|Shares Out. (in M):||0||P/E|
|Market Cap (in M):||4||P/FCF|
|Net Debt (in M):||0||EBIT||0||0|
Warrant Intrinsic Value
|Subject||the truth about BTC warrants|
|Entry||09/06/2007 06:20 PM|
|This gets my vote for the worst idea I've seen in VIC. There's no analysis of the TCYF's business prospects, the author doesn't seem to understand that excess capital (i.e., the cash that the SPAC will contribute to this deal) doesn't deserve the 1.5 multiple that might be appropriate for a small southern regional bank on its core capital, and he has missed entirely the effect of the dilution from the warrants on valuation. The investment thesis is that very few SPACs have failed to get their deals approved by SPAC shareholders, so the warrants are probably worth something. I'd counter that there are very few SPACs that would buy an already public companies, since most of the point of a SPAC is to pick up the private vs. public valuation difference.|
Here are the salient points of the BTC structure (it's a little more complicated than this, but these are the essentials): If BTC doesn't close an acquisition by June 2008, BTC shareholders (excluding insiders) will have the right to get back the money held in the trust fund (currently about $7.70 per share, though the trust fund will accrue after-tax interest, too). If the deal is not approved by 80% of SPAC's shareholders, the deal will not close, though BTC management will have an opportunity to try again until they hit their June 2008 deadline. BTC stock is trading at aroudn $7.33, which might make it an OK yield play on the trust fund, but indicates that the BTC equity market does not assign any meaningful value to the deal. Warrant holders can buy stock at $5.00, but only if a deal is completed, otherwise warrant holders get nothing.
The warrants have a strike price of $5.00. If the deal does get done, that will mean that most shareholders believe at the time of the vote that the post-deal stock is worth something above the trust value (otherwise, they'll vote no and get their $7.70 out of the trust fund). If the deal gets approved, the warrants will be fairly deep in the money, so the option value will be limited. So, as a first approximation, we can treat the warrants post-closing as delta one and just look at the company on a fully diluted basis.
The average price to book ratio for Southern US commercials banks with market caps between $10 million and $100 million trades is 1.4. TCYF book is $30.0 million, giving them a relative value as a going enterprise of $42 million. The SPAC would add $44 million cash, plus $38 million from warrant exercise for $82 million in new funds (I'm ignoring time value here, since warrants might not be exercised for several years). That's a total cash + busines fair value of about $122 million.
BTC has 9.4 million shares outstanding (including 1.9 million held by insiders), plus another 7.5 million warrants. There are 4.6 million shares of TCYF outstanding, and each TCYF share will convert, if the acquisition happens, into 1.42 shares of BTC, adding another 6.5 million shares, for a grand total of 23.4 million shares. At $122 million valuation, that's $5.21 per share. Even if you assume that BTC management gives up ALL of their 1.9 million shares (which, of course, won't happen) to get the deal done, fair value is still just $5.77 per share.
To get the deal to the point where it has a decent chance of garnering a positive vote by BTC shareholders, we need to find an extra $1.25 or more of value per fully diluted share (21.5 million assuming BTC gives up all of its shares), or $26.8 million (which gets us to a value still below the value of the trust, but maybe at $7.00 of value, most of the stockholders will be caught napping). There are only a few places we can find this:
* An upgrade from OTC BB to an AMEX listing. This doesn't exactly blow my socks off.
* By showing that TCYF's business is really worth more per dollar of book value than is the comp group average. I'd be open to this, but I saw nothing in the writeup that suggests it. If you put a $7.00 value on the post-merger company, at the 1.42 new to old share ratio, that works out to $4.93 per current TCYF share. Ignoring the BTC merger offer for a second, $4.93 would give TCYF a current PE of 17, versus 16 for the comps (it gets worse when you figure that they'll need to build scale to put the SPAC cash to work). Captial has declined slightly in the last year, and net income from continuing operations has fallen dramatically, so this isn't an organic growth story.
* By raising the value of the cash being contributed from the trust from 1.0 to 1.3. I could see this if they were falling below regulatory capital requirements, but they don't seem close to any trouble there. If TCYF is so undercapitalized that they really gain $1.30 of value for every dollar they raise, why haven't they just done a PIPE?
* By bringing BTC management's talents for identifying undervalued assets to the table? It seems to me that they've just proved that they DON'T have what it takes to add value in this way.
If anyone can find borrow out there on the warrants or TCYF stock, please let us know where, since I'd love to short both. Barring the discovery of hidden value in TCYF's business that I haven't found, however, I think these warrants are a nightmare.
|Entry||09/06/2007 07:44 PM|
Thanks for your feedback and was hoping to get some negative comments. If you look at some past SPACs you can be this aggressively negative about a lot of them. Apart from a few home runs such as Star Maritime and when American Apparel got bought, the valuations can often appear to be a stretch but regardless the deals get done time after time because mgmt will jump through hoops and do whatever it takes. Your thoughts about what the price of BTC common stock implies about the perceived value of the deal are off because this is how the common always trades when deals are announced, apart from the rare home run, yet the deals still get done. You also have to consider that some portion of the common share holders will also own warrants so that plays into their decision whether or not to vote for the deal.
|Entry||09/06/2007 08:45 PM|
Some more points about the forces on the side of getting a deal done. Assuming the deal gets done BTC founders will own 1.875mm shares of the new company plus 1mm warrants that were purchased on their own dime. That's 2.875mm shares out of 23.4mm shares that would be outstanding, or about 12.2% of a bank that would have about $125mm in equity once you factor in warrant exercise. If you just value that at book their stake would then be worth $15mm and should grow over time. It's safe to say that their primary purpose in life now is to make sure this deal gets done. Which is the primary purpose of all SPAC managements and why the deals tend to get done.
How does this happen? One way is they can cross shares from big holders that plan on voting no to holders that will vote yes. They can also go out in the open market and buy shares themselves. They can also reduce the number of founder shares, which would make the valuation appear better. And they go on road shows to pitch the plan and try to make sure existing holders will vote yes.
AVPA's deal as chronicled by sparky371 is an example of a SPAC merging with a public company and using some of these methods to get the deal done, even though some may have thought the valuation was not overly cheap(and in fact AVPA stock has traded down since).
Given all this I think there are some features of the BTC warrants which makes their possible return better than most if the deal does get done. First is that the warrants expire 5 years after the IPO as opposed to the more usual 4 years, giving us a one more year of time value. But most importantly is the valuation on the warrants compared to what some favorable outcomes are. This gives the warrants tremendous leverage in the case of a favorable outcome and we have an extra year to realize that outcome.
Now I am not dismissing your criticisms at all because I think they are valid and I am also not dismissing the chances of a deal not getting done. But to give me the honor of 'worst idea ever' I think you should have a better handle on how these things tend to work.
|Subject||re: the truth|
|Entry||09/06/2007 09:13 PM|
I think you made one mistake in your math. BTC has $56M in excess cash, not $44M. You are deducting the cost of the shares subject to conversion as if they were converted, without removing those shares from your per share calculations. Using your math, after warrant conversion I get $5.80 per share in value. Since it's reasonable to assume that mgmt will give up at least half of their shares to get the deal done (and the shares given TCYF decline by the same percentage), that gets us to $6.23 per share. If you factor in 20% of the shares being converted in a narrowly approved deal, you end up at $6.10.
Finally you are right that we can't count cash at 1.4x book now. But that cash is going to be used for writing more loans, and opening more branches, and potentially acquiring other small banks, so over time it's going to end up being worth 1.4x or more, as long as mgmt executes as well as the average southern bank. This gives a ultimate deal value of about $7.94, not adjusting for time value of money.
But in the end you don't buy the warrants because you want to invest in the business. You do it based on the likelyhood of deal happening. Using the $6.10 per share value we get an intrinsic value of $1.10 for the warrants. Using BlackScholes with assumed 10% volatility (low?) we get a time value of 90 cents for the remaining 1200 days before expiration. So the warrants may trade at around $2 after deal approval. In the case of JAZ, $5 warrants on a $3 stock sell for 40 cents. In the case of SEA, $8 warrants on a $12.28 stock sell for $4.28 (maybe an arbitrage there?).
If the warrants trade at $1.50 post approval, you need the deal to happen over one third of the time for this to be a good investment. Based on SPAC history that should be easy. Based on this specific deal, maybe not so easy. My guess is that it's 50-50, making this a deal with a positive expectation, albeit a risky one.
Disclosure: I have a large position in the warrants. I'm not happy with the deal they chose, but so far think my upside still outweighs my downside.
|Subject||This, that and another|
|Entry||09/06/2007 09:51 PM|
|As is my want, I'll offer my comments. I have no skin here and have done very little digging.|
The bad news is that on the face of things, it looks like BTC holders get diluted by the deal. The valuation on TCYF appears fair but the hope would have been that they got a deal on the cheap. When you look at the deal on an earnings basis, it looks really expensive. This touches on the issue raised with TFSL and their potential 2nd step, where you end up paying a premium for what is largely a pile of cash.
Getting back to valuation, though, there are not a lot of banks trading below book value, especially when dismissing those with ample goodwill that still trade at a premium to tangible book value. Those left trading below tangible book value generally fall into two camps. One camp consists of zombies or walking dead, with various ills. The other are the illiquid gnats that populate the backwaters of banking.
Then I am reminded of the old saw regarding bank M&A and that it is better to be a seller than a buyer.
While this might seem like a preface to dismissing this idea, there are some merits to it. The inherent flaw with BTC's plan is that they are missing a key component of all bank M&A, namely an existing bank. The thesis of bank M&A comes down to expanding the footprint and in creating operating efficiencies. As with creating a snowman, you need the initial ball of snow with which one can begin rolling up the snow into something of mass. Trancommunity was doing that, buying a bunch of small banks and creating one bank. That is the initial snowball. BTC is provding the additional snow.
The timing is actually good because events of this past summer have done much to bring bank valuations down to more reasonable levels. If you are of the doom and gloom nature regarding further deterioration in banking, then a banking entity with plenty of dry powder and with a desire to go shopping should actually be seen as aatractive, not for what they are today but for what they could be tomorrow.
Buying into the warrants is also of interest. I am not sure that I would buy the common because the process of acquiring banks and integrating them will take time. The 5 year time frame on the warrants provide lots of optionality that make it interesting. From a gaming theory or risk-adjusted perspective, this is a decent bet. Let's say chance of the warrants expiring worthless is 25%, 25% that they retain value, 25% that it triples and 25% that it is a 10-bagger.
Some will trot out that this is the Value Investors Club, not the Vegas Investors Club, and that there is no margin of safety in the warrants. This is true, but even Buffett is known to make bets on currencies and interest rate vectors. The important thing is to be intellectually honest and recognize that it is a bet, not an investment, and allocate accordingly.
If we were all strict Graham-Dodd value investors, we'd each own $10,000 spread across 5 microcaps.
|Entry||09/06/2007 10:54 PM|
|In my prior post I realize I overlooked a couple factors. Typically SPAC warrants have fixed upside, they can be repurchased if the common shares increase to a certain fixed price. In the case of SEA, the reason the warrants don't reflect a time premium (they basically trade at intrinsic value) is that the common ($12.42)is nearing the repurchase price ($14.25). Plus, and I had not realized this, SEA hasn't gotten approval for the merger yet (though it seems a foregone conclusion) so there may be a slight discount on the warrant pricing for that.|
In the case of BTC, the warrants can be repurchased when the common hits $11.50, so the upside is capped at $6.50 per warrant. I'm not sure how to adjust the black scholes estimates for this, but my volatility estimate was already artificially low so I'm pretty sure I am already in the ballpark. Either way the essential point remains, if the deal is approved, the warrants are likely to trade significantly above their intrinsic value.
|Subject||i preach the truth, my brother|
|Entry||09/07/2007 01:43 AM|
|I seem to have touched a nerve here. Mission accomplished.|
First, valuearb, excellent catch, I left out the $11.6 million in assets not reflected in equity to reflect the potential 20% redemptions on no votes. Adding that back in gets you another $0.50 fully diulted. However, I already assumed in my math that current BTC management gives up ALL of their shares to get the deal done (a very conservative assumption), so I'm calling a foul on your bumping up my valuation once again by assuming that management gives up some juice in the deal--there's none left to give up.
Joe, you mentioned that management bought 1 million warrants "on their own dime." Where did you get that from? I haven't seen it. Did they buy those on the open market (and, if so, did they do it recently?). If they bought them from the company, then I'm missing some extra dilution in my model.
Raising an extra dollar of capital does NOT magically create $0.40 of excess value out of thin air. If it did, bankers wouldn't have to work so hard for a living, they could just keep issuing stock. Banks trade above $1.00 per dollar of capital because they have relationships with borrowers and depositors, expertise in local market conditions, institutional knowledge, and human resources, all of which cost money to develop. Also, banks usually carry investments in infrastructure on their books for less than economic value (most bank branches are worth more than acquisition cost, e.g.).
If this deal goes through, the next step for BTC will be to acquire another bank. If BTC management is average in creating value, then they will have to pay around $1.40 for every dollar of the second target's capital, too, since that's what these banks cost. Ditto if they decide to build scale by opening new branches or giving away Cuisinarts to new depositers instead. Is there something in the backgrounds of BTC or TCYF management that makes anyone think they are banking geniuses who can buy banks below fair market value? If so, please educate me, and be sure to suggest to them that they submit writeups to VIC, too.
There is a difference between option value and discounted present value. Both show up as "time value" in a Black-Scholes model. Assuming that the deal gets done and the stock trades in the $7's or higher, delta will be pretty close to one at any realistic volatility. So almost all of the time value you see in a Black-Scholes model results from the ability to defer payment of the exercise price, not from the ability to walk away without any further investment if the stock price falls.
I assumed in my analysis that 100% of warrants are exercised, and all are exercised immediately, again to be fair and overestimate the value of the post-deal equity. If you want to consider the portion of the time value that results from the ability to defer payment for the warrant shares for 5 years, or what little option value there is, too, that's fair enough, but you'll need to reduce the value of the fully diluted equity by the same amount, which again makes approval less likely.
Overall, I think that SPACs are an excellent risk/reward proposition, but they are an institutional product, and they guys in there at the time of the vote are sophisticated enough to factor in the dilution from the low-strike price warrants when they decide whether to get their money out.
I've invested in a lot of SPACs (thankfully, I was smart enough to avoid BTC), and analyzed nearly all of the deals from the last two years. It's simply not the case that only blockbuster SPACs trade up immediately. Good deals are usually rewarded pretty quickly. There are a few diamonds in the rough that take some time for the market to understand (e.g., GLDD), but BTC isn't one of them. That's what everyone else in this game whom I've asked thinks, too. Any SPAC that buys a company that already trades in the US is a joke (what's next, one SPAC buying another, then turning that into gold with a 1.4x multiple on their combined cash by promising to buy a bank sometime down the road?).
I don't have a dog in this particular fight, so I'm not going to put a lot more time into this discussion, but I'd suggest that anyone who's thinking about throwing money at these warrants at least look at what happened to MSMAW, TACAW, CBASW, and CMAQW (perhaps coincidentally, two of the four complete clusterf**k deals for warrantholders were banking industry SPACs). Did those managements have less incentive to get a deal done than does the BTC team? Did those four teams forget to do the roadshows? Were they too busy to try the "stock crossing" strategy (which boils down to talking someone else into buying something at too high a price)?
The main feature that makes the BTC warrants more attractive than those in other deals (provided, of course, that the deal is approved) is the $5 (rather than the typical $6) strike price. What the warrantholders gain in value if the deal goes through, however, they pay for in dilution. When the 50 or so funds who buy these things decide whether to vote for a deal, I can assure you that we do factor that in.
I hope I'm dead wrong on this and this deal does go through. I do know where to locate BTC stock to short, so, the day the call option on the trust fund disappears, I'll be in there shorting. But I don't think I'm going to have that opportunity.
|Subject||preaching the truth|
|Entry||09/07/2007 01:50 AM|
|Sorry, everyone, I shouldn't submit these things at 2:00 am. The fifth sentence from the bottom in my "i preach the truth, brother" post should have read, "What the warrantholders gain in value if the deal goes through, however, the equity holders pay for in dilution."|
|Entry||09/07/2007 09:58 AM|
|Warrants were bought on the open market shortly after the deal as stated in the original reg statement. The underwriters also bought 500k warrants in the open market.|
Look, I totally understand all your arguments. And I realize there are some SPACs that couldn't get the deals done and they have liquidated. But can you really say this deal is so much worse than many other deals where the deals didn't look too good, but got approved anyway, and now the common stock is trading below the original held in trust value. Despite all your valid claims, it still holds that mgmt needs to convince people to buy a bank for 1.4x book value or to find other holders that will want to do that and get the shares in their hands, and they highly motivated to do so. That just doesn't seem as ludicrous to me as you are making it.
These might not sound like great arguments for this type of board, "If management can get convince people to buy their (suspect) story then it works out" but history has shown that most of the time they are able to do that. And when you think about the optionality on the warrants due to the $5 strike and the 2011 expiration then I think you have a bet where the odds are in your favor, even if you think the chances of a deal going through aren't that great.
|Subject||this deal is worse|
|Entry||09/07/2007 12:21 PM|
|"...can you really say this deal is so much worse than many other deals where the deals didn't look too good, but got approved anyway...?"|
I can, and I do. They're taking public a company that's already publicly traded, for heaven's sake. To get the deal done, they need to convince people to put a 1.4x valuation on a bank w/ $30 million of capital plus a cash pool of $80 million. That is not the same as getting a 1.4x multiple to book on a bank.
|Entry||09/07/2007 03:22 PM|
|I didn't double count mgmt givebacks, I felt your estimate of giving up 100% was too aggressive and only counted 50%. Of course, given the vlaue in their warrants they might go higher, but I'm being conservative.|
By my count mgmt bought 360,000 warrants in the open market this year. I think that is all they own. Not sure about the underwriters. The prospectus language "the underwriters have also agreed to place an irrevocable order for the purchase ... of up to 500,000 warrants in the aggregate under identical terms and conditions as the purchases by Mr. Simanson and Mr. Zalman" implies the underwriters bought 180,000 warrants.
And Transcommunity has $6 in deposits for every dollar of equity. Are you telling me they won't be able to put the additional capital to work at a similar ratio? And if they earn just a minimum spread of 2%, doesn't that support a 1.4x price to book on that additional capital? I.e. 2% on $7 is 14 cents on $1 in equity. A $1.40 price to book is then equivalent to a 10x PE.
|Entry||09/07/2007 03:26 PM|
|One other reason our math may be different is that you aren't accounting for the fact that if mgmt gives up some of their shares, TCYF will be forced to give up some of theirs in similar proportion to BTC's total share size. I.e. if BTC's share count declines 10% because mgmt forfeits 950k shares, TCYF is going to receive 10% fewer shares (5.9M instead of 6.5M).|
|Subject||yep, that's what I'm saying|
|Entry||09/07/2007 05:08 PM|
|I model fair value for equity below $5.50 in my most likely case model, but huge differences in valuation views are what make VIC the most interesting. |
Re warrant counts, it's not really central to my analysis. I have no doubt that management (and I-Bankers Securities) have sufficient incentives to try to get the deal done, I just don't think the equity holders have any incentive to vote yes.
> Transcommunity has $6 in deposits for every dollar of
> equity. Are you telling me they won't be
> able to put the additional capital to work at a similar
Yes. Are you telling me that in their next acquisition they will be able to acquire another bank with $40 million in capital for only $40 million? Because that's what you need to put a 1.4 multiple on the new capital the SPAC will bring to the table.
Where do you think the stock will trade after the deal is done, and at what price would you sell the warrants now?
I have to admit, I'm almost tempted to buy 20% of the deal (and collect the yield) just to win the debate. 8)
|Entry||09/07/2007 08:09 PM|
|I would expect Transcommunity to write more loans and take in more deposits and open more branches to convert the cash equity into 1.4x book value. If they buy another bank I'd expect it to be a small private one at a discount.|
And I would probably sell my warrants at around 70 cents. I think that's about the midpoint of upside/downside.
|Subject||the latest and greatest in spa|
|Entry||10/17/2007 10:31 PM|
|Wow, I'm not sure what happened today. I still think the deal is very likely going to tank, but the value proposition has improved a lot with warrants trading in the $0.35 range. If they fall another nickel I might take the plunge.|
If anyone is interested in the latest technology for management to engineer SPAC votes, the PMQC 8-K filed today (Oct. 27) makes great reading. Maybe my next VIC idea will be a SPAC greenmail play.
|Entry||10/19/2007 01:31 PM|
|I'm souring on the warrants a bit, and have sold some of my position. My reasoning is that some active investors have purchased close to 20% of the common and could be doing so to force liquidation. I don't have any insight into their agenda, but combined with the thin value proposition this deal provides the common, it makes me nervous, Of course I'm not selling at 35 cents.|
|Entry||05/30/2008 02:38 PM|
|No official word yet, but management jumped through all the hoops and looks like they got the deal done. They found buyers for 4.1mm shares of common that had voted to opt-out, which is about 45% of the total stock. Looks like management gave up about half of their founders stake to the new buyers in order to get them to commit. Assuming the deal does get done, then the new entity will have about $6.50/sh in book value. It's going to be very overcapitalized(pro-forma equity/assets ~25%) and won't be earning much, so it's going to trade at some sort of discount. It's currently trading at $6.30, with the warrants at 80 cents. The warrants have a $5 exercise price. Could be that people are waiting for the final announcement or could be that people are expecting the common to drop further. Warrants could still be a good deal at this point, especially when you consider they don't expire for another 3 years and will have some time value.|