Note added after first publication - Readers pointed out my harebrained mistake of not including the rights offering of 2.2x shares for each share owned at $5, which brings down the price of current ownership considerably if investors plan to participate in the rights offering (they most certainly will participate if they own shares at $9+ today). This makes a $6.27 valuation post transaction worth about $9.05 in share price today. If investors believe the financials provided by the company as fair, current prices are within 5% of fair value, not 33% overpriced.
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Einstein is paraphrased as saying
Everything should be made as simple as possible, but no simpler.
I applied this approach to the complex Biofuel Energy (NASDAQ:BIOF) purchase of privately held real estate investment company JBGL after researching the deal in detail. It is easy to get confused who has what stake in each side of the transaction, what their motives are, the value of JBGL and its financing pre and post transaction, and what the resulting company should be worth to investors in terms of today's BIOF price.
New Capital wrote an excellent article on the BIOF/JBGL transaction which I encourage BIOF investors to read carefully. Even better, investors should read BIOF's applicable SEC filings for the first hand source of information on the companies' merger:
The complicated nature of the transaction with multiple components of funding, existing equity ownership on both sides and the addition of $150 million of expensive debt (10% interest) may be confusing to investors, thereby supporting the recent volatility and overvaluation built into BIOF's share price. A simple estimation of fair value for BIOF post transaction can be obtained by using the JBGL financials provided in the proxy statement, plus the BIOF assets pre-transaction.
Using the financials provided by BIOF in the Proxy Statement and the most recent SEC Form 10-Q in their most basic form, I estimate fair value at $6.27 post transaction, similar to New Capital's valuation. This results in about a $9.05 current price when we consider that the rights offering will allow shareholders to purchase 2.2 shares at $5 for each share owned (weighted average price resulting in $6.27 if all rights are subscribed).
Note that this assumes we accept the financials in the proxy statement as is. New Capital makes a case for a lower valuation post transaction based on a number of points, of which I highlight two:
- Greenlight and Brickman have injected capital into JBGL in recent years, making growth look strong. This type of capital injection will come at a cost of interest going forward for the new company that is not reflected in past financials.
- Duff & Phelps assumes 50% revenue growth in 2015.
After selling off all of its ethanol business, BIOF is now effectively a shell company with a couple key assets. Per the latest 10-Q filing, relevant pre-transaction BIOF assets consist of $8.1 million in cash and $181.3 million in net operating loss ("NOL") carryforwards. The NOLs add $63.5 million to the post transaction company, assuming a 35% tax rate, which is used in the proxy statements (see 'Deferred Tax Asset'). Cash plus NOLs result in $71.6 million valuation for BIOF's portion. Note that BIOF's market cap has been lower than this because the NOLs are only valuable if they can be used by a profitable business to offset future income taxes.
The firm BIOF hired to evaluate the purchase of JBGL (Duff & Phelps, LLC) summarizes their financial opinion in the Proxy Statement that the $275 million purchase price is fair:
the aggregate consideration of approximately $275.0 million to be paid by the Company in the Acquisition was within the range of values indicated by these analyses.
While they state that this is not to be used as a valuation for JBGL, it is what the Special Committee to the Board used to show that the transaction is fair to BIOF stockholders.
$275 million is also the valuation that Greenlight Capital and James Brickman agreed to sell JBGL. While Greenlight and Mr. Brickman will own about half of BIOF post transaction as a result of existing BIOF ownership and stock allocations as part of the JBGL deal funding, it is important to note that collectively they are effectively cashing out about half of their current JBGL ownership. I make the assumption here that jointly Greenlight and James Brickman consider $275 million a good price for JBGL or they would retain the company or sell it in the open market.
$71.6 million for BIOF plus $275 million for JBGL equals $346.6 million. Subtracting $150 million in debt BIOF is taking on from Greenlight at 10% (an artificially high interest rate by 2-3% for JBGL to take on, in the opinion of Duff & Phelps) to help fund the transaction (see the deal basics here) results in a $196.6 million valuation post transaction.
There are currently 6.24 million BIOF shares outstanding (see the Proxy Statement). Per the transaction, assuming the maximum $5 rights offering price and $70 million raised, 14 million new shares will be sold. In addition, 8.5 million new shares will be given to Greenlight and 2.64 million to James Brickman, as part of the $275 million purchase of JBGL. These actions will result in 31.38 million shares in the new company.
$196.6 million divided by 31.38 million shares results in $6.27/share.
More detailed analysis has been performed to include the nuances of the deal (see New Capital's article and run your own analysis). I believe this estimate is at the high end of those ranges.
Disclosure: The author is short BIOF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Stratesis may initiate additional trades in BIOF over the next 72 hours. Forward Looking Statements This release contains "forward-looking statements." Generally, the words "anticipate," "believe," "estimate," "expect," "intend," "may," "predict," "project," "plan," and similar expressions identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to differ materially from any future results, performance, or achievements expressed or implied by such forward-looking statement. Consequently, no reliance should be placed on any forward-looking statements contained herein and the reader should consider any such forward-looking statements only as Stratesis' current beliefs as of the date of this press release. Even if these beliefs change because of future events or circumstances, Stratesis declines any obligation to publicly update or revise any such forward-looking statements.
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