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Posts Tagged ‘Ironfire Capital’

Eric Jackson of Ironfire Capital has a superb article at Forbes (How a “Cash-Rich Split” Could Take Yahoo! to $41/Share) setting out his “cash-rich split” analysis of Yahoo! Inc. (NASDAQ:YHOO). Here’s Jackson’s analysis:

A “cash-rich split” is the ideal way that Yahoo! should deal with its Asian assets. Furthermore, Yahoo!’s advisers – Goldman Sachs (GS) — must know this. They are smart guys and this is so obvious. If Yahoo!’s board is not yet convinced of this, they should be. Any leveraged recap plan or selling only a small piece of Yahoo! to private equity would be highway robbery of the shareholders by the board compared to a “cash-rich split.”

  • What is a Cash Rich Split? Here is a definition.
    • A cash-rich split-off is an M&A technique whereby the Seller exchanges stock of the Company for stock of a “cash-rich” subsidiary of the Company (“SplitCo”) on a tax-free basis
    • Benefits of cash-rich split-off for Company:
      • Opportunity to tax-efficiently dispose of a non-core asset
      • Opportunity to repurchase shares at attractive price
      • Company should seek to negotiate a share of Seller’s tax savings through a discount in the valuation of the shares repurchased
    • Benefits of cash-rich split-off for Seller:
      • Tax-free disposition of Company’s low tax basis stock by Seller, substantially for cash
      • Seller can negotiate with Company to contribute operating assets which Seller seeks to acquire
      • Alternative use: can also be used to unwind a stock-for-stock monetization structure on a permaently tax-free basis (e.g. Time Warner Cable/Comcast)
  • How would this work for Yahoo? The pre-tax value of Yahoo!’s 40% preferred stake in Alibaba Group is around $14 billion based on related transactions over the past two months (and Yahoo!’s last earnings call). The pre-tax value of Yahoo!’s 35% stake in Yahoo! Japan is $6.5 billion at Yahoo! Japan’s current market price of Y25,000. Let’s discount this to $5.5 billion as Yahoo! Japan might need an incentive to participate and liquidity. Only 66% of the compensation involved in a “cash-rich split” can be in the form of cash. So for their $14 billion of Alibaba Group stock, Yahoo! would receive $9.2 billion in cash and $4.8 billion of “other” assets. The $5.5 billion for Yahoo! Japan shares would be roughly $3.6 billion in cash and $1.9 billion in “other” assets.
  • Where do Alibaba Group and Yahoo! Japan get billions in cash for this transaction? Jack Ma could sell shares of Alibaba Group to Temasek (main contributor) and perhaps other interested parties (such as DST, Silver Lake) also participate. Yahoo! Japan already has around $2.5 billion in cash today. The rest can come from Softbank (who’s also involved in both Alibaba Group & Yahoo! Japan) or a secondary offering.
  • What are the “other” assets that Alibaba Group & Yahoo! Japan can contribute? This looks like a key issue with Alibaba Group’s tangible assets of only a $2 billion and Yahoo! Japan without a non-core asset of significance. The key is that only 5-10% of the total contribution has to be from an asset owned for more than 5 years. The remaining assets (23-28% of total spin value) can be acquired as part of the deal. Hulu might be an interesting asset for $3 billion (or whatever the market price is) and would be a great strategic fit. There are many other content, video, and social acquisitions that could be additive to Yahoo!’s core business.
  • What restrictions would Yahoo! have with the SplitCo proceeds? Yahoo! would have access to the cash the day the transaction closes.
  • What would Yahoo! look like post the 2 “cash-rich splits” of their Asian assets? You’re waiting for $41/share. We’re getting there. This is where it gets very interesting. Post split, Yahoo! would have close to $16B in cash ($3 billion of their existing cash + $9.2 billion from Alibaba Group + $3.6 billion from Yahoo! Japan). Yahoo! would also control almost $7 billion of “other” assets contributed as part of the splits. And Yahoo! would still have their core search and display biz worth $7.5 – 12 billion (based on a 5x – 8x multiple). It’s hard to see this portfolio of assets worth much less than $30 billion vs. the current market cap of $20 billion. That translates to fair value of $25/share.
  • What is the bull case if this plays out as described above? Yahoo! would be advised to use their cash to conduct a massive equity shrink, using a series of tender offers. And, of course, the lower the buyback price, the more shares they could buy back and the higher Yahoo!’s fair value rises. Let’s say Yahoo uses the $16 billion in cash to buy back as many shares as they can for $18/share. The number of the shares outstanding will go from 1.25 billion to 350 million. Yahoo! would still own the $7.5 billion core business + $7 billion of assets (not including any value for the patents which is ludicrous). $14.5 billion/350m shares = $41 stock. And the board — if they were really channeling John Malone — could conceivably lever up and buy back more shares. Simple sensitivity around the average buyback price and leverage is a very interesting exercise for one to play with. You can get to above $45 and $50/share very quickly.
  • What are the risks? 1) I’ve said it before and I stand by it — this is the worst corporate board in America. They could make a dumb decision. Fortunately their advisers understand the “cash-rich split” potential and Dan Loeb is standing at the ready to ensure the board makes no bozo moves. 2) They could name a new CEO first, before explaining the rest of the plan. This gets back to point 1 and a dumb board. 3) There are obviously many parties involved and all have to agree on price, timing, etc.

The YHOO situation is starting to get very interesting with Dan Loeb and Third Point holding a position and agitating for change. With a potential $41/~$15 payoff, it’s worthy of further consideration.

No position.

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Barnwell Industries, Inc. (AMEX:BRN) has filed its September 10Q and the results are encouraging. Even though the stock is up more than 40% since our first post, we believe that BRN is still undervalued and so we are maintaining our position.

We started following BRN because its liquidation value of $55M (around $6.52 per share) was some 86% higher than its market capitalization of  $29M based on its November 28, 2008 close of $3.51. Dr. Eric Jackson’s Ironfire Capital LLC had launched a “‘friendly’ activist campaign targeting the company to unlock shareholder value”.

BRN has now filed its September 10Q and we believe that its liquidating value has increased from our original estimate of $6.52 per share to $6.91 per share, which is some 40% higher than its Friday close of $4.95. Set out below is our summary analysis of the balance sheet (each “Carrying” column shows the assets as they are carried in the financial statements, and each “Liquidating” column shows our estimate of the value of the assets in a liquidation):

brn-summary-q3

Conclusion

Although the stock has risen substantially, at 72% of its written down value, BRN is still cheap and we are maintaining our position.

[Disclosure: We do not presently have a holding in BRN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

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Barnwell Industries, Inc. (AMEX:BRN) is exactly the kind of opportunity Greenbackd likes to find: a company trading at a discount to its liquidating value with an activist investor agitating for change. We estimate the company has a value in liquidation of around $55M, so its market cap of $29M (based on its November 28, 2008 close of $3.51) puts the company at a 46% discount to that value. Dr. Eric Jackson’s Ironfire Capital LLC, an “equity long biased and event-driven activist investment firm”, has sniffed the value and launched a “‘friendly’ activist campaign targeting the company to unlock shareholder value”.

About BRN

BRN, according to its website, is “principally engaged in the following activities:

  • Oil and Natural Gas. Barnwell engages in oil and natural gas exploration, development, production and sales in Canada.
  • Land Investment. Barnwell invests in leasehold interests in real estate in Hawaii.
  • Real Estate Development. Established in January 2007, acquires house lots for investment and for the construction of turnkey single-family homes for sale”

Seems like an odd combination of businesses to us, which makes it a prime candidate for a bust up.

The value proposition

According to BRN’s most recent quarterly report, BRN has a reasonably healthy balance sheet and positive cash flow of operating activities of $8.7M for the three months ending June 30, 2008. Set out below is our summary analysis of the balance sheet (each “Carrying” column shows the assets as they are carried in the financial statements, and each “Liquidating” column shows our estimate of the value of the assets in a liquidation):

BRN Summary

Our liquidating value estimate for BRN is around $53.9M, or $6.52 per share. As the table above demonstrates, most of BRN’s value is in its Property, Plant, and Equipment, which is carried at $25.50 per share. In our valuation, we’ve written down BRN’s Property, Plant and Equipment per share by 50% to $12.75. Our written down value for the other assets is set out in the table. These estimates are often too conservative, but it is the only way we get to sleep at night. This is especially so given that the company is carrying $26M in total debt. With its stock price at $3.51 (at its November 28, 2008 closing price), BRN is trading at 54% of its value in a liquidation, which strikes us as a sufficient margin of safety.

The catalyst

Ironfire Capital has a position in BRN but it is presumably too small to require Ironfire to file a 13D notice.  Its founder, Dr. Eric Jackson, perhaps best known for his Yahoo! campaign, has published a number of “prescriptions” for BRN to enhance shareholder value on the web. Ironfire Capital is an interesting activist investor because it uses “Internet-based social networking tools” to “amplify the impact” of its campaigns. Dr. Jackson also writes a blog about his particular brand of web-based shareholder activism called Breakout Performance and has provided his analysis of BRN in a June post. He has also written about his prescriptions for BRN on his Sharehowner Activism Wiki, which include the following:

Simplify Corporate Structure

Barnwell’s three businesses (oil and gas, contract water drilling, and real estate/land investment) have no synergy. A simpler corporate structure would better allow the market to bid up the underlying value of the oil and gas business to reflect the doubling of the commodity pricing in the last year. Barnwell should sell its water drilling business, which is small and shrinking in revenues and earnings. If the company received 1x its revenues, its cash reserves would nearly double to $14MM, allowing a stock buyback and/or upping the dividend. Selling or spinning off the real estate business might also make sense to focus Barnwell as a small natural gas pure-play.

Reduce SG&A Costs

Over the last year, SG&A costs have gone up 50% to $3.2MM. Yet, revenues and gross profit only increased 28% and 27% respectively over that same period. Barnwell is growing its costs at twice the rate of its sales and profits. As they say in Business School, that’s not sustainable. It’s also not acceptable for a 65 person company. Selling off the water drilling business, which contributes little profit, is a step in the right direction to improving things here, but much more work is needed.

Do a Stock Buyback

The company did agree to pay out a 5 cent dividend recently. Hopefully, that will attract a new group of investors to the stock. However, a stock buyback is both prudent, given that the cash position has increased over the last year and the strength of gas and land development businesses, and would make the company more attractive by lowering further its price-earnings ratio.

Bring in Some New Blood to the Board

Barnwell’s board is large and long-tenured. RiskMetrics awarded Barnwell a Corporate Governance Quotient (CGQ) score that is lower than 70% of other energy companies. The board’s composition is part of the problem. Seven of the 11 directors are older than 64. Four of the directors have been on the board for more than a decade.

It makes sense to change the composition of the board. Some of the longstanding directors should step down now to make way for some new blood, but some of them shouldn’t be replaced. An 11-member board is too large for a $100MM company. Having fewer than 10 directors would lead to faster meetings with more participation and debate.

Better Align Executive Compensation with Performance

Executive compensation policy has also likely contributed to Barnwell’s lower CGQ score. Last year, the CEO was paid $1.2MM. He explained this by pointing to how the company’s profits increased by 200% that year, yet the stock price dropped in half over that same time. Stock price is due to external market conditions, not management. If a CEO doubles a company’s profit, that should be rewarded.”

Conclusion

At 54% of its written down value, BRN is very cheap. With Ironfire Capital agitating for change, we believe BRN presents an attractive opportunity for investment.

BRN closed on November 28, 2008 at $3.51. The S&P 500 Index closed on November 28, 2008 at 896.24.

[Disclosure: We do not presently have a holding in BRN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

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