Monthly Archives: June 2014

May 2014 preliminary returns: +3.3%

Performance statistics are preliminary and unaudited. Returns are presented net of all expenses and fees, including accrued but unpaid performance fees. The Cable Car Composite includes all accounts Cable Car manages on a fully discretionary basis. The performance of individual client accounts can vary significantly from the performance of the composite. The timing of cash flows, the size and type of account, the fee arrangement, and the availability of investment opportunities for each account may lead to divergence from composite returns. Past performance may not be predictive of future results.

Food for thought

Disclosure: No position in FSIC. This post has been edited to remove details of trading activity. This post is intended to follow up on prior analysis and should under no circumstances be considered an advertisement for the performance of past specific recommendations.

I wanted to share the outcome of another special situation which provides some thoughts on how to identify future similar opportunities. (Also, I realize I’ve been writing a lot about tender offers lately, but it’s a consequence of them being relatively easy to discuss in full. I’m a little bit reluctant to describe my core portfolio investments without presenting an exhaustive, detailed rationale for the position. I haven’t had time to do them justice in writing yet!)

I closed a post about a tender offer last month by saying, and I apologize for quoting myself, “…it would have been possible to accumulate and successfully tender a lot more than 99 shares. Food for thought.” In truth I was thinking of a particular opportunity at that moment. FS Investment Corporation (FSIC) had an ongoing tender offer that I did not wish to publicize, as more participants would increase the odds of proration. I believed that the tender was unlikely to be significantly prorated, despite occurring at a significant premium. A holder could potential tender large amounts of stock at a premium, without worrying about a potential decline in price afterwards. FSIC was conducting a Dutch auction between $10.35 and $11.00, while trading around $10.15, well below its net asset value of $10.27. The tender closed on May 28th, and sure enough, the company bought back 96% of tendered shares at $10.75.

It remains quite difficult to predict with certainty when a tender offer will not be oversubscribed, but there are certain characteristics that make it more likely, one of which is of course that there aren’t a bunch of blog posts talking about how great it would be to participate in the tender. There were several other factors that made FSIC an attractive candidate, however:

  • FSIC was a newly public listing of a previously OTC entity with a largely retail shareholder base (tax sensitive and generally less likely to tender)
  • The offer was large relative to the market cap
  • The company had had an ongoing tender offer policy to provide shareholders with liquidity, and previous offers were recent and under-subscribed near the low end of the Dutch auction range
  • FSIC is broadly diversified and traded below NAV, making it a relatively low-risk short term holding
  • FSIC announced special dividends later in the year for continuing shareholders
  • The minimum increment in the Dutch auction was relatively small ($0.05), making for a smoother supply curve and potentially less proration at any given point

In short, FSIC was an unusually good setup for a tender offer, and based on the size of the offer, it was highly scalable too. I estimate it could have contributed meaningfully to funds as large as $200 million AUM. Such opportunities do not come along very often!

Closing the loop on GLRI 3

Disclosure: Long GLRIW, Short GLRI. This post has been edited to remove details of trading activity. This post is designed to follow up on prior analysis regarding a current investment and should under no circumstances be considered an advertisement for the performance of past specific recommendations.

Although there’s a business to run, I do aspire to follow up on blog topics when I say I will. Only a few months in and it seems I’ve already forgotten about one. (I will cover the rest of the seed topics mentioned in my first post eventually). About 9 weeks ago, I said I would discuss how to value the post-transaction Glori Energy (GLRI) business. To my handful of non-blood relative readers, sorry!

Valuing GLRI

As it turns out, I couldn’t quite get comfortable with the valuation exercise myself. I have been exiting my position in the warrants and am presently fully hedged on the remaining position. As mentioned before, Glori has an interesting model. They acquire producing oil fields, apply their proprietary technology, and if successful increase recoveries and reduce the decline rate of the field. In principle the business should be able to generate attractive internal rates of return by purchasing oil fields at an implied yield (from the seller’s perspective), increasing that yield through their recovery technology, and then selling at a premium to redeploy the capital into other fields. By repeating this process using leverage, the business could produce attractive returns over the long term.

While yields might be attractive on a project basis, the ultimate returns to shareholders are considerably more difficult to assess. It is uncertain what projects will be acquired, on what financial terms, and of course with what degree of success in improving the ultimate recoveries. GLRI’s disclosures indicated that the AERO recovery system has had mixed success, including at least one field where recoveries did not improve at all, with a great deal of sensitivity to the geologic conditions of the fields where it is deployed. From my perspective, that makes the success of the technology simply too difficult to handicap, and I will happily let others underwrite the long-term success or failure of the business.

As for valuation, using multiples of forecast EBITDA or earnings is a bit silly given the uncertain acquisition profile, though that hasn’t stopped a few sell-side firms from trying. At the arms length valuation established by the transaction and the new fully diluted market cap, the best one could do in my opinion would be to attempt to extrapolate from the yield profile of the most recent acquisition to the company as a whole. Treating the stock like a fund, assuming the technology works as promised and the company can redeploy all of its available capital in acquisitions on similar terms, what would be the notional levered cash flow yield? At least that is how I would try to approach it. The stock is a little like investing in a listed oil and gas private equity vehicle, and with confidence in the underlying technology, one could conceivably compare the prospective risk-adjusted long-term returns to similar investment opportunities elsewhere. At the current price, there is implied value to the technology. If it doesn’t succeed increasing recoveries, then GLRI should be worth little more than its net asset value. The right assessment of asset value is of course an entirely separate discussion, which depends on reserve valuation estimates, the oil price, and interest rates, but it is significantly below the current enterprise value, and there are plenty of other options for E&P speculation.


As the initial write-up indicates, this was a special situation relating to a one-time transaction. I am ultimately not willing to underwrite speculation on the value of the business itself.

Meanwhile, the conversion right on the warrants has made for an interesting arbitrage situation. The 10:1 conversion window runs May 16-June 15, and creates a sort of convertible arbitrage opportunity during this period. At times during the window, it has been (and may again become) possible to purchase 10 warrants for less than the value of 1 share of GLRI. GLRI was difficult to locate early in the window, but for accounts large enough to participate in a pre-borrow program, I chose to hedge the entire warrant position by shorting GLRI. As the price of the underlying has risen closer to the $10 strike price, the warrants have become more efficiently priced. The slight premium to GLRI in the current price reflects option value over and above the conversion right. This is of course a basic idea behind convertible bond arbitrage — by owning a convertible security with an embedded option and hedging the price risk by shorting the underlying, one can capture some option premium while limiting downside. Cable Car does not generally engage in convertible arbitrage, but at the moment it offers a potentially more attractive risk/return tradeoff than selling the unhedged warrant position outright.