GLOI: Special Situations

This is a liquidation opportunity I have been following since they announce intention to sell their operating businesses. To see an overview of the opportunity, and to avoid repeating the deals, please see this post. What I will try to do here is to assess the liquidation value and answer if there is enough margin of safety to be considered a sound investment.

Valuation
Issues to consider:

• Dilution Issues: Management (CEO and CFO) will have 516,000 shares vested and granted under their long term compensation plans due to change of control. This will dilute my ownership by 3.5%. I reckon there is no potential for other dilution issues going forward.
• Taxes: As it stands right now there is tax issues as most sales occurred below book value. It will depend on the earn-outs amount but I think the taxes will be non issue.
• Management Payments: There is $3,381,000 to be paid CEO and CFO for change of control clauses, bonus, and Rabbi trust in their employment agreement.
• Real Estate leases: The company HQ is leased on month to month basis and will not pose any significant costs during the liquidation period.
• Burn rate: I estimate that the company to have a burn rate of 2000,000 by next year end between the following components:
• CEO/ CFO salaries: $955,000 (including bonus to CFO)
• HQ lease: : $225,000
• Legal fees : $200,000 (this separate from transaction fees as I netted those against the sales proceeds)
• Other: $600,000
• in the worst case scenario I will assume the burn rate will double to $4,000,000.
• The holding company will be be liable for the credit line, which as of June 30, 2010 was $4.1 Million. This is offset by cash on hand of $3.8 million. Please note that in June 30 statements they have already closed on Rosetti transaction so there is $2.9 million that has already received that need to be netted out.

The following is a listing of what amounts that will flow to GLOI from the all transactions:

Please note that earn out could be higher but I based it on rolling unit revenue over the last 4 quarters.

So if we put together all items above with the best and low case estimates I can have the following potential values of liquidation:

All these buyouts are management lead buyouts. that signifies to me that the business is good and the potential of the earn outs to materialize is solid.

Risks

• What I did not did not require any special insight or knowledge to unearth the potential. So what does the upside exist? I think the market is not discounting all the potential earn-outs. Current market value of the company is equal to the current distribution. Also I think the company is too small to be on any-one's radar.
• CEO and CFO share sale, why? The timing of the sale came before the Bode transaction announcement. However transactions do not materialize over night. so why did management sell if the potential to earn higher value for their share down the road? I tried to research as much as possible but could not get anything. the only thing left is to get in the mind of the CEO and CFO.
• There is no word on liquidation and how? so if management have a change of heart and decides to buy another business, then the thesis is over.
• WC adjustments that may go against the company.

Conclusion:
A 15 months opportunity that offers a good margin of safety. I estimate that if all earnouts are not received then you will receive 10-13% return. If some earn out materialize then the potential to earn north of 20% is an outcome with high probability.

Yield Pigs

Several blogs, here, here and here, talked about the “insanity” of the bond markets. I tend to agree with the analysis. However what I am noticing is the other dimension of the insanity in the credit market is the rally in government bonds at the same time as junk and corporate bonds.

In the recovery from the March lows last year, the long term yield t-bill went up, prices went down, as money shifted from safe and liquid treasuries to other credits as they were priced attractively. Several credit classes rallied; corporate debt, junk and municipal bonds. The inverse relationship between treasuries and risky asset classes work 9 out 10 times. However, there is something amiss here.

Treasuries are rallying but at the same time so is credit. Most funds are being crowded out from some of the deals hitting the market. Spreads are coming down yet 10 yr treasuries are yielding under 2.8%. Everyone is a yield pig today ( see post about Klarman).

Moreover if I look at the retail investor instruments such as Closed End Funds (CEF), I find huge premiums for high distribution CEFs. High yielding CEF are trading at large premiums, sometimes reaching 40 and 50%. I put the premium along with distribution yield and got the chart below. It shows a clear relationship between yield and the premium. Investors are bidding up funds with large yields.

Actually anything with yields have rallied. The Wallstreet Journal has a story about investor appetite for Master Limited Partnership (MLP) for their out-sized yield.

I usually will bet with those buying government bonds. Government bond market is the largest and the most sophisticated in any asset class. Usually the message sent by the government yield trumps all other. However it may be different this time.

The Globe & Mail reports” ...the government bond market has been flooded by retail investors seeking what they consider a safer harbour than stocks for their investment dollars. U.S. bond funds have posted net inflows for 72 of the past 73 weeks. according to data compiled by EPFR Global of Cambridge, Mass. The bulk of that money has been earmarked for government issues, including municipal debt.”

The rally in US treasuries are perplexing given the fiscal and monetary policies of the US. Spending and loose monetary policies over extended period of time should push yields higher. The US treasury is indicating that there are no policy issues to worry about, while clearly there are many structural issues that should push yields higher, not limited to:

• Social Security obligations
• Health care obligations
• Public Pension future obligation
• State and municipal deficits and debt

The article brings an interesting conclusion: “....Baby boomers have lived through two 50 per cent market crashes and they are just leaving [equities]” in the mistaken belief they can do better in bonds.”