Gleacher &  Co. is liquidating.  For the VIC members who invest in liquidations, you’ll know this space is in a drought.  Due to reductions in NAV and today’s delisting, we think there’s an opportunity to invest in a relatively large liquidation at favorable prices.  You’d be risking about 8% to get an annual return of 10 to 50%, depending on the amount and timing of subsequent distributions.

The company announced their intention to liquidate in March of this year after failed attempts to turn around and/or sell their investment banking and trading operations (they hired Blackrock in August of 2013 to look at strategic alternatives).  They ultimately decided to liquidate.

The original range put forth by the company was $9.70 to $14.55 per share.  On the Friday before the 4^th of July week, the company announced that they were taking down their original range to reflect additional wind down costs and lower values for their VC portfolio (“FATV”).  The new range was $8.90 to $13.75 per share, sending the shares down sharply the following week.

The shares have been weaker yet again on, what we believe to be, non-fundamental selling due to the 7/17/14 delist.  The shares are now being quoted on the Pinksheets by at least 8 different market makers / ECNs.  The company de-registered today by filing a Form 15-12G.  Transfer books are closed. If you held your shares in physical certificate form, you can’t move them into Cede & co (or “DTC”) in electronic form.  Cede & co. is the holder of record, so regardless of the record date, as long as the shares are listed on the Pinksheets,  FINRA will set payable and ex-dates for subsequent distributions that will allow the shares to trade and still claim future distributions.

The updated range provided by the company is $8.90 to $13.75 with an initial distribution of $3.23 coming shortly (as early as August).  The difference from the original estimate is $5mln, with $3mln coming from increased wind-down costs and the remaining $2mln coming from reduced values from FATV and their other investments.

The liquidation will last three years, and the company will pay out the remaining net assets in lumpy distributions.  There is a chance that the initial distribution gets bumped higher given the recent sale of one of the portfolio companies in FATV.  We asked the company why, given this sale, the initial wouldn’t be higher.  Their response was that the board had not met since the FATV portfolio company sale and so, it was prudent to leave the language the same re: the initial distribution.

In short, investing in this liquidation is about three things.  First, how much money will the portfolio companies and other non-cash assets generate? Second, mitigating liabilities and reversing accruals to push the NAV towards the higher end of the range. Third, the timing of the distributions.  Typically, companies that liquidate tend to payout closer to, if not above, their upper range.  Unfortunately for those invested in Gleacher soon after the liquidation was announced, that has not been the case.  It is difficult to believe that the range will be reduced again.  Companies have no incentive to inflate the range of liquidating distributions and they typically over-reserve.  Every $6.2mln in Reserve and wind-down reversals adds a $1/shr to NAV.

As of the last filing (March 2014 #s in $ millions), the adjusted breakdown is:

Assets

Cash                                    $62.5                    $10.11/shr

FATV/other*                      $17.5                    $2.83

Net non-cash assets          $4.4                      $.72

Totals                                  $84.4                    $13.65

Liabilities

Wind-down**                    $12.9                    $2.09/shr

Compensation                    $3.7                      $.59

Reserves***                       $29.5                    $4.78

Totals                                  $46.1                    $7.46

NAV                                    $38.3                    $6.20

Initial distribution             $20.0                    $3.23

Remaining Stub                 $18.3                    $2.96/shr

Add:

Reserve adj                        $20.0                    $3.23

Wind-down adj                  $6.5                      $1.05

Adj NAV                            $64.8                   $10.47

.* see bottom of report for disclosure from 10K for valuing FATV.

.** the wind-down expenses were bumped up by $3mln due to “increased legal fees and other expenses related principally to ongoing litigation”.  We spoke to the company on this.  They said that the increase was part liability mitigation and part asset recovery, but would not elaborate. We find it hard to believe that the entire bump could be for the pending arbitration with the former CEO (“Hughes”) and COO (“Griff”).

.*** Reserves are broken down into: $7.9mln in change in control payments to former CEO & CFO + legal fees if GLCH loses; $7.5mln related to ClearPoint/Homeward sale (Gleacher was in the business of selling residential mortgages and sold the business in February ’13); $3mln in potential tax claims; the balance being “other”.

At today’s price of ~ $9.70, if you net out the $3.23 initial distribution, you are paying $6.47 to get $5.67 to $10.52 per share.  Using our adjusted NAV, you are paying  $6.47 to get $7.24. With the arbitration with the former CEO and CFO set to occur later this year, and the monetization of the remaining portfolio companies in FATV, you could see another sizeable distribution coming by early 2015.  We don’t think the arbitration with Hughes and Griff is binary. We’ve been part of an arbitration that looked pretty black and white only to see a gray outcome (in that the outcome was not favorable but the liability was much less).

If you make the assumption that they settle for $2.5mln in the arbitration (which would free up about $7.5mln givent eh $7.9mln reserve + plaintiff’s legal fees) and you monetize another $2.5mln of FATV, in addition to the $9 to $10mln from the recent FATV sale, you could see a distribution of $19.5mln in early 2015, which would be $3.15/shr. By that time you’ll have received $6.38 of the $9.70 invested at today’s prices.  The stub at that time would be $3.31 against potentially $4.09 (from our adj range) to $7.32 (the company’s high NAV).  

So, getting $4.09 in one lump sum 2 ½ years after the estimated early ’15 distribution earns you an annual return of 10% and the high end would earn you a return of close to 50%.

Arbitration:

Clearly this is the largest single liability.  CFO and COO seeking $7.9mln + attorney fees.  This centers around change of control payments that were allegedly trigged back in August 2012 (see Aug 2012 8K for the Retention Agreement).  They commenced the arbitration proceeding in September 2013.  It looks like the trigger for the change in control involved the shake-up at the board level whereby Hughes and Griff claim that the incumbent board failed to represent a majority after Matlin Patterson gained control.  However, Matlin Patterson specifically mentions this issue in their own proxy and ended up reducing the total number of board members from 9 to 5 to avoid this change of control provision and left three of the incumbents on the board.

Conclusion:

The downside appears limited.  Historically, liquidations over reserve and distributions come quicker than anticipated.  The upside (to $13.70) relies primarily on the reduction in liabilities, and to a lesser extent, FATV’s value coming in over the current estimated value.

Risks:

Remaining companies in the VC portfolio are not monetized for the current projected amounts.

The arbitration against the former CEO and CFO costs the company the $7.9mln + attorney’s fees.

The $7.5mln in reserve for the ClearPoint/Homeward sale does not come back to the company

Other unknown contingent liabilities show up and cost the company even more money.

Delays in distributions reduce IRRs.

The trustee sets up a liquidating trust for the remaining assets at some point and the shares cease to trade.

FATV valuation methodology from 10K:  

Unobservable Inputs—December 31, 2013

Valuation Technique                       Unobservable Input                         Range (weighted avg)

Market comparable co’s  EV/Rev multiple                                              2.7x -7.0x (5.5x)

                                             Discount applied to multiples                       30-35% (30%)

VC method                         EV/Ebitda multiple                                                        5.0x

                                             Discount applied to multiples                                      55%