|Shares Out. (in M):||21||P/E||NM||NM|
|Market Cap (in $M):||193||P/FCF||NM||NM|
|Net Debt (in $M):||0||EBIT||0||0|
Pro-forma for tonight's announcement, First Federal Bancshares of Arkansas, Inc. ("FFBHD") will have issued 18.3 million new shares, relative to 979k shares outstanding, for $3.00/sh in the month of May. This is 67% below the stock's close of $9.07/sh. With a fair value of $3.00/sh, we believe FFBHD is a compelling short opportunity. The stock has become hard to borrow, so we recommend checking with your broker before doing much work, but we received borrow on FFBHD at GS with a short rebate of -3.
To make sure we weren't missing something, we spoke with Larry Brandt, FFBHD CEO, and Sherri Billings, FFBHD CFO, last week and when we asked the CEO why his stock was trading above $3.00/sh, he commented that he "had no idea" and that he "couldn't figure out why investors were purchasing something worth $3.00/sh for +$9.00/sh." We couldn't figure it out either Larry!
FFBHD is a small-cap commercial bank with branches based in Arkansas. A victim of the housing boom, FFBHD grew its loan portfolio from $507 million in 2002 to $791 million by the end of 2005, with the majority of the growth driven by increased construction and commercial real estate lending. In late 2005, the Arkansas housing market was oversupplied and FFBHD subsequently decreased construction originations from $196 million in 2005 to $12.5 million by 2009. However, the housing oversupply and the recession resulted in an increase in nonperforming assets ("NPAs") and loan loss provisions ("LLPs") that led to FFBHD reporting a net loss of $46 million in 2009. As a result of the large net loss and the growing level of nonperforming assets (NPAs went from 2.7% of total assets in 2006 to 10.7% by 2009), the Office of Thrift Supervision ("OTS"), FFBHD's regulator, issued FFBHD a cease and desist order that became effective on April 14, 2010. The cease and desist order required FFBHD to maintain a tier 1 capital ratio of at least 8% and total risk-based capital ratio of at least 12% by December 31, 2010. FFBHD ended 2010 with a tier 1 capital ratio of 6.4% and a total risk-based capital ratio of 10.7%. As a result, FFBHD found itself in immediate need of additional capital.
FFBHD had already begun evaluating strategic alternatives in early 2010 and the highlights are:
- Five financial institutions were contacted regarding a potential merger and all five declined to pursue a merger, primarily as a result of the high level of NPAs.
- Three investment banks with significant underwriting experience in the financial services sector had refused to underwrite an equity offering due to the high level of NPAs.
- One failed attempt by a small bank advisory firm to assist FFBHD with a community offering on a best efforts basis.
The only remaining options for FFBHD were to pursue a recapitalization through a controlling investment or file for bankruptcy.
FFBHD and Bear State, a group of individual investors from Arkansas, announced a recapitalization on January 28, 2011 after beginning negotiations in the latter part of 2010. The highlights of the recapitalization plan were as follows:
- Bear State would initially purchase $40.3 million of FFBHD's stock at a price of $0.60/sh;
- Bear State would purchase from the U.S. Department of the Treasury the preferred stock and warrants FFBHD previously issued to the Treasury under TARP for $6 million (approximately 65% discount to face value);
- FFBHD would issue to Bear State a warrant to purchase an additional $6 million of FFBHD's common stock;
- Following the investment by Bear State, FFBHD would initiate a rights offering to its shareholders as of March 23,2011 that would allow shareholders to purchase up to $8.7 million of FFBHD's stock at the same per share price offered to Bear State;
- Bear State agreed to purchase any unsubscribed shares at the same per share price offered to existing shareholders, subject to a minimum ownership of 82% and maximum ownership of 95% of FFBHD's common stock;
- Prior to the initial investment by Bear State, FFBHD would consummate a 1-for-5 reverse stock split of its common stock with an effective price per share of $3.00 being paid by Bear State in connection with its investment, and FFBHD shareholders in connection with the rights offering, after giving effect to the reverse stock split.
On April 29, 2011 shareholders approved the recapitalization. On May 3, 2011 FFBHD announced the closing of Bear State's planned investment and on May 4, 2011 FFBHD commenced the 1-for-5 stock split. And tonight FFBHD announced the commencement of the common stock rights offering that allows shareholders as of March 23, 2011 to purchase three newly issued shares of common stock at $3.00/sh for every share of FFBHD owned. The rights offering will expire on June 9, 2011.
So, what is FFBHD worth? While it's fairly obvious to us that FFBHD is worth no more than $3.00/sh based simply on the value awarded the equity in the recapitalization, we triangulated our valuation in a few ways:
1. Book value: based on FFBHD's pro-forma balance sheet on page 41 of tonight's prospectus (also see the appendix in this write-up), the company's pro-forma book value is $84 million. Divided by 21.3 million shares outstanding (19.3 million shares including the rights offering plus the warrant to Bear State for another 2 million shares), this places a valuation of $3.94/sh on FFBHD's common stock, or 56% below the current stock price. In an effort to remain conservative we awarded FFBH a multiple of 1x book value, which is in-line with higher quality small-cap banks with a geographic concentration in Arkansas and surrounding states. With NPAs to total assets of 16.5% as of March 31, 2011, we believe that 1x book value is a heroic valuation.
2. Peak earnings: in 2005 FFBHD reported peak net income of $7.9 million under economic conditions that are unlikely to ever exist for this company again. Divided by 21.3 million shares outstanding, this implies peak EPS of $0.37/sh. At 12.5x P/E, which is in-line with higher quality comps, this places a valuation of $4.63/sh on FFBHD's common stock, or 49% below the current price.
As puzzled as we are by the current stock price in light of the pro-forma valuation and the $3.00/sh recapitalization, we feel this opportunity exists because: (i) shareholders are confused by the stock split and recapitalization details (note the stock was trading near $3.00/sh pre-split when it should have been worth $0.60/sh), and (ii) the stock screens incorrectly in financial databases like Bloomberg which show a current market cap of $9 million. We think the stock will trade down to its fair value in June when the dust settles after the rights offering and recapitalization is complete and investors get a more clear picture of the pro-forma bank and its worth.
|Balance Sheet:||As Reported||Adj. for Reverse Split and 1st Closing||Subtotal||Adj. for Rights Offering||Pro Forma|
|Cash and cash equivalents||40.4||40.1||80.5||8.5||89.0|
|Investment securities for sale||77.3||-||77.3||-||77.3|
|Federal Home Loan Bank stock||1.9||-||1.9||-||1.9|
|Loans receivable net of allowance for $29,113||363.7||-||363.7||-||363.7|
|Loans held for sale||1.2||-||1.2||-||1.2|
|Accrued interest receivable||2.4||-||2.4||-||2.4|
|Reals estate owned, net||43.9||-||43.9||-||43.9|
|Office properties and equipment, net||21.9||-||21.9||-||21.9|
|Cash surrender value of life insurance||21.6||-||21.6||-||21.6|
|Prepaid expenses and other assets||3.4||(0.8)||2.5||-||2.5|
|Advance payments by borrowers for taxes and insurance||0.9||-||0.9||-||0.9|
|Additional paid- in capital - Common Stock||26.8||52.7||79.5||8.5||88.0|
|Additional paid- in capital - Investor Warrant||-||2.6||2.6||-||2.6|
|Other comprehensive loss||(1.9)||-||(1.9)||-||(1.9)|
|Total stockholders' equity||34.8||40.4||75.2||8.5||83.8|
|Total liabilities and stockholders' equity||577.7||39.3||616.9||8.5||625.5|