Steel Excel is an Attractive Special Situation – SXCL

Shares of Steel Excel are trading well below the value of the merger consideration they will receive when the company is taken over by its majority owner, Steel Partners LP.

On December 7, Steel Partners announced an agreement to acquire the 36% of Steel Excel that it does not own in return for preferred units of Steel Partners LP. The units would carry a 6.0% coupon and mature in nine years. Steel Excel shareholders would receive $17.80 in Steel Partners LP preferred units per share. Evidently, the deal was not acceptable to one of Steel Excel’s major shareholders, GAMCO. After discussions with GAMCO, Steel Partners unveiled an amended merger agreement on December 23. The preferred units’ distribution would now be cumulative, and Steel Partners agreed to offer to redeem at least 20% of the preferred units on a pro rata basis in cash within three years of issuance. Steel Partners also agreed to seek an NYSE listing for the preferred units.

Following the announcement, shares of Steel Excel scarcely budged, though the amended terms offered much better value for Steel Excel shareholders. Specifically, the fact that 20% of the preferred units will be redeemed within three years reduces both the effective maturity and the credit risk of the preferred units.

Modeling the implied IRR of Steel Excel shares is a simple matter. When converted into Steel Partners preferred units, holders will receive $1.07 in dividends per year and will have the option of redeeming 20% of their preferred units some time in the first three years after the merger closes. Assuming Steel Partners waits the full three years to redeem units for cash, the IRR for purchasers of Steel Excel shares at $14.75 is 9.3%. Earlier redemption would result in a higher IRR.

9.3% is a generous return for these Steel Partners LP obligations. Though the preferred units are junior to all of Steel Partners’ other obligations, the holding company is quite well-capitalized. At September 30, Steel Partners LP held cash and investments of over $97 million against debt of $57 million. Upon taking full ownership of Steel Excel, Steel Partners will assume direct ownership of another $122 million in net cash and securities. The full face value of the Steel Partners LP preferred units in issuance as the result of the merger transaction will be $72 million.

So what are Steel Excel shares/Steel Partners LP preferred units worth? I think it’s worthwhile to break down the cash flows into buckets and value each using a spread over treasury rates. I ran some numbers using current treasury rates and various credit spreads: 200 basis points over treasureies for 0-3 year cash flows, 350 basis points over for 3-6 year flows, and 500 basis points over for cash flows in years 6-9. The resulting calculation values Steel Excel shares at $17.09, 16% higher than the current trading price. At $17.09, Steel Excel shares would provide an IRR of 6.7%, which seems fair to me.

In reality, I don’t expect the gap between the current Steel Excel price and the face value of Steel Partners LP units to close because of the rich interest rate spread, I expect it to close because investors will see a listed preferred unit trading at a 17% discount to face value (at a $14.75 trading price for Steel Excel shares) and bid the price up.

The Steel Excel merger is expected to close in the first half of 2017 and is subject to a shareholder vote. Holders of more than half of the 36% of shares not owned by Steel Partners LP must approve the deal. GAMCO owns one third of those shares and has implicitly blessed the merger, so I don’t expect approval to be a problem.

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Alluvial Capital Management, LLC holds shares of Steel Excel Inc. for client accounts. Alluvial may buy or sell shares of Steel Excel Inc. at any time. 

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12 Responses to Steel Excel is an Attractive Special Situation – SXCL

  1. whocares says:

    You assume that all holders will be able to tender in 3 years even though only 20% will.

    Then you are stuck for 6 more years in a 6% preferred.

    • otcadventures says:

      Stuck? These preferred units will be NYSE-listed. You can sell any time you like. Also, the repurchase offer will be pro rata, so you literally can be sure that you can redeem 20% of your holdings for face value at some point in the next three years. It doesn’t sound like you read my post or the filings.

      • whocares says:

        I read both your post and the filings.
        My view is the holders of SXCL aren’t the type that will be happy with a 6% preferred over 6-9 years. (Regardless of the ability to cash out of 20-40% within 3 years)
        Thus, they will sell before the deal closes or after driving the price lower.

        I prefer utility SO which yields 4.55% and increases its dividend year after year.

        I also hold JPI which yields about 8% but Is more leveraged. And I’m concerned about it in a rising rate environment.

        The time limit seems to be causing me problems in responding here. I apologize if I double post.
        I appreciate your blog and your views. Just sharing mine.

        • otcadventures says:

          I appreciate you taking the time to share your views. Sorry if I was short earlier, I do get a lot of comments that clearly did not read past my first paragraph and it gets tiring. Not saying you did that. I guess we’ll see where the preferred units trade, yield-wise. SO deserves its valuation, with its valuable regulated assets. So does JPI, which has the risks you identified. I would place SPLP preferred units between those issues on the risk scale.

  2. Doug says:

    Thanks for another interesting find.

    I would attribute part of the discount to the “K-1” factor. Does anyone reading this post currently own Steel Partners LP and receive its K-1? I am curious as to the amount of UBTI SPLP generates and in how many states do partners owe taxes in. If the UBTI is small, this would be a good IRA candidate so as to avoid the extra tax paperwork.

  3. Vincent says:

    Thanks for the idea. I understand the reasoning that the share price should increase considerably after the amended merger agreement. On an absolute level, you mention that an IRR of 6.7% seems fair to you. Can you maybe provide some more color on why that seems fair? I have no experience in valuing preferred shares at all.

    • otcadventures says:

      Preferred stock can be valued a lot like a junior credit obligation, depending on its characteristics. This particular preferred is cumulative and has a maturity date, so it is in fact almost exactly like high yield debt. The cost/required return on this preferred stock ought to be somewhere between the cost of Steel Partners’ senior debt and the cost of its common units.

      As of Sept. 30, Steel Partners’ effective cost of borrowing on its revolving credit facility was 2.4%. Probably a little higher now with the rise in rates, but the cost is still below 3%. I would put the cost of equity for the common units at 10-12% based on the small size of the company and complicated structure. So the yield on junior credit obligations ought to fall somewhere in between. Anywhere from 5.0-7.5% would be a defensible cost of credit in my view, based on the company’s capitalization.

  4. whocares says:

    I also note that Gabelli decreased his holdings recently when he knew or had good reason to know the deal would be amended.

  5. Paul Gagnon says:

    I have a lot of history with SXCL, going back to 2007 when Steel Partners began to acquire stock in Adaptec, Inc (then ADPT, not related to the current ADPT). The short story: Steel Partners drove the stock from $30 down to $9 by buying loser companies. There were about $300M in NOLs (Net Operating Loss carryforwards) on the books at ADPT, now there are over $400M due to their poor business decisions (or maybe they were intentionally creating a “bad bank” out of SXCL and cashing in elsewhere). The NOLs of SXCL are SPLP’s primary interest in squeezing out the minority shareholders. Why else would they be doing this? Just search the 2015 10K for “NOL”. In 2018 some restrictions on the use of the NOLs will expire. SPLP will be able to earn its money “tax free” for quite a while, just as Donald Trump did. The value of the NOLs are not considered anywhere in this much-ado-about-nothing complex offer of $17.80.

    • otcadventures says:

      I agree that the tender price is too low. Steel Partners does not have a track record of treating minority shareholders fairly.

  6. Fabrication says:

    Hey, thanks for this. Isn’t a put or call option bullish or bearish-ness dependent on if it is bought or sold?

  7. Corten says:

    I’d like to attribute a portion of the reduction to the “K-1” factor. Are you reading this blog post? Does anyone have Steel Partners LP and receive its K-1? I’m curious about what amount UBTI SPLP generates and in what states partners have to pay taxes. In the event that UBTI is low then this could be an ideal IRA candidate in order to not have the additional tax-related paperwork.

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