Tuesday, March 27, 2018

Dr. Bob's Rant

You are supposed to sleep on letters or emails written in anger, or at least take a deep breath and walk around the block before hitting the Send button.  I am so glad Dr. Bob Froelich did neither when he announced his resignation as Board Chairman and Audit Chairman from First Capital Investment Corporation.  Dr. Bob's letter is unfiltered and rambling, speckled with spelling and grammatical errors, and the only thing clear in his final analogy, which attempts to clarify his argument while explaining First Capital's bad faith actions, is Dr. Bob's dislike of gingers.  Said another way - the letter is fantastic.

Here is the entire letter:

To: First Capital Investment Corporation:

This email is to serve as official notice of my resignation as Chairman of the Board & Audit Committee Chair for First Capital Investment Corporation. I can no longer continue to serve our shareholders as my major disagreements with management have finally reached a boiling point and I can not take any more of this. My major disagreements with management are twofold. 

First, there has been a complete and total lack of transparency between management and the board regarding what credits management was investing in and why. After our board approved the $3,000,000 investment in First Capital Retail communication to the board basically stopped. Our board had no knowledge of the other 6 investments that were made and why they were made and what was the investment thesis for those loans. The first time we learned of them was when we were informed that they are all in some form of default, weather actual or technical and our shareholders are looking at potential massive write downs of these underperforming assets. This board is still awaiting documentation (that I asked for as Board Chair) of investment memorandums and investment committee minutes including approval by who on the investment committee regarding all of these deals. In addition this board has never received any on going surveillance or updates on any those these investments after the investments were made. As a board we should not be kept in the dark by management and the advisor and because of this complete and total lack of transparency, and questionable if any investment approval process I am resigning.

My second major disagreement with management revolves around their proposed solution to this problem. It shows a complete and total lack of understanding of what it means to operate a company in the 40’ Act space. In the 40’ Act world when management and the advisors so grossly underperforms for our shareholders, as witnessed by the almost complete collapse of every investment the advisor has made, that advisor get fired and the board begins the exhaustive and comprehensive national search for a new advisor. That didn’t happen at FCIC. Instead the advisor is recommending and pushing through a plan that does nothing for our shareholders while it lines the advisors pocket as they walk away from this company. Our shareholders watched their wealth get destroyed while the advisor who allowed all of this to happen gets a big payday. That is just wrong. And to make matters even worse management wants to narrow the focus of this company to be a Healthcare BDC not the multi-sector BDC that all of our investors thought they were investing in. Why would any of our investors what to take on additional risk at this time by only investing in the healthcare sector? It limits your upside and provides a tremendous downside risk if that sector underperforms because there is nowhere else for you to go. I am taking off my board hat now and putting on my shareholder hat. I am a major shareholder in this company and I didn’t invest in a healthcare focused BDC. I don’t want a healthcare BDC!

It was these two major disagreements with management that led me to my decision to resign. While it may be confusing for some of our shareholders to completely understand what is happening perhaps this analogy might help them to understand what is going on. It would be like getting divorce from your spouse because they destroyed 80% of your retirement savings by spending it on having an affair. (Similar to the wealth destruction of the advisor here by investing in bad investments). Now your spouse instead of just walking away comes up with a new plan. Your spouse says why don’t you give me that remaining 20% that I didn’t destroy in the retirement savings you have and I will pick the new spouse for you. In other words you divorce me and I get to tell you who to marry and you pay me for it. And better yet, even though you know I don’t like anyone with red hair you inform me that I now have to marry someone with red hair. That is how silly this is! You would never agree to that, however, that is exactly what is going on here. The advisor instead of getting fired (divorced) comes up with a plan to find a new advisor (finding us a new spouse) and then wants paid for this transaction all the while our investors are underwater and have yet to receive a dividend. As the final icing on the cake the advisor tells us that they have decided to turn this into a healthcare BDC (the same as giving us that red haired spouse that we didn’t want). 

While I am stepping down as a board member, I am stepping up as a shareholder. I will be watching what you do very closely. The job of this board is to protect the shareholders and not to figure out a plan to help the advisor get paid after they destroyed the wealth of our shareholders.

Respectfully submitted,
Dr. Bob Froehlich
Board Chair, Audit Chair & Major Shareholder

A Tale of Bad Toys, Pierced Ears, Lousy Music, and A Misfired Gun

The past two weeks has seen four examples (that I know) of private equity transactions chocking companies to death or into bankruptcy.  Toys R Us, iHeart Media, Claire's, and yesterday Remington, the oldest gun company in America, all have declared bankruptcy, and one, Toys R Us is closing all its stores and liquidating. 

I am not going lament any of these bankruptcy filings.  Toys R Us can blame Amazon all it wants, but the Internet was around in 2005 when the PE firms acquired the toy store, and Walmart and Target sell plenty of toys, too.  I always thought Toys R Us' issues were more of a management problem.  Its stores were ugly and presented a poor shopping experience. Capital required for debt service rather than store upgrades probably helped make this worse.  iHeart Media focuses on radio, and my radio listening is way down, and how lousy and standardized radio has become, I don't plan on making a full scale return to radio listening.   I don't know much about Claire's as my ear piercing and bangles days are behind me.   I do know gun sellers are under pressure, but the troubles are recent, and if Remington - in an industry supported by a political party and the most powerful lobbying group in the country - had to surrender this fast, there were other issues at the company.

I suspect at the bottom of all these deals you will find that private equity principals received big bonuses after they convinced dumb bankers to lend them too much money.  Private equity principals banked their bonuses under phony pretenses using borrowed money with no recourse to them personally, leaving the acquired companies to figure out how to repay the debt.  I also suspect the former executives of the companies that sold to the private equity firms probably did alright, too. 

Consumers, employees, and investors are the big losers.  I always thought the purpose of business was to create long-term value for shareholders.  The goal to maximize shareholder value is the first lesson on the first day of business school.  Private equity deals work just the opposite - buying companies with other people's money, paying the PE principals immediate, big bonuses from the money borrowed to purchase the companies, and then letting the purchased companies struggle to pay the debt.  It is principal risk-free wealth maximization and shareholder wealth decimation.  Ugly business.

Monday, March 05, 2018

The Optomistic View

Colony NorthStar Credit Real Estate (CLNC) has traded over $20 per share for the better part of a week.  CLNC began trading in early February and is a new credit REIT comprised of assets from Colony NorthStar (CLNS) and two former non-traded REITs, NorthStar Real Estate Income Trust (NorthStar I) and NorthStar Real Estate Income II (NorthStar II). CLNC declared its first distribution this week, and the yields to NorthStar I and NorthStar II investors, based on an original $10.00 per share investment in the two REITs, are 6.6% and 6.1%, respectively.  This compares to the pre-merger yields of 7.0% that each REIT was paying.  (NorthStar I investors have a small amount of assets that were not part of the merger that may also pay a distribution at some point.)

Per-merger, Both NorthStar I and NorthStar II were paying more in distributions than they were generating in operating cash flow, a financial position that is unsustainable over the long run.  While CLNC's current stock price represents a discount-to-original-purchase-price of approximately 22% for NorthStar I investors and 28% for NorthStar II investors, the lower adjusted distribution is at a smaller discount than the stock price discount.  In my opinion, that investors are able to receive yields above 6% is positive news considering the previous distribution over payment.

Monday, February 12, 2018

Double Douchery

This blog is not morphing into a Walton-only rant, I promise, but I will comment on an email that Walton sent to investors last week.  The email announced that one of Walton's land funds is making a distribution on a partial property sale.  The fund sold just under half the acreage on one of its property's and is returning about $1 per share on an original $10 per share investment in the fund.  The property is being sold to an affiliate, which is a conflict of interest.  There is no mention of the property's original cost, so you can't put the sales proceeds into any context.  There is not enough information in the email to determine whether the sale covers the cost and fees related to the property.  Investors and their financial advisors need to press Walton to provide more information on the sale. 

Tuesday, February 06, 2018

More Douchery

From the table in yesterday's post, there is another example to support Walton's claim to King of the Douchebags.  In the table, Walton lists a 3% acquisition fee.  This 3% is calculated on the gross proceeds, not the actual price of the property.  The acquisition fee to Walton on the price of the property is 6.4%.  That is an outrageous fee.  I can't think of another sponsor that charges an acquisition fee on gross proceeds, nor one that charges an acquisition fee as high. 

Monday, February 05, 2018

The Douchebag Kings

Walton International is fiscally and morally bankrupt.  As a coronation to its title as King of the Douchebags, Walton sent a letter to investors late Friday afternoon announcing new values for its land funds.  It had previously used the purchase price paid by investors as the value of their investment.  This year it has decided to use the value of the raw land, plus some reserves to determine the values of its shares.  In the example below, the investment is worth $.684 per each $1 invested, or 68% of what investors put in the fund.  The change in reporting methods resulted in some hefty valuation discounts for investors.  The following is a use of proceeds table from on of Walton's land funds:

The Walton letter to investors states that, "For various reasons, Walton determined that using the net asset approach was not appropriate at the time of the final closing, but had this method been utilized the value reported at that time would have been significantly less than the original price of the Units purchased."  Various reasons?  Really?  How disingenuous.  There is only one reason for Walton's decision not to use the asset value method.  If Walton had explained to investors that only $.46 of each $1 was going to buy assets, while the rest of their investment went to initial fees or reserves for future fees, investors would have screamed.

As shown in the table above, less than half of gross investment proceeds were used to buy the actual investment property.  This means the underlying property needs to more than double in value just to return original investment.  Think about it, each land investment needs to more than double in value just to break even.