Great Elm Capital GEC
September 29, 2017 - 1:13am EST by
2017 2018
Price: 3.55 EPS 0 0
Shares Out. (in M): 23 P/E 0 0
Market Cap (in $M): 82 P/FCF 0 0
Net Debt (in $M): -67 EBIT 0 0
TEV (in $M): 15 TEV/EBIT 0 0

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Great Elm Capital Group (GEC)
GEC was written up by EnterprisingInvestor last year, primarily as a play on the rights offering. We also wrote up
the former entity, Unwired Planet (UPIP) over a year ago before its complete transformation. We believe this is
shaping up to be one of the most interesting investment ideas in our portfolio for the coming year and we can
hopefully add quite a bit more depth on top of the other write-ups to make this worthwhile.
Summary of the Thesis:
  • $2.88/shr in net cash and investments with a cash flow positive operating business
  • Expected growth in the operating business alone, through capital raises at the BDC, should provide reasonable upside to the equity value
  • The company has $1.6B in NOL carryforwards and ample cash to acquire cash flowing assets that unlock NOL value
  • There is a reasonable likelihood the company structures a deal where it requires minimal capital investment and allows them to “sell” some of the NOLs, unlocking their value.
  • Shareholder base has completely turned over and now there is a strong base of holders that many of us would recognize
The Current Business:
Please note that the below discussion is about the current business that GEC owns. However, this is likely to be
expanded and added to over the next few years. Therefore, please note these are small numbers and have a small
impact on the overall valuation if they do a transformative deal. We bring this discussion to forefront to make the
point that we have a profitable business supporting the current valuation even before additional transactions.
Great Elm Capital (GEC) is the owner of Great Elm Capital Management (GECM), which is the asset manager for a
publicly traded BDC named Great Elm Capital Corp. (GECC).
GECC currently has $213.7M in assets of which $4.9M is cash. GECM earns 1.5% of average gross assets,
excluding cash and earns an incentive fee of 20% of all gains above a 7% hurdle. However, there is a full catch-up
provision to 8.75% return then 20% incentive fee after that. For example, if the company returned 10%, GECM
would earn an incentive fee of 1.75% + 20% of the gain from 8.75%-10% or 0.25% (1.25% * 20%) for a total
incentive fee of 2% of assets.
Based on the gross assets less cash of $208.8M as of 6/30/17 and a 1.5% management fee, GECM should generate
$3.1M currently in fees before any incentive fee. It should be noted that based on the conference calls and our
discussions with the company we believe this number is understated as a result of the low leverage profile of GECC.
BDCs in general can operate at 1:1 debt/equity leverage and GECC currently operates with 0.39 debt/equity,
implying capacity for another $90M of debt given the current equity. While they are likely to keep it somewhat
unlevered for a BDC, adding another $20-30M of debt is likely. This would imply management fees of somewhere
around $3.5M.
Incentive fees for BDCs are calculated based on net investment income earned. This net investment income includes
interest and dividends from the underlying assets, so it is actually much more stable than most equity hedge funds
and less of the type of “incentive fee” we are all used to. As such, we think it is fairly reasonable to count on another
1-2% of assets through incentive fees, bringing total revenue to GECM to somewhere between $6-8M.
Costs associated with this business were estimated by management to be about 50-60% of revenues, or $3.85M
using midpoints. Please note that after the latest change in GECM’s cost sharing agreement with Mast
Agreement-to-Establish-Operating-and-Governance-Independence.html), GECM employees and Mast employees
have been fully separated and so Mast will no longer reimburse GECM for part of the expenses. GECM is going to
reduce costs/employees but even after that, the costs will still run higher than they were before. So let’s call it $4-
5M in costs for easy math. We expect this to decrease by ~$750K in 2 years once the Full Circle Capital
management team has been fully paid their earn out, which was provided as an incentive to sell FULL to GECC. 
$7M in revenues less $4-5M in costs is $2-3M in income flowing to GEC, with about $1M in its own public
company costs and such. So with a $16.5M EV (23.2M shares x $3.60 - $46M in cash - $21M in GECC common ),
this net income supports the current value of the business all by itself (forgetting about the NOLs). Especially if you
consider that GECM can use GECC’s balance sheet to grow its fees (discussed in paths to unlock value below).
The Balance Sheet:
GEC currently has $45.6M in net cash and ~1.96M shares of GECC that it owns. GECC is publicly traded so the
market is valuing this stake at $21.3M. Please note that the NAV of the GECC shares is $13.36/shr ($153.7M of
NAV over 11.503M S/O as of 6/30), meaning the NAV of GEC’s investment in GECC is ~$26.2M. But we will use
the current trading price to be conservative as the portfolio of GECC has drawn some worry from investors (also
discussed more below).
Combining the cash and marketable securities we have $66.9M of net cash and 23.2M shares outstanding, or $2.88
of net cash per share. Note we excluded the related party note payable as we believe the most recent press release
largely wipes this out. We will discuss this more below.
With the stock currently trading at $3.60, this implies ~$16.5M of enterprise value. As described above, this $16.5M
of enterprise value should be generating at least $1M of net income for GEC and that number is likely to grow
materially over time.
Paths to Unlock Value:
As we see it, there are five primary avenues for unlocking the value of the NOLs and growing the value of our
equity. We will discuss them below in the order in which we believe they will occur:
1) “Sell” the NOLs: With some creative financing (which this team is pretty skilled at) we believe the
company will cut a deal similar to Kingsway whereby they contribute some cash and NOLs and acquire
ownership in a property that is leased out for 10-30 years. GEC will not generate any cash as all cash will
go to paying down the related debt but the equity from debt repayment will accrete to them and allow them
to use NOLs to shield the rental income and the depreciation recapture upon a sale. We don’t have a great
feel for size, but we think it is likely to be in the $50M-100M deal value range with maybe $5M of cash
used by GEC.
2) Clean Up the BDC, Specifically Avanti Debt: A lot of hand-wringing has gone on over the amount of
one particular investment that Mast originally contributed to GECC, Avanti debt. Avanti is a UK listed
satellite company that Mast had a significant debt position in and Avanti has had some issues. When Mast
originally contributed their $90M of assets to acquire GECC stock, Avanti was roughly ~2/3 of their
~$90M contribution (came down with Avanti mark-downs pre-close).
The current carrying value of the Avanti debt on GECC’s books is $47M against a cost of $68M. This is
against $206M of total investments or 23% of the assets. Everyone, including management knows that this
is too high. If GECC can offload a good chunk of this at a reasonable price it would go a long way towards
removing the fear of another significant capital loss from this debt. Especially when equity at GECC was
only $154M at 6/30/2017.
We expect they will do something with this in the next six months as appropriate. Avanti also appears to
have cleaned up their immediate liquidity issues through a number of transactions although the business
itself is certainly not out of the woods.
3) Acquire Additional BDCs Using GECC Balance Sheet: The beauty of being an asset manager to a
publicly traded BDC or REIT is that you are paid on the assets of the entity you are managing, and it is that
entity’s balance sheet that is used (rather than your own) to finance growth. GECC was formed through the
acquisition of Full Circle Capital and an asset infusion from Mast Capital. There are a number of small
underperforming BDCs out there that GECC could purchase and likely improve the portfolio returns using
its skillset. It is hard to get underperforming management teams to sell as they are likely being overpaid for
their results, but we believe there are a few opportunities out there the company will be evaluating.
One barrier, we thought, to this occurring was that GECC is trading at an ~20% discount to NAV. Why
would management want to issue equity in GECC at such a large discount? Well, the answer is they
certainly don’t prefer it and they have been doing substantial buybacks (including a tender offer) to try to
get the price of GECC up. However, we believe they will appropriately look at the discount to NAV they
are using as currency vs. the shares they are buying. If they can use currency at a 20% discount to NAV to
acquire assets at a 40% discount to NAV then it is value accretive.
4) Acquire a Profitable Business: Given the substantial cash balance on the balance sheet the company has
the ability to acquire a profitable business and instantly unlock 30-50% of the value for a full cash tax
payer. The key, of course, is finding the right deal at the right price. The management team continues to
evaluate deals on a weekly basis, but at this juncture hasn’t landed on the right one. We imagine this is only
a matter of time. Given where the market is currently priced, in some ways this is a hedge against a market
downturn as a cheaper market provides more opportunity to get a deal done, which should unlock
immediate value on a DCF basis.
In terms of industry, early on they had wanted to follow the merchant banking model of Leucadia or even
looking to follow in Jess Ravich’s footsteps when he bought a steel company out of bankruptcy. However,
we strongly expressed our concern about wandering too far outside their wheelhouse in terms of trying to
operate businesses they have no experience in and we believe management heard our pleas. So while we
aren’t sure exactly what type of business this would be, we don’t think it will be so exotic that it will send
the shareholder base packing.
5) Launch Additional Asset Management Products: The management team and board is largely made up of
credit / hedge fund guys. A number of them have experience raising money for asset management products,
and therefore we would not be surprised to see them internally launch additional investment funds managed
by GECM or some affiliate of such.
The whole relationship with Mast is a messy saga we can address more in the comments if anyone is interested. The
bottom line is that Peter Reed, who was a former Mast MD, is now leading GEC, GECM and GECC. While fairly
young, at 37, we believe Mr. Reed is extremely motivated, hardworking, smart and has all of his eggs in this basket.
He effectively left his position with Mast to run GEC because of the opportunity he saw before him.
As part of the latest official separation from Mast, Mr. Reed was given over 2% of the company in options in GEC
stock to compensate him for the lost Mast compensation. He now effectively owns 2% of the company and has
additional exposure through this ongoing ownership in Mast funds that hold a position. Most importantly, the
official separation from Mast likely marks the end of a drawn out employment contract battle that can now be put
behind him and allow Mr. Reed to focus fully on finding profitable deals for GEC.
We find Mr. Reed is very open to dialogue with shareholders and wants to hear what shareholders think. We would
encourage anyone thinking about seriously investing to have a conversation with him.
Current Ownership:
Please note that due to the IRS Section 382 Rules governing the utilization of NOL carryforwards, shareholders
cannot own more than 4.9% of the company without express permission from the Board.
Regarding current ownership, it is important to note that prior to the sale of the patent licensing business last
summer, the stock was primarily owned by tech funds. Pretty much all of these holders sold out, which caused the
dramatic decline in the stock over the course of 2016. The shareholder base has been almost entirely replaced with
some holders we would consider very strong, long-term holders who understand the story and the value.
While the report from Factset below shows a few value managers readers might recognize (including Northern
Right, Cannell, Stillwell, Joe Steinberg, and Roumell is a small cap value manager too), remember this is an $80M
market cap company and most holders can’t go over 5% of shares, meaning a $4M position. Therefore, we are
aware of a number (at least 4) of talented small cap value managers who take concentrated positions and currently
have less than $100M in AUM (and therefore don’t need to report their position through a 13F) but who own just
under 5% of the company.
What is also interesting looking at the histories of the holdings is that most of the core holders have purchased
shares in the last 6-12 months. This is interesting from a behavioral perspective because the stock currently trades
around cost or slightly higher than cost for most of the shareholder base. We have found that small cap
transformations where the old shareholder base is still involved and carrying the stock at a substantial loss on their
books can completely impede the stock’s ability to move higher (regardless of the fundamental transformation)
because all of those holders are looking for any rally to unload their losing position. We have the opposite effect
now where holders don’t have the psychological or career pressure to get out of the position, setting up for a very
positive dynamic when deals start to happen.
We would also point out that in the most recent press release, Northern Right was given permission to purchase an
additional 5% of the company. Matt Drapkin of Northern Right is one of the board members and was put in place
originally by Mast to represent its interests. However, it has become clear through Mr. Drapkin’s strong
endorsement of Mr. Reed to lead the company that instead of simply being a voice for Mast, Mr. Drapkin cares first
and foremost about unlocking value for the stock.
Bad Deal The biggest risk is that the company uses the companys precious cash to make a poor acquisition that
doesnt actually unlock any value. We believe this is mitigated by the fact that Mr. Reed is in the investment
management business and is overly analytical and cautious about doing the right type of deal. He knows future deals
are likely dependent on the markets acceptance of the first deal because you need to get the equity price up to
eventually do more deals using partial equity.
Tax Reform Lower tax rates certainly make the NOLs less valuable. However, tax reform is not a new idea and
NOL shells across the market sold off post-election, so we dont think many people were buying this stock over the
last 9 months expecting current tax rates to continue. Additionally, one item that mitigates this is that the NOLs are
not currently factored into the valuation of the business. The cash + operating business alone support the current
value. Lastly, we like that this is actually a hedge on Washington not being able to get anything done. The rest of the
market will likely be disappointed if tax reform fails, and many other companies within our portfolio could benefit
substantially if it passes. This is a bit of a hedge for ones portfolio.
In Summary:
We have a stock trading at $3.60, with net cash and securities of $2.88/share, a profitable asset management
business that can grow without requiring additional capital, $1.6B in NOL carryforwards, and a strong management
team/board who are now focused on unlocking value for this company.


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


     GEC inks a deal to effectively sell its NOLs

·        GECC acquires a BDC

·        GEC uses cash on balance sheet to acquire a profitable business and unlock NOL value

·        GECM launches new funds to manage

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