Quick Pitches For SQZ.L, WWE, AAMC

SQZ.L – Activist Campaign – 40% Upside

WWE – Expected Buyout – Upside TBD

AAMC – Buyback Incentive – Upside TBD

 

NEW QUICK PITCHES

Serica Energy (SQZ.L) – Activist Campaign – 40% Upside
Jeremy Raper issued an open letter to Serica Energy’s board expressing ‘unmitigated disgust’ with the ongoing value-destructive acquisition of Tailwind and urged shareholders to vote against it. Jeremy argues that superior alternatives exist, including status quo or the recently rejected merger bid from a similarly sized peer Kistos at £4.25/share vs the current price of £2.7/share. The recent VIC write-up (free guest account required to access) gives a good background on the company and shows that the standalone Serica Energy is trading at FCF/EV yield of 81% for 2023. Shareholder meeting to vote on Tailwind’s transaction is set for the 27th of January. Given that the outrageous transaction terms are visible in plain sight, the chances of it getting voted down are high. Management seems to have at most 10-15% of votes already in the pocket. SQZ shares are currently weighted down by this pending acquisition and are set to recover if the transaction gets rejected. Below is a quick summary of the case. 

UK’s mid-tier natural gas producer Serica Energy has been a major beneficiary of the gas price spike in European markets and currently trades at 81% FCF yield, while hoarding about 60% of its market cap in cash. Recently, SQZ decided to buy a smaller privately held oil player Tailwind Energy in a cash/stock deal that would give 29% of the combined company to shareholders of the target. The transaction offers no operational synergies and is way too expensive – as per Jeremy’s letter, it’s getting done at a multiple of $20/barrel of 2P reserves with 52% of the consideration paid in SQZ equity, while SQZ itself trades at just $6/barrel of 2P reserves or a 70% valuation discount. Despite management’s attempts to portray the merger as accretive on various per share metrics, in essence, it would be an exchange of £0.9/share in net cash (difference between pre- and post-merger net cash/share) for £0.1/share of incremental net income. Given that SQZ itself trades at low single-digits PE, the deal would destroy a ton of shareholder value, while giving away de facto control of the company. A superior alternative would be going back to a merger of equals with Kistos, which at the same terms currently would present £3.8/share consideration (38% upside). Another option would be to use the excess cash on the balance sheet for a large tender offer – at £3/share the company would be able to retire 43% of outstanding shares. 

World Wrestling Entertainment (WWE) – Expected Buyout – Upside TBD
Mike from Nongaap Investing just covered an interesting setup at World Wrestling Entertainment. The recent governance changes and the launch of strategic review point towards the company getting sold in short order.

WWE’s controversial founder Vince McMahon owns 40% economic interest and 81% voting power. After leaving WWE in Jun’22 amid misconduct allegations, McMahon has recently made his way back to the company, shuffled the board, took the chair seat, and announced a strategic review noting “a narrow window of opportunity to create significant value for all shareholders”. Vince has now assumed the full control of the board – 5 independent directors were removed and a few of McMahon’s comrades were added. The 9-seat board consists of 6 non-independent directors. Media reports have been speculating on Fox and Comcast, among other media firms, being potential buyers given their existing partnerships with WWE. Earlier this week, rumors appeared that WWE is very close to getting sold to Saudi Arabia’s Public Investment Fund, however, the reports were later denied.

The dynamics of the setup are definitely intriguing, however, the valuation part here is tricky. The company is already expensive and I find it hard to assess what potential acquirers might be willing to pay for it. WWE is up +20% since the founder’s return and currently trades at 17.5x TTM adj. OIBDA multiple. Visually, it’s not cheap, yet the company has always boasted high multiples and pre-COVID traded at 30x adj. OIBDA. WWE is one of the largest sports media brands out there with average show views north of 2m, while the main event ‘WrestleMania’ gets more attention than the Superbowl, totaling 1.1bn combined video views throughout all of its channels. The company pretty much holds a monopoly position in the professional wrestling market, so owning WWE is not far from owning the whole sport (think Formula 1, which also trades at c. 30x adj. OIBDA). There are no direct peers, and one more data point is the 2016 sale of mixed martial arts promotion company UFC at around 18x EBITDA. This VIC author argues that WWE should be worth significantly more than UFC given its proven appeal and trophy content assets.

Altisource Asset Management (AAMC) – Buyback Incentive – Upside TBD
Last week AAMC announced a very curious incentive structure for its CEO – the CEO will receive one share of common stock for every share the company repurchases during the preceding quarter. It is hard to wish for a better alignment between management and minority shareholders, even if such a compensation package might seem overly generous. As I explain below, I am quite skeptical about AAMC’s new loan origination business and in turn about this buyback incentive. However, Jeff Moore from ‘Ragnar is A Pirate’ blog has a very different opinion and thinks AAMC is on a path to earn $10/share vs the current price of $25/share. I recommend reading his blog for those interested in the bullish pitch. And below is my less optimistic overview.

We previously covered AAMC back in mid-2021 as one of SSI portfolio ideas. A quick recap: AAMC was a holding company with no operations and $130m of investments in mREITs and cash. In its capital structure, AAMC had toothless preferred equity which kept the BV of the common equity in the negative territory. The elimination of this preferred equity was the crux of the investment thesis. Preferred shares were expected to be bought back from investors for cents on the dollar – a couple of preferred holders had already agreed to this and got their shares exchanged. Such a balance sheet clean-up would have lifted the BV of common equity from the negative -$35/share to +$33/share, or almost 100% upside to the prevailing market prices. The idea was closed a year later after the litigation with the largest preferred holder kept dragging on and the company opted to launch new loan origination business. The liquidation scenario was clearly out of the window.

Fast forward to today, the lawsuit with the largest preferred holder, Luxor, is still ongoing (Luxor is expected to lose eventually). Conversion of the remaining preferreds at 12ct on the dollar would lift the common BV to $23/share – much lower than the previous $33/share, the difference mostly coming from the ongoing cash burn of the new lending business, legal expenses as well as corporate overheads. The loan origination business so far has achieved minimal traction and most of the loans on AAMC’s balance sheet have been purchased ($90m) rather than originated (only $7m). On the origination side, the company seems to be moving up the credit risk ladder and toward shorter-duration loans (DSCR and bridge loans) to reach the required yield. The business is still fresh, as of Q3’22 only two quarters since the launch, and it is impossible to say anything about AAMC’s underwriting standards, the profitability of the loan portfolio, or the profitability of the scaled-up loan origination operations. As it currently stands, the company continues to burn a few million of cash every quarter. Without making any rosy projections, I can see limited indications of why this business should trade above its book value.

 

PREVIOUS QUICK PITCHES PLAYING OUT

Warrego Energy (WGO.AX) – Bidding War Continues +79% So Far
In the previous update, I noted that the WGO bidding war saga is close to the finale and that there is limited scope for further bid price increases. That did not age well. Just last week, one of the bidders, Hancock Energy upped its all-cash bid from A$0.28 o A$0.36 per WGO share with a 40% minimum acceptance condition. At the same time due to a spike in STX shares, the all-stock offer from Strike Energy is now worth A$0.39 per WGO share. The bidders have support from 31% and 26% of shareholders respectively. Warrego Energy trades at a premium to both bids and the board is recommending shareholders take Hancock’s cash offer. As Hancock only needs further acceptances from 13.9% of shareholders (or 30% of the undecided ones), its proposal is now likely to succeed and Strike Energy seems to be cornered to make a further increase. Interestingly, one of the large shareholders, Regal Capital Management, which has previously been in support of Hancock’s offer, sold most of its stake to a large Australian miner Mineral Resources Limited at A$0.35/share. The intentions behind Mineral Resources’ purchase are currently unknown.

Two small community bank mergers completed – FCIT +9% and HSBI +5%
These were rather standard takeovers of tiny community banks and so far similar cases have been closing with a very high success rate. FCIT (covered here) was getting acquired by a credit union for $47.75/share in cash and the spread stood at 9%. HSBI (highlighted here) was targeted by its peer in a stock-for-stock transaction (plenty of cheap borrow was available) and offered a 5% spread at the time. Both mergers had a very clear strategic rationale and were likely to get approved by shareholders due to the solid premium to historical TBV offered by the buyers. Regulatory issues seemed unlikely. As expected, both transactions closed successfully within half a year.