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The P10 Alternative

31 Monday Jan 2022

Posted by nocalledstrikes in Stocks

≈ 6 Comments

Long: P10 Holdings (PX: NYSE)

Current Price: $11.80 (Jan 30, 2022)

Share Count Diluted: 125 mm, Market Cap: 1.5 billion, EV = 1.84 billion

2022 est. EBITDA = 100 mm, EV/EBITDA = 18.4

Opportunity

P10 Holdings is a multi-asset class, private markets solution provider in the lower/middle market alternative asset space. Its business model delivers high margin revenue and highly predictable returns from the ownership of the management and advisory fees of the fee-paying assets under management (FPAUM). With just a 1.5 billion market cap, strong organic growth, an unique and attractive value proposition for the companies it acquires, PX should be capable of 25% plus annual increases in FPAUM, revenue and free cash flow.

P10 Introduction

For its customers, P10 Holding offers its clients differentiated access to a broad set of solutions and specialized investment vehicles primarily in the lower/middle market alternative asset space.

For its shareholders, P10 Holdings is a company with an attractive business model that generates extremely predictable, recurring, high margin fixed management fees earned on the committed capital in long-term contractually locked up funds.

Our revenue is composed almost entirely of recurring management and advisory fees, with the vast majority of fees earned on committed capital that is typically subject to ten to fifteen year lock up agreements. We have an attractive business model that is underpinned by highly recurring, diversified management and advisory fee revenues, and strong free cash flow. The nature of our solutions and the integral role that our solutions play in our investors’ investment decisions have translated into high revenue visibility and investor retention.

From the 2021 Prospectus

Unlike financial holding companies that purchases an equity stake in an asset manager’s general partner, P10 only purchases the management fee of the solution provider it acquires for cash and stock and leaves the performance fee and carried interest of the acquired fund with the original management team. The acquired company becomes a variable interest entity (VIE) under P10 Holdings. This structure ensures the acquired managers continue focusing on performance and can continue raising new assets off their track record.

 We specifically aim to eliminate perceived challenges facing many publicly traded alternative asset management firms, (i) earnings volatility due to lumpiness of carried interest, (ii) tax complexities from the ownership of management and advisory fees and carried interest in publicly traded partnerships and (iii) potential misalignment of interest between investment professionals and the shareholders.“

From the 2021 Prospectus

Established solution providers are incented to sell to P10 because the P10 business model allows the sellers the opportunity to exchange the equity built up in their private partnerships for cash and shares of a diversified public company without losing their ability to earn the performance carry on the current and the future assets they manage and raise. For P10, the same fee split structure ensures the fund’s management team stays fully motivated to outperform.

P10 History and Management

The history of P10 Holdings begins with 210 Capital LLC which Robert Alpert, 56, and Chuck Webb, 40, co-founded in 2017. In addition to P10, 210 Capital owns or controls Crossroads Systems, Elah Holdings, and Globalscape. Alpert and Webb serve in executive roles at all their companies as either CEO, co-CEO, and/or Chair.

Prior to founding 210 Capital, Robert Alpert was the founder and portfolio manager of Atlas Capital Management, LP, a long-short strategy investment adviser from October 1995 to September 2015. Previously, Clark Webb was a Co-Portfolio Manager of the Lafayette Street Fund and a Partner at Select Equity Group, L.P.

In 2017, 210 Capital acquired what became P10 Holdings out of bankruptcy court and through a support agreement made Robert Alpert and Clark Webb co-CEO’s of P10 Holdings with Alpert also serving as Chair. As of June 30, 2021, 208 million of Net Operating Loss (NOL) carry forwards remain available.

At inception, P10 was an empty shell corporation without an operating business. In October 2017, Alpert/Webb’s first P10 acquisition was RCP Advisors, a sponsor of private equity, funds-of-funds, secondary funds, and co-investment funds. Since its founding in 2001, RCP Advisors has raised approximately $7 billion of committed capital and maintains one of the largest internal teams dedicated to North America middle and lower-middle market private equity.

Importantly, P10 only receives the management fees generated from the RCP funds, not the carried interest. We believe that the carried interest provides an alignment between the RCP investment team and its investors. In other words, we want the carried interest to go to the RCP professionals, as it provides those individuals with economic incentives to continue to perform on behalf of investors. The benefit to P10 is twofold: (1) we have an RCP team that remains highly motivated to perform; and (2) the P10 revenues consist almost exclusively of highly predictable and stable management and advisory fees. Moreover, we have an extraordinary team in place with significant capacity to add incremental assets undermanagement (“AUM”). As a result, to the extent we can continue to grow our AUM, thereby growing our management fees, we would anticipate an expanding profit margin and growing earnings for P10. For 2018, we project the RCP business should generate an EBITDA margin in excess of 50% of revenues; and because our management fees are, for the most part, locked up by contract for up to a decade, we believe this profit stream will prove to be stable.

As part of the transaction, RCP principals received 44.17 million shares of P10 common stock, representing approximately 49.5% of our post-acquisition capitalization, making them the largest stockholders of P10, by far. Two RCP partners, Fritz Souder and Jeff Gehl also joined the board of directors of P10.  “In addition to the shares of common stock, P10 issued to the RCP principals approximately $117 million in principal amount of non-interest bearing promissory notes (the “Sellers’ Notes”).”

From the 2017 P10 Shareholder letter

The projections in the letter proved out. RCP revenues in 2018 were 32 million with margins of 55%. Additionally, Fritz Souder continues to serve on the P10 board and as Chief Operating Officer of P10 Holdings as well as Managing Partner and President of RCP. Jeff Gehl continues as Head of Marketing and Distribution of P10 Holdings as well as Managing Partner and Vice President of RCP. Jeff Gehl remained on the P10 board until September 2021 when he stepped down to make room for Ewin Poston, managing partner of TrueBridge Capital and Scott Gwilliam from Keystone Capital to join the board.

P10’s 2020 Acquisitions

Figure 1. From P10 2021 Q3 Investor Presentation

In April 2020, P10 acquired Five Points, a lower middle market alternative investment manager focused on providing both equity and debt capital to private, growth-oriented companies and LP capital to other private equity funds. At acquisition, its strategies focused exclusively on the U.S. lower middle market. Since its founding over two decades ago, Five Points has successfully raised and deployed more than $1.5 billion on behalf of institutional and high net worth clients.

In October 2020, P10 closed on the acquisition of TrueBridge, a leading venture capital investment firm managing more than $3.3 billion in assets. TrueBridge invests in venture and seed/micro-VC funds focused primarily on early-stage IT, as well as directly in select venture and growth stage technology companies.

In December 2020, P10 closed on the acquisition of Enhanced Capital, LLC, an impact investment firm with a two-decade history of deploying capital into socially responsible investment areas including small business lending, renewable energy, and women and minority owned businesses. Since inception, Enhanced has deployed more than $3 billion across its impact verticals.

On September 30, 2021, P10 purchased Bonaccord Capital Partners and Hark Capital from the asset manager abrdn. Unlike their acquisitions of stand-alone companies which include a stock component, this was a cash transaction for 40 million and up to 25.4 million in earnouts. The management teams will transition to P10 and operate from within the P10 Private Equity and Private Credit asset management groupings respectively.

Bonaccord acquires minority equity investments in a diversified portfolio of alternative markets asset managers with a focus on mid-sized managers across private equity, private credit, and real assets. Hark provides loans to mid-life private equity, growth equity, venture, and other funds. P10 expects the transactions to add approximately $900 million in fee paying assets under management.

Price paid for 2020 Acquisitions

Historical Performance Drives Organic Growth

P10’s organic growth is strong and is growing about 30% pro-forma in 2021. Given past performance, the ability of the management teams to raise larger sums for their newest funds in a strong market is not surprising. P10 fund raising benefitted in 2021 from a favorable fund offering calendar, but in 2022, there will be fewer new offerings of existing strategies as not every product is offered every year. Based on the calendar, 2023 and 2024 will have more new offerings than 2022.

 P10 FPAUM Growth

Figure 2, P10 Organic Growth, (P10 2021 Q3 Investor Presentation)

P10 Investment Managers Track Records

Figure 3, P10 Organic Growth, (P10 2021 Q3 Investor Presentation)

Growth driven by leveraging relationships in P10’s Private Market ecosystem

The private market ecosystem lends itself to cross-solution sourcing of investors and investments as well as leverage its proprietary database of middle and lower middle market private venture data.

As we expand our offerings, our investors entrust us with additional capital, which strengthens our relationships with our fund managers, drives additional investment opportunities, sources more data, enables portfolio optimization and enhances returns, and in turn attracts new investors. We believe this powerful feedback process will continue to strengthen our position within the private markets ecosystem. In addition, our multi-asset class solutions are highly synergistic, and coupled with our vast network of general partners and portfolio companies, drive cross-solution sourcing opportunities.”

from the 2021 S-1
Figure 4. From 2021 Q3 Presentation

Growth through Geographic expansion

Second, there are opportunities for cross selling and leveraging networks of investors and investments across the company’s platform especially geographic expansion. At the Annual meeting in July 2021, Alpert/Webb gave the example of introducing the TrueBridge fund to European investors in its network where TrueBridge was previously unknown and raised 700mm in new commitments.

Alternative Assets Market Growth

P10’s middle and lower-middle markets funds that invest in portfolio companies with revenues between $25 and $500 million is an underserved, growing and relationship-oriented market where growing scale generates a self-reinforcing virtuous cycle. This market is too small for firms like BlackRock with trillions in assets to pursue, but it is a long runway for growth for a firm like P10.

Figure 5. From 2021 Q3 Presentation

Acquisitions

While future acquisitions are a given, their timing will never be predictable. At the Annual Meeting in July 2021, Robert Alpert mentioned that discussions are usually occurring with 6-7 firms at any time, but obviously most discussions do not lead to transactions.

We expect to expand within other asset classes and geographies through additional acquisitions and future planned organic growth by providing additional specialized investment vehicles within our existing investment asset class solutions. As of the date of this prospectus, we are pursuing additional acquisitions and are in discussions with certain target companies, however the Company does not currently have any agreements or commitments with respect to any acquisitions.”

From the 2021 S-1

P10 IPO

In October 2021, P10 up listed from trading as PIOE on the OTC market to PX on the NYSE through an IPO with lead book running managers Morgan Stanley, JP Morgan, and Barclays. The company sold 23 million class A shares at $12 in the IPO. The shares were half primary and half from insiders. The 130 million raised in funds from the primary sales were directed to corporate debt reductions while the corresponding insider sales reduced insider holdings by approximately 7%. After the IPO, insiders own 57% of the economic interests and 69% of the voting power.

Commencing with the IPO, the previously held 126 million shares of PIOE were reduced to 7 shares for every 10 in a reverse split and became 97 million class B shares with 10x voting rights. Holders of Class B common stock may elect to convert shares of Class B common stock on a one-for-one basis into Class A common stock at any time. With limited exception, upon any transfer, Class B common stock converts automatically on a one-for-one basis to shares of Class A common stock. The voting rights are subject to a “Sunset” provision triggered by when the original class B holders cease to maintain control of 10% of the shares, 25% of the voting rights, or 10 years which ever happens first.

The IPO shares were originally indicated at a $14-$16 range making the final pricing at $12 a disappointment. The unfamiliarity of P10 to market participants was probably the biggest negative factor on the pricing, but the use of dual class stock, even with a sunset provision, likely played a role as well.

As I am investing in P10 specifically for Alpert and Webb’s leadership and vision, I do not see the lack of ability to easily remove them in the first ten years as a negative. I will however miss the price insensitive purchases of PX stock from the index fund buyers of the indexes that do not track dual class stocks. Given the high ownership of PX by insiders already, the use of two class stock seems unnecessary, but my hunch is that Alpert and Webb expect future acquisitions of sizes to be large enough to change the balance of ownership without it.

Value of NOLs

Given the predictability of P10’s earnings stream, P10 is the first NOL shell company I’ve ever owned where I am confident that all federal tax carryover losses will be consumed. The $208mm on 125mm shares is currently worth an undiscounted $1.66 per share in saved taxes.

While we anticipate $0 of federal income tax for several years, we will have some state and local income taxes”

Q3 2021 Investor Presentation

New Credit Line

“A new credit facility provides for a term loan in the amount of $125 million and a revolving commitment in the amount of $125 million. The company will use the loan proceeds to pay off the outstanding borrowings under its existing credit facility, pay off seller’s notes related to the RCP acquisition, and pay transaction-related expenses, as well as for working capital and other general corporate purposes. 

Terms of the new credit facility call for a variable interest rate of approximately two and a quarter percent (2.25%) which offers significant savings over the seven percent (7%) interest rate with the previous credit agreement.“

December 23, 2021 announcement

Not only will this net savings of over 5 million annually (4.75% *125mm), the granting of these terms by JP Morgan Chase confirms the stability and visibility of earnings provided by the P10 business model.

Comparables

Hamilton Lane (HLNE, MCap=3.2B, EV=3.7B) with 3x the fee-paying AUM (FPAUM) of P10 and StepStone Group (STEP, MCap =1.9B, EV=3.0B) with 4x are the closest comparable public companies to P10. Both competitors maintain ownership of the performance carry in their funds which increases profitably in rising markets but reduces revenue visibility and steadiness. Both are highly profitable companies with EBITDA margins in the upper 40’s.  Unlike P10, STEP provides infrastructure and real estate options.

Hamilton Lane and StepStone both benefitting from growth in private market assets.

Reasons to sell

  • If Alpert/Webb were to leave or sell out, I would exit as this is fundamentally a relationship business and the loss of current leadership would likely result in a period of underperformance.
  • A more likely risk is that more firms begin to pursue small private alternative asset credit funds and in doing so, increase the cost of P10’s acquisitions.
  • If a P10 component fund starts underperforming, its future fundraising will be impaired. This is partially mitigated by P10 continually acquiring new managers with strong histories to increase the number of top performing funds for clients to choose from and keeping product offerings fresh. However, a rash of underperformance not tied to macro events would be a flag.
  • Lastly, a major economic change could clearly impact P10 as the alternative asset classes have certainly benefitted from investors seeking substitutes for low yielding securities.

P10 Financials Pre-IPO

Post IPO adjustments

Cash raised from sell of new shares = 130 mm

Post IPO, Debt – Cash = 315.5 + 199 – 21.6 -130 = 362.9 mm

New Share Count (diluted) = 125 mm

Share Price = 11.8 on Jan 30, 2022

Market Cap = 1.475 b

Enterprise Value = 1.84 b

2022 EBITDA est.  = 100 mm

2022 EV/EBITDA = 18.4

Valuation

I am using a simplistic model with simplistic assumptions to generate a range of outcomes.  

  • Organic growth of 15-20%. 2021 organic growth was 30%, but 2021 was a peak cycle year at RCP. 2022 is a low cycle year with fewer new funds scheduled to open than in 2021 or are projected to open in 2023.
  • P10 acquisition growth was over 80% in 2021 and I certainly expect more acquisitions in the coming years but modeling more than 10-20% annually seems like magical thinking.
  • I expect most acquisitions going forward to be paid with cash from the new credit line, but some transactions may still use a modest amount of common stock. For comparison, the Enhanced acquisition consumed $27 million in stock, while True Bridge required $84 million. Whereas the most recent acquisitions from abrdn were all cash. In the table below, I retain all earnings and increase debt and stock in both scenarios for acquisition funding. More time spent on the cost of acquisitions would improve the model, but a rough guess is sufficient for my purposes.
  • I expect a slight increase in the adjusted EBITDA margin as the company scales in FPAUM.
  • As organic growth continues, I expect P10 to rate a slightly higher valuation rating closer to HLNE.

The decision to purchase P10 comes down to whether one believes the company can continue to grow AUM at 25% – 40% annually over the next decade through a combination of organic growth and continued accretive acquisitions.

My answer is yes, because I find the P10 business model advantaged in its ability to acquire well-run private asset firms in the attractive alternative asset space at private company prices, incent the management to manage existing assets while continuing to add new ones, and receive a premium valuation for the growth potential.

Make money with mutual funds, buy a mutual fund manager (HNNA)

05 Wednesday Oct 2016

Posted by nocalledstrikes in $HNNA, Stocks

≈ 1 Comment

Not sure which mutual fund to buy? You might want to consider the mutual fund manager instead.

perfchart4

Hennessy Advisors (HNNA), the red line in the above chart, is a publicly traded stock mutual fund manager.  The other lines represent its two largest mutual funds as well as the SP500. Any questions?

In rising markets, its almost axiomatic that an investment in a mutual fund management company will be more profitable than an investment in any of its mutual funds. (The inverse is mostly true as well).   For an investment advisor, revenue is proportional to the quantity of assets under management while expenses are not, so the mutual fund management business becomes immensely profitable in rising markets with pretax margins approaching 45% in the case of Hennessy.

Mutual Fund manager Hennessy Advisors (HNNA)  is a tiny, overlooked player in the investment advisor business with 16 open ended mutual funds holding combined assets under management (AUM) of 6.6 billion. The company started its first mutual fund in 1996 focused on quantitative factors. Later, the company added a broader range of more traditional equity funds through acquisitions for other fund companies.  Today, over 70% of its assets are less than five years old with the largest jump resulting from the purchase of FBR’s mutual funds in 2012. More recently, on September 23, 2016, the company obtained 440 million in new assets from the Westport fund management company growing AUM by an additional 7%. Due to the advantages of scale in the mutual fund industry, earnings from the acquisition should increase by a slightly higher amount, say 8-10%.

Hennessy is currently priced substantially below its peers based on its current earnings trend. Due to the company’s small size (174 million market cap), fund concentration and low liquidity, a discount to peers of 10 – 25% would be reasonable, but the current  50% discount seems  excessive especially in light of the recent Westport transaction.

To acquire Westport, the company paid 1.75% of the 646 million in assets at the time of the agreement or 11.3 million, even though it appears that only 440 million in assets remained in the fund by the time the transaction completed. [edit – I originally wrote that the purchase price was based on assets at close date, but actually it was based on AUM at agreement date – my mistake].  The assets were merged into the Hennessy Cornerstone Mid Cap 30 Fund which will charge 1.0% of fund assets annually (4.4 million) for fund expenses and shareholder services. With less than a three year payback, this acquisition should yield strong returns, but that’s only if most of the customers’ funds remain with Hennessy.

In the bull case, the clients who own the Westport funds will appreciate the lower fees and better record of the Mid Cap 30 Fund and want to stay.  Additionally the transaction preserves continuing fund holders tax basis, while creating a tax liability for those who chose to sell instead of stay. But, Hennessy’s record for keeping assets is stronger when they retain the existing fund using a sub-advisor than when they merge, so the move for higher fees may raise  asset flight.

Lastly, the acquisition of mutual fund companies creates an accounting asset on the acquirer’s balance sheet that gets amortized over time increasing cash earnings. In 2016, the company will record a deferred tax asset of approximately 2 million due to amortization so cash earnings are about 8% higher than reported earnings.

Risks:

Market Sensitivity: Hennessy’s fee generation is directly tied to market performance and fund holder retention. While no one complains about this in the good times, in a down market not only will the value of the funds’ assets drop, but the lower prices will also scare investors into redeeming their shares dropping AUM even further. This is why leveraged companies do and should sell at discounts.

Concentration Risk: The Hennessy Focus Fund (HFCSX) is Hennessy’s largest fund with 2.4 billion or 36% of all Hennessy assets under management. Morningstar gives the fund a five star rating a special Bronze star analyst rating. The second largest fund with 1.46 billion or 22% of AUM is the Hennessy Gas Utility (GASFX) Fund with four stars from Morningstar. For those counting, 58% of the assets are in just two funds.  As these funds go, so goes the bottom line of Hennessy Advisors.

Management Compensation: The CEO, Bill Hennessy, is also the founder and largest owner with 30% of the shares outstanding.  In 2014, he made a sweetheart contract for his services and collects 10% of the net profits each year.

Mr. Hennessy is entitled to receive a quarterly incentive-based bonus in the amount of 10% of the company’s pre-tax profits for each fiscal quarter, as computed for financial reporting purposes in accordance with accounting principles generally accepted in the United States of America, except that pre-tax profit is computed without regard to (A) bonuses payable to employees (including related payroll tax expenses) for the fiscal year, (B) depreciation expense, (C) amortization expense, (D) compensation expense related to restricted stock units (or other stock-based compensation expense) and (E) asset impairment charges (such amount, for each quarter, the “Quarterly Bonus”).

Wow, nice work if you can get it!  Fortunately, his ownership stake is  18 times greater than his his 3.3 million compensation in 2015, so he is still well motivated to build shareholder wealth.  His leadership team is also highly paid with his CFO and Executive Vice President making $1.3 and $1.0 million in 2015 as well.

Neil Hennessy is only 58 and show no signs of selling the company.  Eventually, when the company does get sold years from now, the acquirer will likely already have a President, CFO, and EVP, so the 5.6 million in bonus and salary can be eliminated which will increase the value of the company six to eight times that amount over its worth as an ongoing investment with the extra salary.

A look at some numbers:

epsaum

Share Count (Diluted) 5,154,094
Price 34
Earnings for TTM: $2.67 PE 12.7
Earnings as 4 times last quarter $3.04 PE 11.2
Earnings with last quarter annualized + 6% earnings increase for Westport acquisition $3.22 PE 10.6
MV (millions) 175.2
Debt (millions) 27.0
Net Cash after Westport (millions) .4
EV 201.8
2016 Second Quarter Numbers
Operating Income Q2 2016 (millions) 6.1
Interest (millions) 0.1
Taxes (millions) 2.0
Depreciation (millions) 0.3
Amoratization (Deferred Income Tax) 0.5
EBITDA for Q2 2016 (millions) 8.9
Annualized Ebitda 35.8
EV/EBITDA 5.6

 

Comparable Companies: While Hennessy does not have any publicly traded micro cap peers, larger investment managers in the 2.5 to 8 billion market capitalization range like Janus Capital (JNS), Federated Investors (FII), Legg Mason (LM), Eaton Vance (EV), and Affiliated Managers Group (AMG) have P/E ratios for 15-18 compared to 11 for HNNA. While P/E’s are easily manipulated by debt, in this case several of the larger companies are carrying proportionally more debt than Hennessy as well.

Management: While I think they are overpaid, Hennessy management is competent and adaptive. The company has adjusted its strategy over the years to grow the business by adding funds and providing more services, they are survivors of the 2008 financial crisis, and they have successfully integrated acquisitions.  But I’m not impressed with the board, it includes family members and appears more typical of a 15 million nano-cap than a 175 million small cap. At the end of the day you have to be comfortable with Bill Hennessy as the CEO/Chairman and not expect much from the board; fortunately, he did build this company after all and  appears to know what he is doing.

So is Hennessy cheap? Yes, but there is a reason mutual fund companies sell at a discount to the market. For Hennessy to continue growing at 15-20%, several trends must continue to be favorable: general market performance needs to remain bullish, the company’s largest funds (Focus, Gas Utility) can’t have bad years, newly purchased fund assets need to be at least somewhat sticky, and new acquisitions must be available for purchase at fair prices.  I’m not betting the company goes five for five on that list, but then I also don’t believe the price I am paying requires perfect execution either.

Conclusion: I recently bought Hennessy Advisors stock because I don’t believe the positive earnings trend is priced into the stock. But due to the inherent leverage in a market leveraged investment, the concentration of the majority of assets in just two funds, and the secular headwinds facing all actively managed equity funds I cannot justify over-weighting the position, but I expect it to continue performing better than the overall market until the next recession (whenever that is).

One more blogger writing about Awilco Drilling (AWLCF)

25 Friday Apr 2014

Posted by nocalledstrikes in Stocks

≈ Leave a comment

Awilco Drilling

Awilco drilling is seemingly every small cap value investor’s favorite North Sea driller; you’ll find it written up wherever value guys hang out.  Its high dividend is its primary attraction and the dividends sustainability, its primary question mark.

Usually high yields usually scream trouble to me, and I can identify several scenarios where Awilco’s dividend could be challenged, but I believe Awilco also holds a sustainable niche. I purchased it last year before the first dividend was paid and while it’s not the “load up the truck” buy of last year, it’s still attractive.

This post is my one year update. I wrote it to help me freshen up my valuation.  Your constructive criticisms will help me refine my analysis, so have at it, but please note I am using a yield based analysis to ballpark the value of the company. In the links to other sources at the bottom of this article, you can find a more traditional cash flow model if that’s your preference.

History of Awilco

Awilco Drilling PLC is a UK based drilling contractor. It owns and operates the two refurbished and enhanced mid-water semi-submersible drilling units, WilPhoenix and WilHunter, each rated to operate in 1200 and 1500 feet of water respectively.  In 2009, Transocean wanted to merge with GlobalSantaFe, but the combination would have created a total monopoly in the North Sea. To obtain UK approval, Transocean was required to sell off two ships to another operator. Transocean needed a buyer quickly, the Awilhelmsen group fit the bill, and thus began the current incarnation of Awilco Drilling.

For those like me, who hadn’t heard of the Awilhelmsen group before, it is a private Norwegian company with interests in shipping, oil field services, real estate and financial investments.  They owns 48.7% of Awilco Drilling and are the controlling investor. Awilco’s market cap is approximately 645 million with 125 million in 5 year debt. The stock was listed publically in 2011 on the Oslo Axess exchange as AWDR:NO and  is also available on the pink sheets as AWLCF. Not surprisingly, liquidity is significantly better on the Axess market than the pink sheets.

The WilPhoenix and the WilHunter rigs were almost 30 years old when they were purchased from Transocean in December 2009. Upon receipt, Awilco’s first action was to take the old rigs to dry dock and invest another 97 million to upgrade the rigs, enhance their capabilities and extend their life another 20 years.  The upgrades improved the rigs highly desirability and reliability. They have been under continual contract since released from the shipyard in 2011.

In January 2013 the company announced it would begin paying out all its available cash over a $40 million reserve as dividends.  Until then, the company was aggressively paying down debt. The first dividend payment began at $1/quarter in May 2013 and was raised to $1.10/quarter this past November.

On a $21.50 stock, a $4.40 per year dividend is a yield of 20.4%. Pretty good, eh? Well yes, but there are some gotchas. For starters, the rigs only have 18 years of fatigue life left in them.  This means (a) we only get the dividends for 18 years and then nothing, and (b) part of our dividend is really the depreciation of our rigs as they covert from productive equipment today to scrap in 18 years.  We should consider this portion of the dividend as a return of capital and definitely not earnings.

To model the depreciation in value, we can divide the share price of $21.50 by 18 years of remaining life or $1.20/year. Now the value of the rig probably only declines as a straight-line if you’re an accountant. In reality, the decline in the rigs useful value would be more back end weighted, but I’m being intentionally conservative. With this assumption, the $4.40 actual dividend, less this $1.20 adjustment equals a $3.20 normalized dividend.  At our $21.50 share price, we get a normalized yield of 14.9%.

But we still have some adjustments to make. We need to account for scheduled and unplanned maintenance. For instance, one ship is due to dry dock for two months in 2016.   While the cost of the maintenance is already accounted in the cash the company keeps in reserve for maintenance; there is no reserve for the loss of revenue while the rig is in dry dock.    So if both rigs are out of action two months every five years for scheduled maintenance and we have another two months of unplanned downtime per rig every five years as well, we need to reduce the normalized yield by 4/60 or 6.6%. This takes us down to a normalized yield of 13.9%.

While 14% is not as eye catching as 20%, it’s still a pretty impressive number in a low interest world. For comparison, Awilco’s 5 year bonds yields 7%.  If a normalized 12% would seem reasonable for a small cap with good management, then a little more capital appreciation would seem possible as well.  With a 16% bump in price to $25/share, Awilco would trade for a 12% normalized yield while still paying out $4.40 per share in dividends.

Currently, day rates in the North Sea are benefiting from a tight market.

Can this last? Normally, I would advocate for a quick revision to the mean, but Awilco is a little different situation that many rig operators.

Awilco management thinks day rates will soften in 2015 and firm back up in 2016.  The following two charts from their March presentation show the status of North Sea rig utilization and contracts.

AWDR_Mid-Water_Fixtures

 

AWDR_Floater_Availability

But aren’t day rates are notoriously volatile and what about all those new super rigs being built?

Yes, rates are volatile, but only where there is an active, changing market. For me, this is where the investment gets very interesting and Awilco picks up a little bit of a moat.

The North Sea is a mature oil province that was drilled up in the 1970’s and 80s. In its day its wells drilling in 1000 feet of water were considered deep, but that was 20 years ago.  Now, no one considers the North Sea to be deep water anymore. So while plenty of new rigs are being built, all of them are being built for much deeper water (5000-10,000 feet) where operators will pay much higher rates.

No one is building brand new rigs for the old mature fields and no one can afford to pay deep water rates for routine work in the North Sea. But the old mature fields aren’t dead just yet; there is still remedial work to be done and spot opportunities to apply new technology. If nothing else, the current rigs in the North Sea could stay busy plugging and abandoning the old wells for years to come.

What keeps competition from moving in and lowering day rates?

While rigs can be moved across the ocean from one basin to another that takes months during which time the rig is not earning money.  Furthermore, not just any rig can be certified for North Sea operations, so there is a regulatory hurdle to be overcome to operate in the UK during which time the rig would also be sitting around not earning any money.  Finally, but not insignificantly, the old rigs made for the North Sea were designed for the North Sea and deal with its notorious weather and rough seas better as well, but no one is building brand new, old rigs anymore.

The most likely competition would be someone doing what Awilco did.  Buy an old rig take it off the market for a year and retrofit it.  To make the economics work best, it would help to have a forced seller like Awilco had with Transocean.  It could happen, but it will not happen overnight.

The company’s current contracts are with strong counter-parties, so we’re covered through 2016, but long term this is probably the most significant risk.

Key Indicators to watch: 

Day rates for Awilco’s drill semi-submersibles – Any changes on the contracts?

Day rates for North Sea drillers – Is anybody bring new rigs into the market?

Any significant change in the price of oil? – Obviously a long-term significant price drop would impact the day rates.

Additional Risks

Rig accident –   Every 10 years there is a catastrophic offshore drilling accident resulting in a huge fire, spill, destruction of the rig, and a tragic loss of life.  However, every year 600-700 offshore rigs across the globe operate safely without incident and news coverage.  Yes, a tragedy could strike Awilco, but this needs to be weighted as a 1 in 500 type event or even a 1 in 100 probability and can be accounted for by reducing the value of your investment by 1 per cent.

Unfavorable acquisition – Currently, Awilco is a cash generating dividend paying machine. What happens if Awilco purchases another rig or makes another large acquisition?  Will this dry up the dividends? Perhaps, but let’s don’t forget that the Wilhelmsen’s made a pretty good deal when they bought the two rigs from Transocean a few years ago. Maybe should want them to make another good acquisition and make us even more money.  This risk is probably a wash. They do seem like intelligent operators.

Extended drop in oil prices – Some North Sea work is mandatory for regulatory reasons and needs to be performed regardless of the current oil price, but the majority of well work is done for purely economic reasons which would obviously suffer with a 30% drop in oil prices.  Of course, a rise in oil prices is always possible too.  Shave a little more off fair value for this risk if you want, but wait until Mr. Putin is finished annexing the Ukraine first.

Regulatory Risk – There’s been chatter of a change in UK taxes, but nothing firm.

Other good sources of information:

To learn more about AWILCO, check out these links:

Company Presentation March 2014

2013 Annual Report

www.Valueinvestorsclub.com

http://otcadventures.com/?p=1066

http://alphavulture.com/2013/11/14/awilco-drilling-reports-q3-results/

Tim Eriksen’s Value Investing Congress Notes

 Disclaimer: I own AWLCF and AWDR:NO

 

How to make 26% annualized without really trying (too hard)

23 Wednesday Apr 2014

Posted by nocalledstrikes in Stocks

≈ Leave a comment

How to make 26% annualized:

  1. Find a small bank which suspended its preferred stock’s dividend during the credit crisis.
  2. Make sure the dividend was cumulative and will pay interest on the dividends in arrears while you wait for it to resume payments.
  3. Make sure the bank will have the resources to payback the dividends it missed.

Here is our candidate:

Old Second Capital Trust I, 7.80% Cumulative Trust Preferred Securities (Nasdaq: OSBCP)

Old Second Bank is a small bank holding company serving the western Chicago suburbs.  Like many banks it was unprepared for the financial crisis of 2008/9, needed TARP money, and got overextended.  At its nadir, it suspended payment of its preferred stock effective June 2010 and became subject to Federal Reserve  supervision.

The preferred is redeemable by the bank at $10 plus all outstanding dividends at anytime prior to 2033.  At $10/share, OSBCP yields 7.8% or 19.5 cents per quarter.  Since last paying its dividend in June of 2010,  the preferred will have missed 16 payments by June 30, 2014 for a total of $3.62 ($3.12 in dividends and $.50 in interest on the missed dividends).

So why buy the preferred now?  Well for starters, the bank is doing better now and is no longer under a Federal Reserve consent decree, so it can pay dividends again. Second, the bank recently issued new common stock with the stated goal of “We plan to use the proceeds of this offering to pay the accrued and unpaid interest on the Trust Preferred Securities”.  While no date has been announced for the dividend payments to resume,  my calculations use the next available payment window of June 30, 2014.

The math:

Purchase price 4/23/2014:  $12.98

Dividends to be received on June 30th, 2014: $3.62

Absolute Return on investment = $.64/$12.98 = 4.93%

Annualized return on a 67 day investment = 4.93% * (365/67) = 26.8%

Assumptions: I am assuming the preferred will trade at $10/share once the back dividend is paid and the regular dividend schedule resumes.  Most likely, it will actually trade a little below $10 once the dividend is first paid out and then start to trade a little above $10 once yield investors see a bank preferred paying 7.8% interest and bid up the price.

Taxes: You will want to do this in your IRA our else as the $3.62 dividend is fully taxable as ordinary income.

Risk:  The largest risk is that the bank delays paying off the suspended dividends for another quarter.  While we would continue to earn the 7.8% rate while waiting; our annualized return will suffer. Also, this issue is thinly traded.  Use a limit order and be patient else you could get a really bad price when buying or selling.

The prospectus:  http://www.sec.gov/Archives/edgar/data/357173/000104746903022390/a2113714z424b1.htm

Disclaimer: I own OSBCP and may sell it at anytime.

 

4/25/14 Update:  Since posting, I’ve received some valuable feedback from readers that leads me to be concerned that this issue may not be very liquid after it resumes its dividend. As a result, this security is unlikely to trade near par anytime soon after its dividends resumes and would therefore be unlikely to achieve a high annualized rate.

Its probably best to take a pass unless you have room for an illiquid holding.

 

 

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