On the heels of the failed going private transaction in Emmis Communications, another recent special situations investment paid off in the last few weeks.

As I originally wrote back in June, American HomePatient, Inc. (AHOM) was going private in a transaction valued at $0.67.

Steps to Closure

On the surface, the transaction seemed to be complicated, as the company needed to go through multiple steps to close the transaction including reincorporation in a new state, the tender of more than 90% of votes, followed by a tender offer and debt restructuring.

On July 30, company shareholders voted to approve the reincorporation (an expected result, since Highland Capital, the acquirer, owned approx. 48% of shares outstanding).

The tender offer statement was officially filed on July 7, with an original end date of August 4.

On August 5, the company issued a revised offer statement and updated shareholder count – only 87% of shares had been validly tendered, slightly short of the required amount. The company extended the tender offer until Wednesday, August 25.

On the new closing date, the tender offer was extended again, with a key condition changed: the minimum tender condition would now be set at 80% vs the original 90% figure.

Since 87% of shares were still validly tendered, this modification allowed the transaction to proceed as planned.

On Sept 2, AHOM announced that 6,917,314 shares, or 87%, of the company’s outstanding stock were validly tendered at $0.67/shr.

I received the money in my account on Sept 3.

Return

Although the transaction took a month longer than I expected, it was a very profitable transaction on both an absolute and annualized return basis.

Conclusion

Looking back at these going private transactions, it is clear that investors must be conscious of the fact that tender offers do not always go as planned.

Although the deals were similar in many ways (i.e. each acquirer had a dominant ownership position in the company), there was one key difference:

the acquirer was not relying on outside financing for the transaction.

With no third party in the mix, Highland Capital was able to extend and modify the offer statement as required to complete the transaction without worrying about an outside investor pulling support at the last minute.

Disclosure

No current positions.

A good portion of special situation investing, or ‘workouts’, involve transactions with limited upside and tight spreads, yet significant downside risk if the transaction is called off.

The drawn out situation with the Emmis Communications (EMMS) going private transaction is a prime example of the risks with these transactions.

Last week, the deal fell apart after the company failed to negotiate a deal with a group of preferred lockout holders and the company’s original financier, Alden Global Capital.

Transaction Background

As I originally wrote back in back in June, the company’s CEO and Chairman, Jeff Smulyan, was trying to take EMMS private in a cash offer for $2.40/shr.

At the time, the deal was offering a spread of nearly 5%, with most conditions for the transaction all but guaranteed since Smulyan owned a controlling interest in the radio operator.

Preferred Shareholder Lockout

However, as I wrote several weeks later, the EMMS transaction was derailed when a group of preferred shareholders came together to collectively vote against the deal.

While the intentions were never disclosed, it is likely that lockout group was trying to get better terms as part of the transaction, as the company’s original offer priced the preferred shares at only 60% of face value.

After the lockout was announced on July 9, the parties engaged in a back and forth round of negotiations over the next two months.

Vote Delayed – Again and again and again…

EMMS’s stock varied widely during the time period, generally falling during periods of no news before leaping back up after another extension.

On August 4th, the company put out a positive press release, saying that the company was seeking an alternative structure for the transaction, only to extend the offer again.

On August 30th, another extension was announced, but with new and dire language:

“Emmis, JS Parent, JS Acquisition, Mr. Smulyan, Alden and the representatives of the group of holders of Preferred Stock negotiated and agreed in principle on revised economic terms for the contemplated transactions that each indicated it would support. Subsequently, Alden has informed Emmis, JS Parent, JS Acquisition and Mr. Smulyan that it would no longer support the negotiated terms. Accordingly, although discussions are continuing, JS Acquisition believes it is unlikely that an agreement will be reached with either Alden or the group of holders of Preferred Stock.”

In total, the shareholder vote was delayed a staggering 9 times, as it looked increasingly unlikely that the transaction would be completed.

Deal Falls Apart

On Sept 9th, EMMS’s going private transaction officially collapsed. According to the company’s COO,

“I think Jeff and the entire Emmis team are bitterly disappointed that the transaction didn’t conclude successfully,” Patrick M. Walsh, Emmis’ chief operating officer, said Thursday morning. “We thought we had a deal, and it’s unfortunate that Alden backed away from the deal.”

The stock market reacted swiftly, and the stock dropped more the 33% over the ensuing week.

Exiting my Position

I held onto my stock through most of the long ordeal, counting on the fact it would be very difficult for Smulyan to walk away from the deal again if there was any way possible to complete the transaction.

In addition to the negative press release on August 30th, strange trading in the preferred shares caught my eye as well. I’d been closely monitoring the preferred shares throughout the ordeal, figuring they would give a better picture about the odds of success.

On Thurs, Sep 2, the preferred shares (EMMSP) dropped more than 14%, with a large sale of 8.1k shares. This was by far the largest sale in the previous 2 months, and significantly below the original purchase price of many of the lockout holders.

Combined with an increase in the common price (the common & preferred had traded mostly in sync since the lockout), it appeared that someone ‘in-the-know’ had sold out.

I sold my shares on Friday, August 30, at $1.70, for a loss of 26%.

Lessons Learned

These special situations investments are designed to supplement an existing portfolio, with many ‘easy’ transactions for small but guaranteed profits.

With these investments, it is very easy to feel committed to a position, even though the circumstances surrounding the deal can change drastically.

In hindsight, I should have sold my shares for a small loss as soon as the lockout was announced (knowing I could probably buy back in if a deal was reached again.)

I’m sure a similar situation will occur in the future, and next time I’ll be disciplined enough to sell when the guarantee is no longer there.  No sense in being too risky while picking up nickels in front of a steamroller!

Disclosure

None

NexCen Brands Inc (NEXC) is a brand management company holding 7 brands in two different operating segments: quick service restaurants and footwear & accessories.

Across the brand network, the company operates approx. 1,700 retail stores for brands like Great American Cookies, Marble Slab Creamery, and The Athlete’s Foot.

The current arrangement provides another special situations investment opportunity, with the company’s liquidation providing potential returns for the patient value investor.

History & Financial Situation

NexCen purchased the rights to the seven brands back in June 2006.  Since then, the stock has plummeted, as the company has lost money every year since 2005 while book value per share has been negative since 2008.

NEXC took on a great deal of leverage as it expanded its brand portfolio, borrowing over $138m under its credit facility in 2008 in order fund the acquisition of Great American Cookies.

However, the investment did not pay off, and the company struggled under the debt burden, casting doubt over whether it could continue as a going concern.

From the most recent 10-K, NEXC’s

“Credit Facility obligates us to make a scheduled principal payment of $34.5 million on our Class B Franchise Note in July 2011. We currently do not hexpect that we will be able to meet this obligation.”

As a result of the debt load, the company began seeking strategic alternatives for its debt and capital structure with the goal of maximizing return for shareholders.

Strategic Asset Sale

On May 13, 2010, NEXC announced an agreement to sell its franchise businesses to an investment firm with significant franchise experience for $112.5m, subject to stockholder approval. The proceeds would be used to pay off the company’s credit facility.

The definitive proxies for the transaction were filed on June 11, 2010, with special shareholder meeting scheduled for July 29. The proxy described the asset sale of the majority of the company’s assets, followed by a dissolution and liquidation of the company.

On July 30, 2010 the shareholders voted to approve the sale and dissolution proposal, effectively ending the company’s status as a working business.

NEXC Plan of Dissolution & Liquidation

According to the proxy filings, the company expects liquidation distributions in the range of $0.12 to $0.16 per share.

The stock is trading only slightly above the low point of the estimated range, providing a downward floor from a risk perspective but with significant upside.

Potential Catalyst

Further increasing the chances that the company will end up distributing cash towards the high end of the range, NEXC announced the hiring of a strategic consulting firm who will handle the wind-down of the company, including the distribution.

The fee for this service is $100k, money that could potentially go to shareholders. However, I like this arrangement because the terms of the agreement provide an incentive fee in the event that at least $8m is distributed to company shareholders.

I’m a big believer that people will focus exclusively on what they are incentivized to do – in this case, it should influence the consulting firm to quickly wrap up the transaction in a timely fashion and for the lowest cost.

Since the biggest risk in these transactions is the final closing being bogged down in legal and logistical nightmares that take a great deal of time, I view this arrangement as a very positive development for shareholders.

Return Scenarios

Major Risks

Although the company is estimating the low range of net proceeds to be $0.12, there remains the possibility that shareholders might not receive any compensation at all.

Also, despite the consulting arrangement, these type of liquidations can sometimes take years to wind-down, as the company pays down creditors and satisfies remaining obligations.

Conclusion

While there is definite risk in the deal, substantial upside remains if the consulting company can finalize arrangements in an orderly and efficient manner (right in line with their incentive arrangement).

I believe that the firm will do everything in its power to reach their success target of $8m, allowing for a potential return of 12.14%.

I’m adding NEXC to the Value Uncovered portfolio at Friday’s closing price of $0.123. The record date for the liquidation distribution is today, Sept 13.

Disclosure

Long NEXC