A Catalyst For WMI Holdings To Finally Begin Utilizing Their NOLs
| Apr. 22, 2015 3:42 PM ET | 5 comments | About: WMI Holdings Corp (WMIH), Includes: KKR
Disclosure: The author is long WMIH, ALJJ, SWKH. (More...)
WMIH's annual meeting on April 28 will set up the company to finally make an acquisition.
Nearly $6 billion of Net Operating Losses are a massive asset and will soon be put to use.
Incentives are in place for a large, levered transaction.
WMI Holdings (OTCQB:WMIH) has been a fascinating company ever since JP Morgan (NYSE:JPM) picked up the remains of WMI's predecessor, Washington Mutual. April 28 may finally be the day when the new company can move forward towards its promising future. That's the day when the company will be holding its 2015 annual meeting and shareholders will vote on several measures that will set it up to make a major acquisition.
Followers of the company know that KKR committed to making a significant investment in WMI in early 2014. KKR (NYSE:KKR) subsequently amended and added to that investment in January 2015, effectively taking control of the company. These transactions were structured as convertible preferred stock to allow the company to retain its valuable net operating losses (NOLs). These NOLs will shield $5.97 billion of earnings from federal income tax, a massive asset. These NOLs won't begin to expire until 2031, which gives WMI and KKR plenty of time to use them up.
Investing in NOLs
In the quest to find hidden value, companies with large NOLs can be a great place to look. There are several stages in the process. Some interesting companies are shells with limited or no operations. Others have made one or more acquisition with the hopes of using the NOLs they have accumulated. Others are being held by a parent company in the hopes of consolidating financials at some point in the future. Still others have started a new line of business or sold off or shut down an unprofitable subsidiary.
A few notables that used to be NOL shells, but are now generating net income to shield are ALJ regional Holdings (OTCPK:ALJJ), which made two transactions in the past few years, and SWK Holdings (OTCQB:SWKH), which successfully started a new line of business. Warren Lichtenstein also has an interesting collection of NOL-related companies under his Steel Partners Holdings (NYSE:SPLP) umbrella. There are dozens of other examples, perhaps more, of varying sizes and at various stages.
I'm not aware of a way to effectively screen for these types of companies prior to an acquisition. This keeps out a lot analysts and larger investors and gives an advantage to investors interested in this niche. Plus, companies with minimal operations and a history of losing money usually aren't high on the list for traditional research. However, given the right circumstances, an NOL shell can be a very attractive investment as can a company currently applying their NOLs.
WMI has a combination of attractive characteristics. They are post-bankruptcy with the small remnants of a run-off business. This limits skeletons in their closet. They have the support and substantial ownership of KKR. KKR gives them access to deals, access to current and future capital, and access to elite operational talent.
The Importance of WMI's Annual Meeting
Why is WMI's annual meeting important? It clears up several matters that will then allow the company to make an acquisition. There will be an important vote to reincorporate the company from Washington to Delaware. Delaware is a preferred venue for several reasons, including more certainty and clarity for amending their bylaws and making future acquisitions. The company will also increase the size of the board from seven to 11.
The company has indicated that they then will be appointing two executive directors, William Gallagher and Thomas Fairfield, and two KKR designees, Paul Raether and Tagar Olson. Both Gallagher and Fairfield come from Capmark Financial (OTCPK:CPMK). Their specific mandate will be "developing and executing on the company's acquisition strategy."
Along with the move, WMI will dramatically increase the number of authorized shares of common and preferred stock and make it easier to raise capital.
Investors have patiently waited for three years for WMI to make an acquisition. This year's annual meeting removes the last hurdle to that happening. After the most recent capital raise, the company has $600 million in escrow to apply to an acquisition as well as cash and investments of about $150 million, about half of which may not currently be used to fund an acquisition. Of course investors such as KKR, Citi, David Tepper and others will likely prefer to lever the company up in a manner that would preserve the NOLs. This may include a rights offering or convertible debt or preferred stock.
It doesn't really pay to speculate on what acquisition WMI will ultimately choose as their field is wide open. We do know, though, that an acquisition will likely be large, leveraged, and will generate substantial net earnings. The NOLs provide this incentive. The open question will be what multiple or valuation they will be able to make the acquisition.
A Stab at Valuation
As part of the capital raise there will be substantial dilution. We also have the unknown of any additional capital raise as part of an acquisition. At year-end 2014 there were about 201 million shares outstanding. However, there had also been one million shares of Series A Preferred Stock issued in January 2014 that can convert to common stock as well as warrants to buy another 61.4 million shares. Then there were another 600,000 shares of Series B Preferred Stock issued in January 2015. The most recent preferreds automatically convert into common stock on the closing date of the acquisition. There is pricing mechanism attached to that conversion, but it currently appears as if the conversion price will be $2.25 per share, meaning that the number of shares of common stock issued as part of the Series B conversion will be approximately 267 million shares. While this may be a moving target, it appears that there will be about 530 million shares of common stock after the preferreds and warrants are converted.
With this dilution, we can estimate about $3.94/share of NOL value with a 35% federal tax rate applied (without discounting for any time value). We also have about $1.40 in cash and investments, though some of that is currently restricted. Of course there are a lot of variables here and a lot that will change when an acquisition is identified.
The annual meeting and reincorporation now give the company a clear path to realizing this value, and likely much more. They have a strong management team ready to put in place, access to deal flow and a willingness to use WMI as a vehicle to go large. An investment here takes trust in the incentives of the situation and the talents of KKR. Traditional investors will be scared away by the uncertainty. However, with an acquisition of the size contemplated, along with uplisting to an exchange post-transaction, you can bet there will be substantial future analyst coverage. The key is to own the company in anticipation of that.