April 2019 – Focused Compounding

Geoff Gannon April 29, 2019

VieMed Healthcare (VMD): A Founder Led Canadian Listed U.S. Ventilator Company Faces the Risk of Competitive Bidding for its Medicare Patients Starting in 2021

Write-up by REID HUDSON

(Geoff’s note: VieMed trades under the symbol “VMD” in Canada and over-the-counter in the U.S. under the symbol “VIEMF”. The stock is a lot more liquid in Canada than in the U.S. However, the price difference between the shares in Canada and the U.S. doesn’t always perfectly reflect the U.S. Dollar to Canadian Dollar exchange rate.)

VieMed Healthcare Inc. operates in the home health space and provides services and equipment to a variety of respiratory patients. Its main market consists of stage 4 COPD patients who are in need of non-invasive ventilation (NIV) therapy to continue living without excessive time spent in a hospital. VieMed also offers a range of sleep apnea, oxygen, and other respiratory solutions to patients. VieMed employs Respiratory Therapists (RTs) to assist patients with the set-up of machines, education, continued monitoring, and other services included in respiratory treatment. The company states that NIV treatment makes up roughly 90% of its business. VieMed is a Canadian listed company that operates in the United States. Its corporate structure consists of a Canadian parent company listed on the TSX called VieMed Healthcare Inc. This parent company is the sole owner of a Delaware incorporated U.S. subsidiary called VieMed Inc. that owns two subsidiaries of its own. The company operates through these two Louisiana based subsidiaries: one called Sleep Management, LLC and the other called Home Sleep Delivered, LLC.

As the graphic above shows, Sleep Management was founded in 2006 by its current CEO Casey Hoyt. It got into the Non-Invasive Ventilator (NIV) market in 2012 and began to focus on COPD, changing its name to VieMed shortly thereafter. After being acquired by PHM, VieMed completed a spin-out in 2017. It was listed on the TSX Venture Exchange mainly because the company that it spun-off from was listed there.

VieMed claims that it cares for more patients with non-invasive ventilators than any other company in the United States. NIVs are non-invasive machines that are used to lessen the effort required to breath. They are primarily used by patients with late-stage COPD and neuromuscular diseases that both make it very difficult to breathe without assistance. These machines are non-invasive as opposed to invasive ventilators that require insertion through the mouth, nose, or directly to the trachea by way of a tracheostomy tube.

Since entering the NIV market, VieMed has grown revenue and active vent patients at a fantastic rate. Its revenue has grown at a CAGR 44% since 2010 and around 29% since its name change in 2014. However, this number is weighed down by a negative year in 2016, when Medicare slashed reimbursement rates for NIVs. Most recently, VieMed grew its top line number 39% in 2018 and around 50% in 2017. The number of active ventilation patients that it serves grew to about 5,905 in 2018, representing a growth rate of about 35% for the year. Active vent patients grew at almost 43% in 2017. While this growth has been impressive, what …

Geoff Gannon April 28, 2019

Sandridge Energy (SD): A Carl Icahn Controlled Post-Bankruptcy Oil Producer With 10-35 Years of Proved Reserves in Colorado, Oklahoma, and Kansas Trading at a Fraction of Net Asset Value

Write-up by JONATHAN DANIELSON

Sandridge Energy (SD) is an upstream oil and nat gas exploration and production company with operations primarily in the Mid-Continent and North Park Basin in Colorado. The Company is an onshore driller and owns three principle assets: Mississippi Lime, NW STACK, and the North Park Basin. The Miss Lime is a mature asset that will continue to decline in production, while the STACK and N Park assets are newer, higher growth, and more economically attractive.

I believe SD to be one of the most demonstrably mispriced and most compelling E&P play around for a multitude of reasons. SD is not a stock for a concentrated investor and extreme caution in trading the name is urged by your author.

Despite being in a tough industry, there is no reason for this valuation discrepancy and it is very unlikely to persist. SD has cleaned house with a new management team in place which has shed unproductive assets, implemented tighter cost controls and will invest future cash flows into their more productive assets.

Recent Events:

There are several factors at play as to why SD is currently trading so cheaply. For one, it’s a post-bankruptcy stock. With headquarters in Oklahoma City, Sandridge was founded by Tom Ward in 2006. Ward went on to accumulate over $10 billion from Wall Street investors and pursued strategies that entailed growing without regard to the underlying economics of the transaction in question (Empire building), leveraging the balance sheet with billions in debt, and subsequently entering Chapter 11.

SD emerged from bankruptcy in late 2016 and has seen its share price slide ever since. The reasoning reorg stocks face selling pressure is well documented in Greenblatt’s Stock Market Genius book, so i’ll be brief – as former bondholders now become equity holders there’s a mismatch in owners of the capital structure. Entities who specialize in distressed debt now find themselves owning equity, which they likely have very little interest in. Thus, selling pressure ensues.

Second, the past 5 years have been brutal for all E&P companies with the collapse in oil prices. Many of whom have subsequently filed for Chapter 11. That’s what happens when you take a commodity business notorious for cyclicality and add leverage. Upstream producer’s woes were exacerbated in the second half of last year as oil was again hammered.

Third – and most importantly – SD was on the bidding block last year as part of their “strategic review” and bids came significantly lower than what was expected. I believe many special situation-type investors owned SD last year in hopes of participating in a quick asset sale. As these hopes failed to materialize these investors likely dumped their shares in droves, as they were now stuck with a mediocre oil producer at a time when crude was crashing.

These factors have culminated in a stock that I believe is too cheap to ignore.

Overview:

Upstream Oil & Gas producers represent the epitome of high risk business models – hundreds …

Geoff Gannon April 27, 2019

Garrett Motion (GTX): Messy Financials, A Peculiar Indemnification Liability, & Typical Spin-off Dynamics Have Obfuscated Garrett Motion’s Attractive Underlying Economics

WRITE-UP BY JONATHAN DANIELSON

Overview – Recent Events and Thesis

Garrett Motion (GTX) was spun off of Honeywell in September of last year as part of Honeywell’s ongoing series of divestitures (REZI, GTX, & ASIX). GTX primarily is in the business of designing and manufacturing turbochargers for automotive OEMs. They also design and make E-boosters for hybrid vehicles. As part of the spin-off agreement, Honeywell dumped their Asbestos Indemnification Liabilities on the newly formed entity (approximately $1.4 billion in total liabilities) in addition to loading the newly formed company up with debt that was 3x EBITDA. These dynamics have most likely led the market to view Garrett as a “garbage barge” spin, designed to solely benefit the parent by improving its capital structure and allowing the parent to quietly remove toxic assets off their balance sheet.

Investors in the special situation arena must pay close attention to this possibility, as buying into a garbage barge spin can have devastating results on your portfolio. Nevertheless, assets that the market apparently view as being “garbage”, a closer examination reveals a company that’s an entrenched market leader, possesses a formidably wide moat, earns adequate returns on capital employed, has reasonable growth prospects over the coming years, and is trading at a ludicrous 25% Free Cash Flow yield.

In addition, the Company is inherently highly cash flow generative, with a proven management team in place, and a business model that lends to a good degree of top-line visibility as car/engine designs are started years in advance.

The Company – A Brief History

Founded in the 1930s by Clifford Garrett, GTX was originally an aviation company, supplying the industry with turboprop engines and turbochargers. It wasn’t until the post-war 50s that the Company first started supplying the auto industry with turbos. In 1954 Caterpillar selected Garrett’s T15 turbo for its D9 mining vehicle. Then in the 60s came the Oldsmobile Jetfire Turbo Rocket and the T04 turbo for Deere’s farm tractor. Garrett was gobbled up by Honeywell in the late 1990s and went on to play a significant role in the company’s Transportation Systems segment.

Now, if some of you reading this didn’t grow up with a ‘grease-monkey’ older brother, then you’ll be forgiven for being a bit fuzzy on the specifics the role turbochargers play in enhancing the performance of internal combustion engines. Essentially, in order to increase the power of an engine, you have to pump more air into it (not just more gas). There are really only two ways to do this: by increasing displacement of the engine (which has obvious limitations) or by making the engine more efficient. Here’s a fun video to give you an overview: Turbocharger Basics.

It’s important to note the differences between turbochargers and superchargers as they are very much competing products. The differences between the two products has led to a secular tailwind for the turbocharger market. The way turbochargers increase an engine’s efficiency is by using the engine’s unburned fuel (the exhaust) to …

Geoff Gannon April 25, 2019

Bonal (BONL): An Extremely Tiny, Extremely Illiquid Stock that Earns a Lot But Doesn’t Grow at All

Bonal isn’t worth my time. It might be worth your time. It depends on the size of your brokerage account and the extent of your patience.

So, why isn’t Bonal worth my time?

I manage accounts that invest in “overlooked” stocks. Bonal is certainly an overlooked stock. It has a market cap under $3 million and a float under $1 million (insiders own the rest of the company). It often trades no shares in a given day. When it does trade, the amounts bought and sold are sometimes in the hundreds of dollars – not the thousands of dollars – for the entire day. It’s also a “dark” stock. It doesn’t file with the SEC. However, it does provide annual reports for the years 2014 through 2018 on the investor relations page of its website. In the past, the stock has also been written up by value investing blogs. Most notable is the write-up by OTC Adventures (the author of that blog runs Alluvial Capital – sort of another “overlooked stock” fund). That post was written back in 2013. So, it includes financial data from 2008-2013. I strongly suggest you read OTC Adventure’s post on Bonal:

Bonal International: Boring Products and Amazing Margins – BONL

The company has also gotten some coverage in a local newspaper. For example, I’ve read articles discussing Bonal’s attempt to sell itself at a below market price. Shareholders rejected this. So, the stock isn’t a complete enigma. You have write-ups like OTC Adventures, you have some old press coverage, and you have annual reports (complete with letters to shareholders) on the company’s investor relations page. At the right price, it’s definitely an analyze-able and presumably invest-able stock.

But, not for me. Because I run managed accounts focused on overlooked stocks, I try never to eliminate a stock simply because it’s very, very small or trades almost no shares on most days. Even stocks that appear to have zero volume are sometimes investable. In my personal experience, I can point to cases where I bought up to 10,000 shares of a stock in a single trade that had a history of trading less than 500 shares on average. And that’s not a one-off fluke. It’s happened to me more than once. So, if the shares are out there – your best bet is to bid for the stock you like best regardless of what the past volume of that stock has been. Often, it may be easier to get into – and even out of a stock – in a few big trades than it appears on the surface. This is due in part to people trading much smaller amounts of the stock than you – and a few other bigger, or simply more concentrated investors – will want.

However, in the case of Bonal – there simply aren’t enough shares held by non-insiders to make it worth my while. The accounts I manage are not big. But, the investment strategy I practice is not one …

Andre Kostolany April 6, 2019

Citigroup Capital Securities XIII – a high yield trust preferred from Citi

This is a writeup for Citigroup Capital Securities XIII, or Citi N’s. Citi N’s are trust preferred obligations of Citigroup. Why write up a pref instead of a stock? This one has some interesting special features.

A trust preferred is basically a subordinated debt obligation of the issuer. It ranks above common equity, above preferred shares but below senior in the capital structure. Coupons on subordinated debt are deferrable for up to five years but cumulative, meaning that if Citi cannot pay the coupon on Citi N’s in any given year, this does not constitute an event of default. If Citi does not pay a coupon for five years, this does constitute an event default. As coupons are cumulative any coupons that were skipped at one point have to be repaid later on. Here, I am simply explaining the structure of the security. Citi has never skipped a coupon on Citi N’s and is unlikely to do so in the future.

Citi N’s pay a coupon of Libor + 637, which means the current coupon is 9.1205%. It is a $25 face security currently trading at 27.70, so the current yield is about 8.2%. 8.2% is a very high yield for a high quality credit like Citigroup. For comparison, JP Morgan and Bank of America Preferred Shares currently yield 5.6%, Morgan Stanley Preferreds yield 5.7% and Goldman Sachs Preferreds yield 5.8%. Trust Preferreds are higher in the capital structure than preferred shares, yet Citi N’s have a significantly higher current yield.

Citi N’s have a final maturity of 2040, but are immediately callable today. If Citigroup decided to call Citi N’s tomorrow, they would fall from 27.70 to something closer to par + accrued, so around 25.50. Citi could call Citi N’s tomorrow and issue new preferred shares with a coupon around 5.6%-5.7%. Why has this not happened yet?

To understand this we have to go back to the financial crisis. On January 15^th 2009 Citigroup entered into a loss-sharing arrangement with Treasury, the Federal Deposit Insurance Corporation (the “FDIC”) and the Board of Governors of the Federal Reserve System related to a pool of $301 billion of assets. Citigroup issued to Treasury $4.034 billion of its perpetual preferred stock as consideration for the loss-sharing protection provided by Treasury and $3.025 billion of its perpetual preferred stock to the FDIC as consideration for the loss-sharing protection provided by the FDIC. Treasury’s and the FDIC’s perpetual preferred stock was exchanged for capital securities issued by Citigroup Capital XXXIII on July 30, 2009. On December 23, 2009, as part of an agreement to end the loss-sharing protection, Treasury cancelled $1.8 billion of the $4.034 billion Capital XXXIII Capital Securities it held, and the FDIC agreed to transfer an additional $800 million of its remaining Capital XXXIII Capital Securities to Treasury upon the maturity of Citigroup debt issued under the FDIC’s Temporary Liquidity Guarantee Program. On September 29, 2010, Citigroup modified Citigroup Capital Trust XXXIII by redeeming $2.234 billion of those securities …