Hmm 🤔
Check out previous issues of Weekly Ideas👇
Weekly Ideas #20: Greenhaven, Alta Fox and Maran Capital's 2021 Q4 Letters
Weekly Ideas #19: Baron on Real Estate, Nitor Capital on VST, CF, JOE
Weekly Ideas #18: Upslope Capital & Alluvial's Q4 2021 Update, Kuppy on Oil, Pete Panda on Tin