Description

I originally heard about this idea from Ycombinator on the MMPIQ thread.  Some of this information can be found on that thread, but I think the idea deserves its own space and a more detailed description.  I’ve tried to consolidate information about the liquidation from various sources to try to discover an indication of recovery.  In my opinion, it’s trading at the bottom of its ultimate payout range, and has an imminent catalyst. 

HearUSA– here is a company description (although it’s irrelevant at this point because HEARQ is a liquidation, and a fairly straightforward one):

HearUSA Inc. (“HearUSA” or “the Company”), a Delawarecorporation, was established in 1986. As of July 2, 2011, the Company had a network of 170 company-owned hearing care centers in eleven states, including HEARx West centers inCalifornia. The Company also sponsors a network of credentialed hearing care providers, with over 2,600 access points, that participate in selected hearing benefit programs contracted by the Company with employer groups, health insurers and benefit sponsors in 49 states including HEARx West centers inCalifornia.  The centers and the network providers provide audiological products and services for the hearing impaired.   The Company is also the administrator of the American Association of Retired Persons (“AARP”) Hearing Care program, designed to help members of AARP who have hearing loss. On May 16, 2011, the Company filed a voluntary petition for reorganization relief under Chapter 11 of the U.S. Bankruptcy Code.  See further discussion of the Chapter 11 Case described in Notes 3 and 12 below.

There are 39mm shares outstanding.  The company has 57.5mm in cash on the balance sheet, as of 10/31/2011.  Of that 57.5mm, a little over 5.1mm in escrow for winddown and professional fees + escrow funding for pre-sale expenses, leaving the debtor with 52.4mm of cash afterwards.  As ycombinator mentioned on a previous thread, 5.1mm seems very high in light of their recent expenditures.  In October, total disbursements were $217k.  Most of the heavy lifting has been done already – the 363 sale has been completed and cash is in the bank.  Professional fees should be negligible going forward.

For the purposes of this write-up, I’ll conservatively say that the entire 5.1mm is used, which leaves 52.4mm of cash.  As far as I can tell, the only potentially substantial payment that remains is for taxes.

Now, according to docket 364,

http://cases.bms11.com/Documents/FL76/11-23341-EPK/ECF_DOC_364_11954855.pdf

(I will cut and paste to save you the trip to the site):

(Omnibus Objection to ( 326 Objection filed by Creditor Siemens Hearing Instruments, Inc., 339 Objection filed by Interested Party The Official Committee of Equity Security Holders) Filed by Debtor HearUSA, Inc. (Attachments: # 1 Exhibit A) (Gart, Brian) (Entered: 07/29/2011)

Tax Losses

42. The Equity Committee asserts additional time is needed in order to analyze

certain tax attributes and the ability of the Debtor to utilize those attributes to reduce any gain on

the proposed sale, or whether the tax attributes are better preserved to apply against future

income in the context of a Chapter 11 reorganization structured either on a standalone basis or in

the form of some other form of non-sale transaction.

43. The problem with this request is two-fold. First, based upon current estimates, it

appears that there will be a sufficient net operating losses to sufficiently offset any tax liability

such that there will be relatively small tax due on account of the proposed sale based upon the

initial Demant and Siemens’ bids, and that there will be more than sufficient cash from sale

proceeds to pay such tax. Second, the Debtor has previously explored every avenue and quite

simply does not have the financial wherewithal to wait around for the mere possibility of a

potential, and as of yet unknown, possible future transaction, particularly not at the expense of

the proverbial bird in the hand that will result in unsecured creditors being paid in full, and the

likelihood of a distribution to equity.

It appears that the expectation was that the taxes would be negligible for the initial bids.  The final bid, 109.9 million, was ~30mm higher than William Demant’s initial stalking horse bid.  Even if we assumed that 80mm was the inflection point for the tax basis, and anything above 80mm would be taxed, using a 35% tax rate we’d arrive at a 10.5mm tax liability.  Using that “full” tax liability, we’d be left with 52.4-10.5, or around 41mm in cash.  Since there are 39mm shares outstanding, in this scenario, I see a recovery of 1.05 (41mm/39mm).  It’s unclear to me what should be included to calculate the tax basis, but I do think there is the potential for 109.9mm to be too high, as some assets/consideration might not have to be included, which would lower the tax liability.

As a sanity check, notice this document 497, p13:

http://cases.bms11.com/Documents/FL76/11-23341-EPK/ECF_DOC_497_12698780.pdf

Note that $1 is the assumed recovery for their options analysis.  Earlier in the doc, note this line on page 5/13:

“A schedule of the unvested options with an exercise price of less than $1.50 per share is attached hereto for illustration purposes only as Exhibit “B”.  Based on the Debtor’s estimate of options likely to be capable of exercise pursuant to the relief sought herein, it appears that the additional shares would result in a further limited dilution and cost to the estate of not more than approximately $210,000.00.”

In other words, the Debtor thinks the recovery should be ~$1.00.

As a final data point, remember:

“In addition, Siemens has agreed to an unconditional waiver of its right to receive any distribution with respect to the 6.4 million shares of the Company's common stock that it owns in the event that the sale to the Purchaser under the Siemens APA is consummated. For purposes of the bidding in the Section 363 auction, the Company estimated the value of the waiver of distribution to be in the range of $6.0 to $7.0 million, subject to final reconciliation of assumed liabilities, excluded liabilities, taxes and common stock dilution effects of the transaction.”

Using Siemens math, they think the minimum distribution should be $0.93, or just about where the stock has recently been trading, and it could be as high as $1.09. 

Although none of these numbers are concrete, the all seem to indicate that $0.93 should be closer to the minimum of the range of ultimate recovery, and better base case would be $1+.  Probably other VIC’ers will see higher recoveries, and I see how they can get there, but for the purposes of this write-up, I wanted to be conservative.

Timing:

I’m posting this idea now because I think there is a quick catalyst to release the value in the shares.

Previously, on the Debtor’s second motion to extend exclusivity, the Equity Committee commented that they would not object to the second extension, but reserved rights to object to a third, indicating that they were disappointed that the Debtor needed more time.  However, in this recent doc:

http://cases.bms11.com/Documents/FL76/11-23341-EPK/ECF_DOC_566_13439833.pdf

it’s noted that the both official committees supported the relief, and that the exclusive period ends on Jan17th.  The Debtor anticipates that this will be the third and final request for the relief sought herein, and they will seek authority to expedite the plan, ie a no-vote confirmation. 

As Ycombinator noted, “Per s.505 of the BK code, the IRS has 60 days from the filing of the return to notify the Debtor if they want to audit the return.”

I don’t know if the taxes have been filed, but seems like they should be filed before Jan17th.  While the process could take longer, I don’t see any reason why this shouldn’t be wrapped up in 3-4 months, and probably shorter, because of the relatively small tax liability.  Either way, I think when the plan is filed on Jan17th, the uncertainty of the tax overhang will be lessened, and the shares will trade closer to their ultimate recovery value.

Overall, I view this as an uncertain situation where we should recover at least $0.93, likely somewhere from $1.05-1.09, and potentially more if things better than expected.

Catalyst