Premium Post: June Monthly Thoughts and Updates
Two new ideas and three updates.
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Lots to talk about this month! But, first, thank you so much for subscribing to the premium site!
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Anyway, on to the update: two new ideas and three updates
WUBA special situation
REZI (insider buys)
RESI update
IWG mini-update
TCO update
WUBA special situation
I’ve long been a bear on investing in Chinese companies. When you combine the fraud risk (Luckin Coffee being the most high profile recent example) with the structure risk (almost all of these are structured as Cayman Island holdcos with loose claims on the Chinese assets; there is a non-zero chance you wake up one morning and find out that everything you thought you owned was gone), I thought there was simply too much tail risk to invest in these long term.
Still, that doesn’t mean there aren’t interesting situations here. In fact, given poor corporate governance at the majority of these, there can be really interesting situations where management tips their hands that shares are under or overvalued and you can take advantage of that.
I suspect 58.com (WUBA) is one such situation. Shares are currently trading for ~$50/share. There is a buyout offer at $55 on the table from a consortium that I think is highly likely to go through (and reasonably likely to go through with a little bump). Most importantly, the CEO / Chair / Founder is part of the group offering to buy the company out. I think his involvement is the “tip” here; if he wants to buy the whole company for $55, there’s a good shot that $55 is too cheap and, despite being too cheap, a founder being involved with a bid normally means the bid will go through.
WUBA runs China’s largest classified site (the “Craigslist of China”). The company IPO’d in 2013 and got a big strategic partnership with Tencent in 2014.
Let’s fast forward to today. In early April, Ocean Link, a China-based PE firm, offered to buy WUBA for $55/share. It’s important to note that Ocean Link was the only firm mentioned in this offer, though they did say they would look to add more people to a consortium of buyers.
WUBA clearly took the buyout offer seriously. Through the rest of April, WUBA made three big moves related to the offer:
They added two independent directors to the board.
A week later, WUBA forms a special committee to evaluate the offer. The special committee consists of two board members….. the board members who were added just one week prior!
A week after that, the special committee hires financial and legal counsel.
I think these moves are important for two reasons. First, it shows that the company clearly believes the bid is credible. Second, they added two board members and then a week later creates a special committee to evealuate the transaction consisting of just those new board members. It feels like he board members were added specifically to negotiate a transaction, and in general if you add someone to a board for one reason, they tend to do that thing (i.e. they were added to get a deal done, and get a deal done they will!).
A few days after the committee hired counsel, Ocean Link came back with an updated offer. Of note, the new offer added several members to the consortium; in addition to Ocean Link, General Atlantic, Warburg Pincus, and WUBA’s Chairman/CEO were now looking to take the company private at $55/share. Combined, those four owned 44.1% of WUBA and were not looking to sell their shares or support any competing bid to their offer.
That’s a unique look: having four shareholders who own roughly half of a company join together and offer to buyout the rest of shareholders for $55/share while saying they will not sell or support any other deal and that the CEO is on their side really puts the company in a tight spot. The four shareholders are clearly knowledgeable and think the company’s value is a lot higher than $55, but if you’re on the special committee and presented with those terms it’s going to be pretty tough to walk away from the deal (as the major shareholders could just vote you out of your seat and try again in a few months) or to extract more than a token bump (given the negotiating leverage against you).
Anyway, I don’t love the business or the ownership structure here. But insiders are showing an appetite to buy the whole company for $55/share, and the market is valuing the company below that. I think the most likely way this plays out is within the next few months management makes a slight bump to their bid and the committee accepts. From today’s share price, minority shareholders would make out very well with a small bump, though I suspect management will be the real winners long term…..
REZI insider buying
There’s been a mini-wave of insider buying at REZI (not to be mistaken with RESI, which I’ll discuss next) recently. One director bought 5k shares for ~$50k, another bought >10.5k shares for ~>$100k, another bought ~110k for ~$1m, and a fourth bought ~60k for ~$500k. Add it all together and the four directors bought almost 200k shares. That’s not a mammoth amount, but per REZI’s proxy directors owned <200k shares of REZI before those buys (see p. 34). In other words, in the past two weeks, four directors have bought more REZI stock on the open market than the entire board owned a month ago. That’s interesting!
REZI is a spin off from Honeywell, and the spin has been absolutely bungled. But that’s in the past. Now there’s an activist involved and a new CEO and CFO have been hired. Both the new execs have significant experience with private equity firms and received decent equity grants as part of their appointment. Combine those equity grants with directors starting to buy, and it’s possible REZI is on the cusp of a turn.
REZIupdate
From REZI to RESI, a quick update on my thesis for RESI (which I posted on the public blog).
Since that post, a major RESI stockholder, ASPS, has been conducting a withhold vote for the board. In response, RESI published a shareholder letter yesterday.
On reading the response and relooking at the situation, I’m even more confident RESI won’t be a standalone public company in the next year or two. In particular, I’d highlight the last paragraph of the letter, which clearly indicates the board is looking to terminate their external management agreement and is still open to a sale. I’d also note that their merger break agreement with Amherst gave Amherst a right of first refusal (ROFR) if RESI decides to sell themselves again in the next year (see section 5.07). The only reason Amherst negotiates one of those is if they still have interest in RESI and believe RESI is likely to try to sell themselves in the near future.
It seems pretty clear to me that RESI and Amherst both wanted to merge, but the frozen financing markets at the height of the crisis hit the deal. With single family homes performing very well right now, Amherst just raising money / having a ROFR, and a major RESI shareholder itching for change, I think it’s extremely likely RESI revisits a sale and Amherst ends up acquiring them in the near future.
Note also that there’s something weird going on the the management team at RESI’s external manager. Altisource put both their CEO and CFO (who double as RESI’s CEO/CFO) on leave due to a shareholder allegation. In response, RESI published a statement saying they unanimously support the CEO/CFO. I have no idea what’s going on there, though it’s really weird for a board to give a unanimous support statement without having a very clear idea of what’s going on. Still, turmoil at the C-level likely only increases the odds of RESI looking to sell themselves.
IWG mini update
I gave a brief update to my thesis on IWG at the end of May. My main point in the update was results were good and largely in line or better than my thesis, but I didn’t love the equity raise.
I still don’t love the raise, but IWG promised the raise was for offensive purposes, so I wanted to highlight that they appear to be acting on that promise in a small way by taking over some former WeWork spaces.
I continue to like the stock and the company, even at today’s higher prices. Yes, I don’t love the raise. But it’s comforting the CEO wrote a big check (~$100m) to participate pro-rata in it, as did several board members. They appear to be playing offense, and I think post-Covid social distancing and flexible office needs will be a big wind at their back. At today’s prices, I think you’re paying a fair to cheap price for the standalone business and getting all of their growth initiatives and optionality plays (in particular, the optionality on resuming franchise sales) for free.
TCO update
Last but certainly not least (in fact, I know TCO is very top off mind for more than a few of you!), an update on TCO. Recall that I posted a long TCO pref / short TCO idea back in March, as well as an update after earnings.
Yesterday, SPG filed in court to break the merger agreement. This was unexpected but not entirely so; I noted in the update that SPG’s body language on the deal in their earnings was awful, and anytime a buyer is stuck in a deal that materially overvalues a target there’s always a risk they try to break the deal.
I was a little surprised by SPG’s filing. The SPG / TCO contract is quite strong, and I thought the largest risks were around TCO breaking a debt covenant or improperly drawing down their revolver. SPG’s filing argues for none of that; instead, they argue that COVID disproportionately effects TCO (recall that pandemics are excluded by the merger agreement, so the only way SPG can use the pandemic to legally get out of the TCO agreement is if they argue TCO was uniquely effected by the pandemic).
I read SPG’s filing several times, and I’m eagerly looking forward to TCO’s response. My first take is that SPG’s filing is extremely weak and they would likely get wiped out in court if they tried to argue this. I believe that’s a somewhat unique take; most arb shops I’ve talked to have the odds at ~65% chance for TCO. I suspect SPG’s main game here is that they are filing now to apply maximum pressure on TCO; in particular, I bet SPG think TCO will breach their debt covenants before this trial happens. When TCO does, SPG can add that argument to the court case and that’s a real winning argument.
I think the most likely outcome is TCO and SPG recut their deal with a nice haircut and the deal goes through. Something around $40/share probably makes sense for everyone; TCO still gets a nice premium to their unaffected price (and a mammoth premium to where they’d trade in the current market) and certainty of close, while SPG saves themselves hundreds of millions of dollars and the embarrassment of trying to use this case in court.
I continue to think the prefs are an absolutely unique was to play this deal. As I write this, the prefs are trading <$21. If the deal goes through, the prefs will get paid off at par ($25/share, plus you’ll continue to clip divs through the deal). If the deal doesn’t go through, I’m sure the prefs will trade sloppily for a little bit but given where peers are trading there’s an enormous equity cushion underneath the prefs. I suspect that a few months after the deal break, the prefs would actually be trading higher than the current price if TCO was a standalone / no deal company (and assuming reopenings continue to happen at a reasonably steady pace).
However, when I initially recommended the trade (and note that nothing in here is ever investment advice!), I liked the “short TCO / long prefs” trade. With the prefs ~flat from where I recommended them and the common down ~20%, I think that trade has largely played out. I still think the deal goes through (likely with a price cut of some form), but with the common down so much the risk reward of shorting the common is much different. I personally like the prefs more as a standalone play than a hedged play at this point.