Description

In January 2017, we published a VIC write up which presented Ambase as a “little-known opportunity to invest at a discount alongside well-respected developers in a high-profile, luxury high-rise residential tower under construction at 111 West 57th St. in NYC.”  

Since that time, as we updated in the comments, Ambase has potentially lost its investment in the development project due to foreclosure.  The foreclosure was surprising as there was apparently third-party capital available to correct the “out of balance” condition in the mezzanine construction loan.  Nevertheless, at this point in time, ABCP shareholders will likely no longer benefit directly from the real estate project.

Despite the foreclosure process, our assessment of Ambase’s ongoing lawsuit against its Joint Venture partner, the Developers of the project, leads us to conclude that ABCP presents an interesting, if risky, litigation stub opportunity at the current price.

This opportunity presents a riskier profile as the concrete margin of safety might be zero. However the risk-reward trade-off might prove attractive. We identified the Equity Put Right (discussed below) as part of the margin of safety in our initial write up.  While we are disappointed to find the company in this situation, setting aside what was or could have been and focusing on the merits of the opportunity today, we think the new set of circumstances is worthy of consideration.

Given this is a new thesis and a different opportunity, we have prepared this new writeup.

SUMMARY

• Special situation: thinly traded litigation stub.

• CEO (and 40% shareholder) recently agreed to underwrite the litigation on a contingent basis.  If Ambase receives no cash from litigation, CEO will not be reimbursed for litigation advances.

• ABCP is legally pursuing a contractual Equity Put Right that, if enforced, could give Ambase a 20% IRR on its investment in the development project - an amount currently in excess of $136mm (reference paragraph 47).

• Current market cap: $10mm

• A legal settlement that merely recouped ABCP’s investment in the foreclosed project would result in gross payment to Ambase of ~$70mm.

• Defendants’ Motion to Dismiss the initial case (Index No. 652301/2016, Sequence number 006) is pending.  It was filed in November 2016.

• Tax loss selling may further pressure price in near term.

• Existing 20%+ holder recently added to their position in high $0.20s.

• Recent article about the current situation.

OVERVIEW

In June 2013, Ambase purchased an equity interest in a real estate development property through a joint venture with two New York real estate development firms, JDS Development (Michael Stern) and Property Markets Group (Kevin Maloney), collectively, the “Developers”.  The JV was established to develop a luxury condominium at 111 West 57th Street.  The building is nearly half built.

In June 2017, Spruce Capital, purchased a $25mm piece of the project’s existing mezzanine loan from Apollo Commercial Real Estate Finance. Days later, Spruce declared an event of default and initiated a foreclosure proceeding upon Ambase’s AND the Developers’ equity interests in the building.  On August 30, 2017, Spruce issued a Notice of Retention of Pledged Collateral in Full Satisfaction of Indebtedness. By accepting the pledged collateral, pursuant to a Strict Foreclosure process, Spruce claims to have completed the retention of the collateral pledged by the junior mezzanine borrower, and therefore, the Company's interest in the 111 West 57th Street Property.  That investment represented substantially all of the Company's assets and net equity value.  

Ambase is appealing the foreclosure but wrote off its entire investment in the project as of 9/30/17 while it continues to pursue two lawsuits against its JV Partners (and the Mezzanine lender).

The first lawsuit (New York State Supreme Court for New York County (the "NY Court"), Index No.  652301/2016), was initiated in April 2016.   We will refer to this as the “Put Lawsuit.”

In the second lawsuit, filed with the NY Court on July 25, 2017, the Company filed a complaint against Spruce and the Sponsors and requested injunctive relief halting the Strict Foreclosure. Index No. 655031/2017. We will refer to this as the “Foreclosure Lawsuit.”

The Foreclosure Lawsuit is on appeal after ABCP suffered a setback in the NY Supreme Court (not “Supreme” in the Federal court sense) as the company points out in the most recent 9/30/17 10Q.  My emphasis added:

“Pursuant to the Strict Foreclosure process, Spruce Capital claims to have completed the retention of the collateral pledged by the junior mezzanine borrower, and therefore, the Company's interest in the 111 West 57th Street Property.  That investment represents substantially all of the Company's assets and net equity value.  The Company's motion for a stay or injunctive relief pending appeal has not yet been resolved. 111 W57 Mezz Investor, LLC and Spruce Capital Partners LLC filed an opposition to that motion and the Company filed its reply brief.”

For the purposes of this write-up, we focus on the Put Lawsuit and we assume ABCP is not successful with its appeal in the Foreclosure Lawsuit.

THE PUT LAWSUIT

In its Second Amended Complaint (“SAC”) in the Put Lawsuit, Ambase alleges that the developers (Defendants) “engaged in an unlawful scheme to dilute Ambase’s equity interest in the joint real estate venture…” and “that defendants have failed to honor the exercise of Ambase’s equity put right.”  Ambase raises a number of issues in the lawsuit, but our focus is on the Equity Put right and the arguments from both sides related to the Put.  We believe the Put, which entitles Ambase to a 20% IRR on its investment in the project, is a crucial element in the matter given both the leverage it provides and the concrete anchor value with respect to possible damages. Based on our reading, we don’t find the defendants’ arguments particularly compelling.

The Developers had sole control over the project budget.  Their entity, referred to as “Sponsor” in the filings, served as the developer and construction manager for the project. Roles for which they received tens of millions of dollars in fees, payroll and reimbursed expenses.  Furthermore, to the extent that some of the budget overruns should be considered “Manager Overruns” as defined in the JV Agreement, they would be obligations solely of the Developers and not the Joint Venture.

Here is how Ambase makes its case in the SAC.  After alleging budget problems in paragraphs 88-90 and 94, ABCP presents its argument in favor of the exercisability of the Put Right based on a budget received on August 12, 2016 (“the August 2016 Budget”).  “Sponsor” is the Developers’ entity. “Investment” is Ambase’s entity:

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Reference link - Note that the document referenced above as “JDS_PMG 0000028-29” is completely redacted.

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Here is the Developers’/Defendants’ Response. (“Investment” is Ambase’s investment entity):

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Reference link

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From our perspective, what is of interest in the Defendants’ reply is what they do NOT say:

• They do not dispute that they neglected to provide budgets as required by the JV Agreement

• They do not dispute the numbers in the August 2016 budget showing the project is materially over budget

• They do not dispute that the numbers in the disputed budget would trigger the put right

Instead, the Defendants appear to rely on the fact that the disputed budget was never “submitted” for Investment’s approval and therefore, if it was not submitted for approval, how could Investment disapprove of it?

Ambase filed a memorandum in opposition to Defendants’ Motion to Dismiss restating its view regarding the Put among other items.

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Reference link

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Subsequent to the filings referenced above, in December 2016 the Developers approached Ambase with a request to approve a dilutive financing led by Baupost according to a transcript of a January 30, 2017 court appearance.  This transcript indicates that Ambase considered approving the financing, but requested more information from the Developers before doing so.

Included in the Baupost investment approval request was a new budget, the “December Proposed Budget.”  In a subsequent filing, Ambase alleges that the December 2016 Budget had been “manipulated in an effort to avoid triggering Investment’s [Ambase’s] Equity Put Right” (per Ambase’s Foreclosure Case Complaint paragraph 40-47).  In the excerpt below, note that “Related Action” refers to Index No.  652301/2016:

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Reference link

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In a consequential decision, Ambase ultimately withheld its consent for the Baupost financing.  In the 9/30/17 10Q, Ambase explains its decision as follows:

“The Company considered approving the additional financing, but informed the Sponsors that it had concerns about the Proposed [December 2016] Budget and the implications of the Proposed Budget, as well as other questions which needed to be addressed first.“

Why would Ambase withhold consent for the Baupost financing?  Certainly 17% interest is dilutive, but clearly it is preferable to foreclosure.  Approval of the December 2016 budget would likely have represented Ambase’s acceptance of the budget increases to date, and therefore it would have obviated their right to exercise the Equity Put Right as it related to those increases.  Given the state of the relationship between Ambase and the Developers at that time and/or the state of the project and/or the market for ultra-high end real estate, perhaps Ambase thought they would rather exercise their right to put their stake to the Developers and take their 20% IRR and go home.  Ultimately, Bianco and their legal team must have concluded that pursuing the Put Right, even in the face of possible foreclosure, was the optimum strategy.

The Developers attempt to portray Ambase as the cause of the foreclosure since it did not consent to the Baupost Financing.  However, Ambase claims they proposed a separate financing that took into consideration that a portion of the additional required capital was due from the Developers as a result of Manager Overruns (Manager Overrun Contribution).  The Developers apparently rejected this proposal, as shown here:

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Reference Link

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The lack of new financing (from Baupost or anyone else) to remedy the ‘out of balance’ condition of the mezzanine loan ultimately led to a foreclosure, by Spruce Capital, on the equity interests in the project.  Remarkably, the Developers did not join Ambase in objecting to a “strict foreclosure” and seeking a “foreclosure sale” as was their right.  Just weeks before the foreclosure commenced, the $25mm Jr. Mezzanine Note was sold to Spruce at par and the Mezzanine lender (Apollo Commercial Real Estate Finance - ARI) indicated this was evidence that their more senior loan was unimpaired.  Furthermore, ARI indicated some condos in the building had already gone under contract.  Given these circumstances, it is unfathomable that the Developers did not seek to sell the collateral securing the Jr. Mezz. note (the equity in the project) in a Foreclosure Sale and allow themselves the opportunity to recover any value in excess of the ~$25mm owed to Spruce for the JV.  Nevertheless, they did not, and Ambase alleges a back door deal with the lenders is the only explanation.

While Ambase appears to have lost its interest in the development project, the Developers continue to build the building and presumably collect fees. Construction has continued unabated throughout the foreclosure dispute.  

INVESTMENT THESIS

• Intriguing risk/reward trade-off given current stock price ($0.25).  

• A negotiated settlement equal to just 25% of the value the Equity Put Right would produce attractive return. (See analysis below)

• CEO, who has best knowledge of the lawsuits’ strengths and weaknesses, has agreed to personally fund litigation with no guarantee of repayment

• Public filings in lawsuits indicate Developers did not adhere to JV Agreement obligations to file budgets for approval – Undisputed by either party

• The budget grew by more than $50mm from the last “approved” budget dated June 2015 – Undisputed by either party

• August 2016 Budget apparently triggered Put Right, but Developers say it was not “submitted” for approval

• December 2016 Budget was “submitted” but Ambase alleges it was “manipulated” to not trigger the Put Right

• According to Ambase, legal discovery has yielded at least one other document to support its case based on this May 10, 2017 letter from Ambase’s attorney to the presiding judge, Justice Bransten

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Snippets of Letter to Justice Bransten:

• 

• [………]

• 

• 

Reference link

Link to Affidavit of Kevin Maloney referenced above

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• Growth of the budget was the proximate cause of the loan’s “out of balance” condition, which ultimately led to foreclosure by Junior Mezzanine Lender.  Ambase argues this is precisely a circumstance the Equity Put Option was intended to avoid.  The Developers agreed to give Ambase this right in the JV Agreement in exchange for control over development of the project.

• The complaint in the initial action has been filed, a motion to dismiss is pending and discovery is ongoing.  The Motion to Dismiss was initially filed in November 2016.

• If Motion to Dismiss is rejected, Developers may be motivated to explore settlement to remove cloud of lawsuit as condos in the building officially hit the market.

POTENTIAL PAYOUT VALUE PER SHARE

Following is an analysis of possible payouts to ABCP based on these assumptions:

• Bianco funds $7mm of litigation expenses per his funding agreement

• Settlement received at end of three year window from date of litigation funding agreement (9/26/17), but within 30% Bianco share period.

• CT office building is sold and net proceeds repay all estimated working capital loans provided to ABCP by Bianco

Similar assumptions except:

• Settlement received four years from date of litigation funding agreement (9/26/17), therefore within 45% Bianco share period.

WHY IS IT CHEAP?

• It’s a litigation stub

• Uncertainty of the lawsuit’s merits and eventual outcome

• No margin of safety

• Thinly traded nano-cap

RISKS

The downside scenario with ABCP is a total loss.  There is no margin of safety if both lawsuits are decided against Ambase. CEO Bianco is personally lending to the Company to fund working capital and litigation efforts and Company has no assets other than an office building in Greenwich, CT that is pledged as security for the Bianco working capital loans.  The Defendants are better capitalized and can likely extend litigation to try to stress Bianco’s liquidity and appetite for litigation.  Yet, Bianco has experienced a success in protracted litigation with a better-funded opponent (the Federal government) before.  He may have the desire and cash to persist. Furthermore, even if the Developers have the cash to protract the litigation they will have to weigh the cost of settling vs. the cost to the development project of ongoing litigation.  Will prospective buyers pay tens of millions of dollars for a condo in a project beset by litigation?

Another risk is a judgment in favor of Ambase but against an entity that cannot fund it.  As it is written the Equity Put is against “Sponsor”, which is defined as "111 West 57th Sponsor LLC".  A look at the corporate structure seems to indicate that this entity does not have assets to fund a settlement given the foreclosure.  However, given Bianco is putting up at least $7mm of his own money to litigate this, it seems reasonable to assume that his legal advisors have a strategy to find settlement monies.

Given the structure of the Bianco Future Recovery Litigation Funding Agreement, there appears to be an incentive mismatch after the initial three-year period expires on 9/26/20.  As shown below, assuming Bianco’s share of the litigation recovery is fully taxed at current Federal income rates (he appears to be a FL resident, so no state income tax), he might benefit if settlement occurs after three years plus one day when his share percentage increases from 30% to 45%.  The current Ambase board is not particularly independent so it is not clear what role it would play in addressing this issue.  However, this will only be a potential problem if there is in fact, a recovery of some amount.

Finally, the Developers appear to have outmaneuvered Ambase as it relates to the initial court ruling in the foreclosure matter.  It may be reasonable to ask if Ambase brought a knife to a gunfight.

CONCLUSION

Bianco has made clear at shareholder meetings that a lot of time was spent negotiating the issue of control in the JV Agreement with the Developers.  In exchange for giving the Developers project and budget control, Ambase received the unusual Equity Put Right as an emergency escape hatch.  The undisputed growth in the Developer-managed budget created an emergency.  Shouldn’t Ambase be allowed to exercise its right to escape?

Catalyst

• Action on Defendants’ Motion to Dismiss initial lawsuit