Friday, March 19, 2010

On ACAS: News vs. Rumor

Noticing that ACAS took a 23¢ dive, I looked for possibly explanatory news. As is often the case, ACAS didn't have any news at all this particular day. However, trolling for something – anything – about the company on Google swiftly led me to articles and comments at SeekingAlpha, which in some respects was worse than bad news.

First, is ACAS really out of business except for hoarding cash to throw at hungry creditors? Or selling shares below NAV to pay overdue bills? Despite the apparent conviction of one poster, there's no evidence of either. Curiously, that poster says: "Why would they issue shares below nav [sic] and not repay lenders with it?" The answer, of course, is that management (which owns shares personally) has an incentive to do things that make the value of the company go up, not down, and selling shares for less than the value ACAS believes to be the value of the assets backed by the shares drives the value down, and thus management has a strong incentive not to do something this stupid.

The reason to sell for $1 shares backed with $0.50 in assets is to buy something priced less than $0.50 per dollar of value. This is almost the only reason to issue shares at such a discount. The alternative, of course, is to create a conversion feature for some innovative debt instrument to ensure creditors they can liquidate if they want – with the clear understanding that the pricing of the conversion feature and the conditions of exercise would have to be carefully weighed to ensure they made economic sense ... something paying off debt with below-NAV shares simply doesn't do. Moreover, the poster didn't cite any reason to conclude ACAS was up to something so vacuous, and nothing to contradict management explanations of its thinking on share issuance (which one can gather, free, from conference call recordings).

Long-published idiocy aside, of course, what was there to move ACAS? Apparently nothing.

This second point is worth thinking about: in the absence of news, and without any expectation of a dividend any time in the foreseeable future, ACAS can droop like a wilting flower simply because it's not giving anyone a reason to buy. The income investors are gone, and many of the remaining investors seem perfectly happy to worry about things like bankruptcy (a situation that could actually improve ACAS' cash flow by reducing ACAS' interest payments to non-default rates) and ACAS' ability to make interest payments (despite ACAS' substantial and growing cash hoard), while wringing their hands that ACAS isn't doing any business (when in fact over 2009 ACAS bought a dozen and a half distressed opportunities and invested additional money in existing portfolio companies, then this year obtained authorization to issue stock below NAV to take advantage of mispriced opportunities without adversely impacting its FAS-157-compliant valuations in the face of its debt:equity ratio issues). This kind of thinking is simply mysterious. While I'm happy to consider real sources of worry, I'm simply unable to understand panicked fantasy.

ACAS has good interest coverage despite the jacked-up "default" interest rate it faces (simply because its net-worth covenants have been blown, not because it's ever missed a payment), and ACAS is clearly looking for good distressed opportunities and working on ways to make them work despite its challenging financial situation. NAV is on the way back up, and as ACAS' financial situation becomes more clearly unbleak, the share price will follow.

While running for the hills may in hindsight have been a great idea when the stock was at $40, the explanations why to run simply haven't been the causes for ACAS' woes. Likewise, the predicted doom is unlikely to materialize as claimed. Are there risks? ACAS could fail to make a deal with creditors, and management could lose a lot of freedom to bankruptcy oversight while restructuring to deal with creditors – and lots of ACAS' portfolio has been pledged as collateral on debt, so ACAS needs to keep making payments or it's in trouble ... so factors that would threaten ACAS' capacity to pay its bills could crater the company by costing it the most valuable parts of its portfolio. But with interest coverage at 2x, NAV improving, and management continuing to be able to reap its claimed fair values on deal exits, what serious reason is there to doubt ACAS' management will pull off the seemingly simple trick of treading water?

But There Is News
The news that did come out isn't bad at all. ACAS' portfolio company Mirion Technologies, which has appeared repeatedly in press releases touting the company's success in landing contracts for materials and services in nuclear facilities around the world, is apparently set for an IPO under the symbol MION, due to trade on the NASDAQ. When the dust settles, ACAS will own a substantial and likely controlling interest in the definitely-liquid entity, will be paid a $8m fee to terminate a banking services agreement, and will have been repaid some $97.8m of the funds lent by ACAS and its affiliates. This will leave ACAS with some MION notes that MION will repay with new borrowings (see page 5) to be made with credit available on termination of MION's banking services agreement. ACAS will also be a seller of MION equity in the offering, though it will ed up owning 10,740,324 of the outstanding 18,583,660 shares following the transaction (or, if underwriters exercise their over-allotment options in full, 9,090,324 shares of MION. Thus, ACAS will not only be paid an $8m severance fee, and be repaid about $180m in senior and subordinated debt, but will also realize revenue for the MION equity it liquidates while selling down to something between 41.7% and 49.3% of the outstanding shares of MION. As a bonus, ACAS becomes owner of what is probably a control block of a publicly-traded corporation.

Since the fair value of ACAS' MION holdings was last given at $321.5m, and the predicted $16 per share IPO would value the company at about $297m, it seems that ACAS may trade its illiquid MION holdings for about $188m (in debt and termination fees, but excluding equity sales) plus a control block in a publicly-traded company worth roughly $300m, and the revenues ACAS derives from its sale of MION. Valuing the control block would be difficult without knowing the size of the control premium properly placed on the position, but it's clear that the transaction makes immediately liquid ACAS' largest holding. It's also hard to tell exactly what fraction of the MION being sold other than by MION is actually being sold from ACAS holdings, and how much is coming from ACAS-managed funds or other parties. The exact economic impact on ACAS is thus hard to know. However, it's clear that ACAS seems close to hundreds of millions in additional liquidity and an opportunity to diversify out of its largest holding while retaining a block of shares large enough to ensure ACAS' interests continue to be protected.

So, what's the bad news? ACAS looks likely to end up with increased liquidity in its holdings, over a billion in cash, and another publicly-traded affiliate. With results like these, companies looking for investment will be very keen to have ACAS look over the opportunities they offer investors. Being the buyer of choice in its market has long been an objective of ACAS, and success with MION enhances both its existing position and its long-term capacity to reproduce the same success.

Therefore ...
With the "news" being either non-existent or positive, the apparent sell-off in ACAS seems unwarranted. Folks may be tiring of ACAS' continued dickering with its creditors, but the delay seems to work all in ACAS' favor. Creditors' threats of acceleration have to ring hollow once one realizes that a debtor-in-possession in bankruptcy can continue operating his business provided he keeps making timely payments of non-default-rate interest, and acceleration would only cause ACAS to make a $1,000 filing fee to obtain bankruptcy protection while the creditors' claims were sorted out. The billion in cash can't help creditors' claims that ACAS needs to be liquidated to pay its bills, or that ACAS is in danger of failing to make timely interest payments. Bankruptcy could be a nice ride for ACAS.

The real risk of delay in making a deal with creditors isn't a cause for panic among investors: the real risk seems to be that ACAS' business continues to be conducted by ACAS' longtime managers, and interest and dividends keep being collected from portfolio companies, and ACAS' financial position keeps looking better and better until the terms of the deal with creditors becomes more favorable. ACAS never wanted to pledge its portfolio as collateral, and delay keeps ACAS in the position of making sure it retains the freedom to do as it needs to manage its business without interference by third parties or the risk of loss of portfolio in the event of another catastrophe. ACAS' management seems to be looking after shareholders' interests, and their own.


Anonymous said...

I would like to add...Cramer said on Friday ACAS was too risky for him. The CEO of Keel Asset
reports that he likes the name.....they will write down the last 19mm of the CMX investment of about 130mm was already written off. was trading with a 80 RSI and it was overbought...but still above its moving average....:)

Jaded Consumer said...

Cramer has always hated ACAS, claiming he didn't understand it. Not understanding it might be a reason to steer clear, but it's not a reason to tell people who care to look at it that they can't understand it.

Watson's take is interesting, but I wonder about the "high risk" element he refers to. To the extent investors speculate that debt restructuring this month will drive the shares back toward NAV, sure. But the ability of the company to cover debt means that creditors won't get far in bankruptcy: they'll get stuck being paid, rather than getting acceleration, default interest, and other bonuses/penalties that would work against ACAS.

Delay, on my view, should work for the company (though of course not for market psychology; I'm only looking at what I think will impact business, solvency, and long-term returns). At this discount to NAV, I'm eager to see the long term.

Its_not_my_business_but said...

First, very good article.

In your Mirion discussion you mentioned that it was likely that ACAS would own a controlling interest. That was more likely in a previous IPO prospectus, but if the IPO goes as planned ACAS will own just under a controlling interest .. it is MOST likely that ACAS will not end up with a controlling interest.

Also, another way of looking at the entire Mirion IPO is that it will be a write-up of approx $90M on NAV from the last fair value and as you pointed out increased liquidity that should push ACAS > $1B cash along with other realizations.

Finally, your analysis is a fantastic primer on where ACAS is now, but given it's run-up to high $4's, the small pull-back would be hard to characterize as a "sell-off".



Jaded Consumer said...

When I talk about a control block, I don't mean that ACAS will be a majority owner, only that as the largest owner it'll be in a position to vote in the most Board members and most powerfully influence MION. Further, with (apparently) over 40% of the shares, ACAS will not need much in the way of outside agreement to get a majority on any issue it wants voted in.

I never actually saw a prospectus that left MION >50% ACAS-owned, but I've seen companies described as transferring a control block when they had even less of a percentage ownership. Practical control can be much easier to see in a 42% interest when one considers the number of non-voting shares in a given election. Since ACAS will vote all its shares, and will all vote them toward the same purpose, it's even possible that with <50% of the shares, ACAS could control >50% of the Board.

As to how much the MION deal is worth to ACAS shareholders ... I'm not sure how much of the MION equity or notes are in the hands of ACAS and how much are in ACAS-managed funds. I also don't know how much of the non-MION-sold stock is coming from ACAS and how much from managed funds, so it's hard for me to feel I have a strong handle on the absolute bottom line to ACAS from the MION IPO.

However, for ACAS to get repaid all its debt and be paid a banking services termination fee and be paid for a partial sale of equity after exercise of its preferred conversion and warrant exercise, I'm inclined to think ACAS will be realizing a nice profit, over and above that already baked into the "fair value" given in the last FAS-157-compliant valuation. ACAS will end up with what is likely a control block of what is certainly a liquid asset, and will thus likely be entitled to apply a control premium to its holding much in the same way it's now required to record an illiquidity discount to the same investment. The effect on FAS-157-compliant NAV could be very significant for ACAS (recall, MION is ACAS' largest single investment).

Thanks for reading, and feel free to drop corrections and notes as you see fit. I'm just one pair of eyeballs ....

its_not_my_business_but said...

>> older Mirion IPO's

Here's the SEC link with all the past prospectus's.

>> entitled to apply a control premium to its holding much in the same way it's now required to record an illiquidity discount to the same investment.

Great point that I had not considered. Thanks!