Enzon Pharmaceuticals Still Has a Few Puffs Left

I recently opened a small position in Enzon Pharmaceuticals (Ticker: ENZN). Where I normally would disregard a nano-cap penny stock, I was intrigued when I noticed that Carl Icahn is invested in it. The guy is a billionaire. What is he doing fiddling with a $16m market cap company? Additionally, he has already shaken down this very same company multiple times… why take a big stake in November?

Here’s a pretty good Seeking Alpha post which lays it all out, but I’ll recap some points here. Enzon Pharmaceuticals, Inc receives royalty revenues from existing licensing arrangements with other companies primarily related to sales of four marketed drug products: PegIntron, Sylatron, Macugen and CIMZIA. Enzon conducts no R&D and has no operating business at this point, it simply collects royalties on 4 existing drugs The company has no employees, only contractors at this point, and has not even updated its own website in some time apparently.

The company is slowly self-liquidating via dividend distributions over the coming years, and the stock traded down to $0.35/share after distributing a 15 cent dividend in December on a stock price of 45 cents per share. I expect the 2017 distribution will be in the 10 cents range, accounting for a 27.7% yield at the current share price. The stock is a cigar butt investment for Icahn from which he is clipping the dividend, with optionality to the upside from increased royalties from pending FDA approval of SC Oncaspar by Shire and a potential legal win against Nektar. The FDA approval in particular should yield another $5m in royalties.

Currently the company is sitting on $0.14/share in cash, and the stock is currently priced at $0.36. Management disclosed that they expect to receive approximately $29m in royalty revenues from the beginning of 2016 thru 2021 when they will likely liquidate the remaining assets. This estimate does not appear to include either of the two scenarios mentioned above.

I estimate that the company will receive $1.5m in royalties for 4Q16, approximating $9m this year, with the remaining $20m  coming through 2017-2021. I would expect operating expenses to decline to about $1.5m per year. So the company has good line-of-sight to pull in another $20m in cash over the next 5 years, minus $7.5m in expenses ($1.5 x 5), yielding an additional $14.5m in cash flow. Added to the current balance sheet assets of $21.74 million and subtracting the December dividend payment of $6.63 million, I get a fair value of $29.61m, or $0.67/share vs the closing price today of $0.36/share. Getting more conservative and only adding in the cash on the balance sheet (ignoring $8.61m in tax deferred assets) gives me a fair value of $21m or $0.48 /share. This is not including the Shire and Nektar optionality mentioned above.

Normally I stay away from penny stocks, but this is a legitimate business, and investors appear to be mispricing the future royalty streams. Additionally, when the company was delisted from the NASDAQ this likely forced several institutional investors to sell their positions due to internal investment policies. They typically can’t invest in over-the-counter stocks, or stocks trading under $5/share, or nano-caps.

On top of that, liquidating trusts (which Enzon will eventually become) currently have very odd tax penalties associated with them. This actually makes the most tax-appropriate investment in ENZN a tax-protected account in an amount small enough that it does not risk hitting the $1,000/year UBTI taxable threshold. We have to be careful about sizing so that the liquidated value returned to shareholders in any year do not exceed $1,000. For small investors like me, this is an attractive stock to open a small position in, and will remain highly unattractive to institutional investors as a nano-cap penny stock with taxable liquidation distributions. But we aren’t buying it on the expectation of share price appreciation we’re buying it for cash flow.

If the existing royalties do not collapse, and no additional royalties or immunity fees pan out, investors are conservatively looking at a cash return over the next 5 years of between  130-180% at the current price of $0.36 per share.

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So, I Bought a Quadruplex Apartment

For the past two years I’ve increasingly been looking at ways to generate income outside of the stock market or my job. I also stumbled across a podcast called BiggerPockets, which aside from being genuinely entertaining is  a great resource if you want to learn more about real estate. I currently own and rent out a former primary residence in Georgia, and clear about $200/month in cash flow after paying the mortgage, maintenance, and property management fees. The financial factors driving real estate are pretty attractive to me at this point in my life, and the more I learned about duplexes, triplexes, and quadplexes the more excited I became.

I have found that no matter what the market is, illiquid investments are where the most attractive mispricings occur. 2-4 unit apartment buildings occupy this weird mid-market niche that makes them unloved and illiquid relative to larger apartment units or single family homes.

  • Too small to be gobbled up by commercial investors, and tend to have a stigma attached for first-time home buyers. It just isn’t what they picture as the American Dream. This increases the potential to find diamonds in the rough.
  • Treated like a single family home for financing purposes, with the same government subsidy benefits attached. VA loans and FHA loans are both options. A typical apartment complex would cost an extra 1-3% in mortgage interest compared to the financing which I can get in a fourplex.
  • Easily house-hacked.
  • 4 doors instead of 1 door reduces occupancy and turnover risk compared to a single-family residence.

Do you see where I’m going with this? My family is currently in the process of building a house, but being fans of Maslow’s Heirarchy we could also use a place to stay while we sell our current home and build the new one. I also happen to love anything that yields a cash flow of >10% per annum.

Each unit is a 2 bedroom, 1 bath which rents for approximately $600/month. 3/4 occupied units will fund our mortgage, allowing us to live rent free while also putting equity into the building. When we (eventually) move out the building should conservatively cash flow $100/door after setting aside money for maintenance and property management. The downside is that we will have neighbors and live in a relatively small space.

It is important to note that I used VA loans on both my single-family residence in GA and my new multi-family property. These loans effectively guarantee 25% of my mortgage with government backing in case of default, meaning that I do not have to put much money down up to a certain level. In my case, I was covered for $417,000 initially, with ~$225,000 of coverage after my initial home purchase in GA for $190,000.

Readers who are not veterans could do something very similar using a FHA loan, which only requires 3.5% down. Mortgage coverage limits for these programs often vary by region, so readers on the coasts are hopefully not crying just yet…Going over the numbers using the remainder of my VA loan coverage after accounting for the $190k house which I bought with no money down in Georgia:

Remaining VA mortgage principal coverage: ~$225,000

Final Price of Multi-Family property: $262,000

Remainder after VA coverage: $262,000-225,000 = $37,000

Required initial equity from me: 25% * 37,000 = $9,250

After inspections and fees my all-in initial cash costs was $15,000. During the first year on that $15,000 I am budgeting a return of zero, because we plan to inhabit one unit for free. After that first year, with a minor rent increase our cash flow should be approximately $8,000. That’s roughly a 50% return within two years, with full payback by the end of year 3 assuming no major emergencies. This is not counting the associated tax benefits or potential for price appreciation for the structure.

“You make your money on the buy” is a phrase real estate investors like to say, and so when my agent told me this property was $20k cheaper than comps, and my home inspector put it in his top 10% for overall quality I got pretty excited. The Kansas City area is doing well. Over time, rents tend to rise along with housing prices, and so I expect that our cash flow from the property should increase in-time. I am also interested in buying trailer parks (easy financing, depreciation benefits, and low overhead), as well as practicing the BRRR strategy on more multi-family units. If anyone has experience doing either one please let me know!

M&A Speculation in Healthcare and Spectrum – New positions in HUM, CI, DISH, GSAT, and TSL

Over the past month I added several new positions as I think about the evolving M&A landscape. A new wind is blowing in Washington and I want to be positioned to catch some updrafts, so I’ve purchased a mix of value and catalyst driven investments.

positions

New Healthcare stocks – HUM and CI

I’d mentioned interest in Humana previously, and decided to take the plunge along with Cigna.I already owned UNH, and it seems that all 3 have good catalysts in there favor:

  1. Fundamentally low valuations at times of purchase. Trading less than 10x EBITDA, 10x FCF.
  2. More favorable Medicare outlook for HUM in particular, but really a better regulatory outlook for all 3.
  3. Potential to benefit from rising interest rates.
  4. Higher probability of M&A approval post-election.
  5. Enough cash on hand and deal-break-up fees to provide meaningful shareholder returns should either deal fall through.

The ultimate catalyst would be for the acquisitions to go through, but even if they fail I think health insurers (along with telecom and cable providers) face a much more favorable regulatory environment than they did 6 months ago. Cigna is the longer M&A shot between HUM and CI, but also has about 2x the potential return upon deal close.

Speculating on spectrum – DISH and GSAT

Spectrum is a fascinating asset. It is as ethereal as property can get, akin to owning yelling rights at a certain note, and yet it appreciates in value over time in a manner similar to real estate or guns. To that end, I have been thinking about two companies which hold a lot of spectrum assets: DISH and Globalstar. It is becoming clear that 5G is still 3-4 years away from mass implementation. Furthermore, it seems to be the case that new transmission technologies are moving towards higher bands.

Crazy Old Coot Charlie Ergen may have overpaid for AWS3 spectrum, but let’s think about the cards which this well-known gambler is holding now. He owns a legacy satellite service company which he can either milk for cash or spin-off in the future, and separately he’s sitting on a lot of mid-band telecom spectrum. I opened a small placeholder position, but it is hard to get too excited about DISH at this level. There could be more attractive entry-points in the coming months.

I would be a rabid buyer under $50. Not for the legacy company or for Sling TV, which is meh, but solely for the spectrum. Even with the current Broadcast Incentive Auction’s crappy $/mhz-pop numbers as a potential detractor, I think eventually that mid-band spectrum will be valuable. 5G is looking to be similar to 4G, except also utilizing mid and high band spectrum. If anything it should result in a higher premium for Dish’s ~75MHz of mid-band spectrum holdings, which the market is currently not valuing appropriately.

Reports started swirling this week that GSAT was finally going to receive TLPS approval from the FCC, so I bought in at $1.81 yesterday. The official FCC approval came out today. This is another small speculative position. 11.5Mhz of spectrum that sits alongside 2.4 GHZ is worth something. Many wireless devices already have the hardware in place to use the extra spectrum, requiring at most a firmware update. I don’t fully understand what Globalstar is working towards at this point, but the stock has been so heavily  beaten down from these proceedings (and is so heavily shorted), and I expect some upside in the near-term.

The company plans to use the spectrum in question for “low-power operations that support traditional mobile broadband services, including a variety of voice, data, and text applications. With its future terrestrial partners, Globalstar would operate these low-power systems in a variety of settings across the United States to support high data rates and provide consumers with additional terrestrial broadband capacity.”

I honestly think GSAT’s business plan is not great, and I am also wary of the secondary offering which GSAT will need to issue within the next 6 months. Alternatively, GSAT has lots of issued debt.With a company this precarious, I prefer to open a small equity position and await the announcement of some sort of partnership, and I think it could go to $3 by springtime on the news. GSAT has been a seemingly endless story of FCC bludgeoning, so I expect shareholder interest to rise. This is a highly speculative and very small holding at this point given the debt load and lack of operating cash flow.

As an aside -I haven’t been following Maglan Capital much, but they have both a position in GSAT and in FairPoint Communications which is now being acquired. Merry Christmas to them. This might be a fund worth watching in the future.

Thinking about where the telecom space is going I am still most excited about CSAL, CHTR, and TMUS based upon the fundamental cash flow growth and potential for M&A.

Trina Solar is acquiring itself with cash

I am putting a premium on cash liquidity right now for the most part, and most of my recent positions involve catalysts within the next 12-24 months.So why am I messing around with a Chinese solar manufacturer?

The offer is all cash for $11.55/share. The current price is $9.25. If the deal closes by April 2017, it would yield a 24.7% return, or 92.6% annualized.

The story here is pretty simple. Trina Solar happens to make solar panels in China. The biggest shareholder, CEO, and founder Jifan Gao wants to take the company private. China is working to restrict capital flight from the country. From what I’ve read, it doesn’t look like TSL will be impacted by this new rule. The small market cap and dominant solar market position increases likelihood that the deal gets approved in my mind. My reading is that China primarily wants to slowdown the overseas acquisitions rather than stop a company from buying itself back. TSL is also not trading expensive at 6x EV/EBITDA, even with modest expectations going forward.

Intel – Rebuilding the Old Moat Unlikely

I bought into INTC in March of this year at a price of $30.85. I looked at INTC as short-term valuation reversion play. It was simply too cheap at the time relative to the market at the time. Having my holding appreciate >20%, and with no near-term catalysts within sight to drive the stock higher, I recently sold the position.

The basic reasons are as follows:

  1. INTC no longer has the same monopolistic powers which it’s alliance with Microsoft once provided. A new PC cycle could continue to serve as a minor catalyst, but Intel already relies too much on its PC and server segments for cash flow.
  2. Nvidia GPUs are ripping away INTC’s former bread and butter high-end performance market. I expect this trend to continue.
  3. ARM CPUs have captured a large portion of the mobile market, with QCOM and a bevy of other mobile semiconductor manufacturers waiting in the wings.

The intense demands associated with GPUs and mobile processor workloads, both fields which Intel chose to ignore for long periods of time, have forced Nvidia and ARM to become area experts with strong market positions. I don’t believe that Intel can overcome its own organizational entropy at this point, and decided to exit my position in favor of cash.

The counter-argument would likely be that Intel’s recent acquisitions like Nervana will put INTC on an equal footing with NVDA, but I don’t personally find the story that INTC is pitching to be very compelling at this point. FPGA could be an interesting avenue of development, but I am not sure that management fully comprehends the bind that it is in. Intel’s history is replete with examples of expensive tech acquisitions which fizzled.

Additionally, Google, Apple, Facebook, and even Microsoft have become adept at playing hardware vendors off of one another. A great example is what Alphabet and Microsoft each accomplished with specialized software defined networks, which helped them avoid being locked-in to a single network vendor.

While Intel is still cheap relative to peers, I don’t see a return to the good old days of monopolistic dominance. I also want to see more proof that INTC is all-in on Nervana and that the corporate culture is not broken. Consequently I sold my shares, and will be looking to see how FPGA develops. If it is truly a game-changing must-have solution which only Intel is capable of providing I may reconsider.

Adding to Smith & Wesson

I’ve written previously about Smith & Wesson (SWHC soon to be AOBC), and recently increased my position after the post-earnings downturn.

Investors thought guidance was disappointing which combined with short interest of >20% resulted in a major post earnings sell-off of ~10%. People are worried about gun sales declining, but that bogeyman hasn’t actually materialized yet. The FBI reported record NICS applications for the month of November.

(Some) fear is warranted. Gun sales can be volatile. There should be no question in the minds of investors that 2017 and 2018 will likely be tougher years for SWHC given the likely demand which was pulled forward into the election cycle. When gun sales do decline revenue can decline by as much as 50%. I don’t believe that this is a likely scenario.

Additionally, management intends to continue bolt-on acquisitions which could result in higher revenues, but lower margins. In spite of these potential headwinds, I think SWHC is one of the safest stocks selling in the market currently on a valuation basis. The risk/reward profile is too favorable for patient investors to ignore.

Ibn Khaldun’s  “asabiyah” in the U.S. is very low -in my opinion- due to a general lack of trust. Gallup’s  well known confidence in government institutions poll is also at record lows. From my reading of Peter Turchin’s War and Peace and War, this is highly unlikely to improve under Trump, perhaps even unstoppable without some sort of credible external pressure to the homeland which forces U.S. citizens to coalesce ie: a China, Russia hegemonic threat. Now major new sources are advocating for the liberal purchase of guns due to fear of Trump apparently??

Revenue guidance is up 90% y/y. EPS guide up 93% y/y, free cash flow continues to grow in time with EPS. So I don’t think gun sales are going to fall off the rails entirely, though we could see a 10-30% post-election pinch in revenue as excess inventory buildup gets removed. Ultimately I think SWHC can look past any short-term demand concerns. The stock is a valuation hedge at these market levels and tends to react inversely to the stock market as a whole.

  • 7x Price/Free Cash Flow
  • 5x EBITDA/EV
  • PEG of 0.5-0.7
  • Debt to Equity of 0.52

Applying a 30% reduction in revenue to these metrics still yields a fairly valued stock.One could argue that this unproven bearish outlook is already baked into the share price. While Joel Greenblatt’s Magic Formula is far from perfect, it is also worth noting that both SWHC and RGR are currently on the list.

Furthermore Smith & Wesson currently pays a tax rate north of 30%. A 15% tax rate on the most recent quarterly earnings would have resulted in EPS of 0.74 vs the actual 0.57.

Short interest of >20% of the float also leaves room for a short-squeeze, and the company has a great CEO who has a history of well-timed buybacks. Additionally, SWHC guidance is always conservative and usually beats estimates.

The long-term trends behind lack of institutional trust and growing interest in concealed carry are powerful drivers. In the aggregate, overblown concerns about gun sales, an attractive valuation, potential tax rate reductions, and solid management all point to the potential for share price appreciation over the next year.

For the reasons above, I believe SWHC (new ticker AOBC in the coming months) has a compelling margin of safety relative to the market, with upside optionality from better-than-expected gun sales and/or a significantly lower tax rate within the next two years.