Description

Thesis

Syncora Holdings equity is trading at a valuation of ~$27mm (~$0.31 /share) while we think that it is worth ~$52mm ($0.60 /share), which equates to the shares trading at 52% of intrinsic value on a levered basis (32% on an unlevered basis) and offering an estimated ~126% IRR.

Syncora Holdings has commenced a voluntary liquidation and its equity trades at a valuation of ~$27mm, but we think it is worth ~$52mm. We estimate Syncora's equity is trading at 52% of intrinsic equity value, and at 32% of unlevered intrinsic value. We project a ~126% IRR assuming a ~1-year duration on liquidating cash flows.

Our valuation of Syncora Holdings equity is comprised of six components:

1. +$22mm in cash

2. +$19mm in Detroit Real Estate (~9 acres near downtown along the river + a $6.0mm discount certificate to buy real estate from the city)

3. +$15mm for an 80% stake in Swap Financial Group (“SFG”), a boutique advisory business that provides interest rate swap advice and valuation work to municipalities

4. +$3mm for its investment in Crown Global Insurance

5. -$8mm for litigation liability (Principia Partners, a software vendor of Swap Financial Group, is suing claiming it's been underpaid)

6. +$1mm for net cash generation (corporate & wind-down expenses offset by cash generation)

We estimate a weighted average duration for this voluntary liquidation of ~1 year. The timing of cash returns will be primarily driven by 1) the timing of the sale of the Detroit Real Estate assets, and 2) the timing of a sale of Swap Financial Group (which will likely be held up until the litigation with Principia concludes either through a settlement or ruling after a trial).

We think this opportunity exists for the following reasons:

• This is a voluntary liquidation and an investment in Syncora is only 6% of what it was pre-January 2020 distribution, resulting in this being a tiny stub position for previous shareholders, which in turn has likely triggered some indiscriminate selling

• Additionally, the small size of the stub results in an asset that is different from the prior assets and thus is not well understood

• The Detroit Real Estate assets have been held on the books at $0 (vs our valuation at ~$19mm or ~70% of the market cap)

• The 80% stake in Swap Financial Group was valued on the balance sheet at $1.3mm as of 9/30/20 (vs our valuation at ~$15mm)

• Most liquidations burn cash as the company winds down, but this situation should generate cash instead as Swap Financial Group is a cash generative asset that should be around until the bulk of the operations are monetized and distributed

• The maximum amount of $ that can be put to work in this investment is capped for most people at a mere $1.3mm (not allowed to own ~5% or more of shares outstanding without Board approval as per the "bye-laws")

The primary risk is the compound result of two negative outcomes -- 1) Principia is successful in piercing the corporate veils of Swap Financial Group and the intermediate Syncora HoldCos such that Syncora Holdings Ltd. is held liable for damages, and 2) the damages (and ultimately the judgment) is much larger than currently anticipated. On May 11, 2020, the NY Supreme Court entered an order dismissing Syncora from the lawsuit; Principia filed for appeal on 6/1/20 and the appeal is currently pending.

Valuation – Real Estate

Syncora’s real estate assets are held within its Pike Point subsidiary (the equity of which is owned by HoldCo – which is relevant later given the Principia litigation discussed later). Through Pike Point, Syncora effectively owns two lots of land called the Jefferson Lot (2.1 acres) and the Chene Lot (6.8 acres). The Chene lot is owned outright and the Chene Lot is effectively owned via an option to buy the land at a $0 strike (instrument came out of the Detroit bankruptcy). These two lots are adjacent to each other, and together represent 8.9 acres of land near downtown Detroit and sits alongside the Detroit River.

We estimate the land is worth ~$1.5mm per acre in our Base Case for an aggregate value of $13.4mm. Our $1.5mm valuation is supported by the following 3 transaction comps that we think are the most relevant (with a haircut for the COVID disruption):

• $2.16mm per acre – 249 Chene Street and 241 Chene Street sold on 8/4/15 and 8/16/15 respectively for a total price of $0.95mm for 0.44 acres (Note that this 0.44 acres of land when combined with the 6.9 acre Chene Lot constitutes the entire block)

• $1.82mm per acre – 2.75 acre Atwater Property that Pike Point sold on 11/20/18 for $5.0mm; this lot sits only 3 blocks to the west (towards downtown Detroit) of the Chene and Jefferson lots; additionally, we would note that this lot while a little bit closer towards downtown is probably viewed as less strategic given its smaller size

• $1.81mm per acre – 3.1 acre property that is 4 blocks west of the Chene and Jefferson lots (and immediately adjacent to the west of the lot described directly above)

In addition to the 8.9 acres of land, Syncora owns a certificate that can be used to get $6.0mm of value when applied to the purchase of land from the city of Detroit. We value this certificate at 90% of face value or $5.4mm in our Base Case.

In total, we value Syncora’s real estate assets at $18.8mm ($13.4mm for the real estate and $5.4mm for the certificate).

Valuation – Swap Financial Group

Swap Financial Group is a small, boutique advisory business that primarily provides municipalities advice on their interest rate swaps. Syncora acquired an 80% stake in SFG in 2015 for an estimated ~$12.6mm (~$15.8mm implied 100% ownership valuation). Today, we value Syncora’s stake at $14.6mm (100% of SFG valued at $18.4mm). SFG’s revenue and UFCF have been fairly flat over the last ~5 years. And our valuation assumes the business is sold for ~6x estimated fully-taxed average UFCF for 2016-2019 of $3.1mm. Alternatively, if the business is never sold, given the company’s ~$281mm NOL resulting in ~$0 tax drag, our valuation equates to a ~22% UFCF yield.

Valuation – Crown Global Insurance

Syncora previously made a $4.9mm equity investment in Crown Global Insurance. We value this investment at $3mm which is consistent with its current liquidation-accounting balance sheet value.

Valuation – Litigation Liability

On 8/31/18, Principia Partners filed a complaint against Swap Financial Group in federal court (SDNY 1:18-cv-07998). Principia is a vendor of FSG and provided the company with swap valuation software from 2005 to 2018. The alleged facts, as per the complaint, are:

• On March 17, 2004, Defendant, a bond and swap advisor company, contracted with Plaintiff for access to Principia Analytic System ("PAS")

• The Contract required that Defendant pay Plaintiff two fees: (i) a fixed $18,000 per quarter fee, and (ii) a portion of the revenue SFG generated from reports created by PAS equal to 50% of revenue on the first $96,000 of annual revenue and then 25% of revenue thereafter

• After each quarter, SFG was required to disclose the amount of its qualifying revenue in reports

• On January 8, 2015, Syncora acquired an 80% stake in SFG

• In late 2017, Principia discovered a discrepancy in the customers in SFG's reports, as compared with the customers listed on SFG's website

• SFG also did not disclose the qualifying revenue associated with these unreported clients and failed to remit to Principia the contractually required fees for revenue generated from such clients

• Principia notified SFG of these discrepancies on 2/1/18, SFG admitted in a letter dated 2/22/18 to omitting customers

• After Principia's attempts to conduct an audit of SFG's records were unsuccessful, Plaintiff terminated the Contract effective 6/17/18

The complaint's causes of action were 1) breach of contract, 2) breach of duty of good faith and fair dealing, 3) misappropriation of trade secrets under the DTSA, 4) misappropriation of trade secrets under New York State common law, 5) fraud, and 6) negligent misrepresentation

The complaint sought a judgement for a) damages equal to unpaid fees with 1.5% per month interest, b) punitive damages, c) cost of investigating and auditing SFG's fraud, and d) attorney's fees

On 9/26/19, the complaint was dismissed from federal court without prejudice to be filed in NY State court as Judge Analisa Torres dismissed the sole federal law claim under the Defend Trade Secrets Act and declined supplemental jurisdiction over the remaining state law claims

On 10/22/19, Principia filed a complaint against SFG as well as the Syncora Entities (including Syncora Holdings Ltd.) in NY state court (656163/2019). The complaint's causes of action and defendants are:

• Count 1: Breach of contract - Underpayment of fees against SFG directly and the Syncora Entities as alter egos

• Breach of contract - Failure to submit to an audit against SFG directly and the Syncora Entities as alter egos

• Count 3: Fraud / fraudulent inducement against SFG directly and the Syncora Entities directly and/or as alter egos

• Count 4: Unjust enrichment against SFG directly and the Syncora Entities as alter egos

• Count 5: Aiding and abetting fraud against the Syncora Entities

On 12/6/19, the Syncora Entities moved to dismiss all of the causes of action. On 1/10/20, Principia opposed the motion. On 1/24/20, the Syncora entities filed a reply in support of their motion.

On 5/11/20, the Syncora Entities were dismissed from the lawsuit leaving SFG as the sole defendant; additionally, only the breach of contract causes of action against SFG were allowed to continue. 

On 6/1/20, Principia appealed the order dismissing the Syncora Entities from the lawsuit; the appeal is currently pending. The litigation against SFG pertaining to the breach of contract causes of action is currently proceeding through discovery.

Principia has not yet taken a firm stance on its alleged damages, but from its repeated use of the phrase “millions of dollars” combined with what we know about the max size of the fees that could possibly be owed to Principia (~25% of up to ~100% of all revenue with revenue averaging ~$6mm per year for the 6 years corresponding to the statute of limitations), we think the max damages are likely in the high single digit millions range pre-interest.

We think the arguments attempting to pierce the corporate veil to go after the Syncora Entities are very weak, and we think the probability that this litigation liability extends beyond SFG is remote.

Absent a revival of the veil piercing arguments through a successful appeal of the order dismissing the Syncora Entities, the absolute worst case for Syncora is that this liability consumes all of the value of its subsidiary SFG, which would still leave Syncora shareholders with the HoldCo cash, the real estate assets sitting in the Pike Point subsidiary, plus the investment in Crown Global.

Valuation – Cash Flow Burn/Generation

Unlike many liquidation scenarios, we think Syncora will not burn much cash as it winds down. In fact, we estimate net cash generation of $1mm. This happy result is a function of SFG steadily generating cash while future cash expenses should be light (2 employees left plus some litigation costs for the most part).

Conclusion

Syncora Holdings equity trades at $0.31 /share while we estimate it is worth closer to $0.60 /share. We think that ~$0.60 /share of value will be realized in our Base Case via liquidating distributions with an average duration of ~1 year resulting in estimated ~126% IRR. We think an investment in Syncora’s equity at current price levels comes with limited risk of loss as even in our Low Case, where we utilize lower real estate values in addition to assuming the litigation consumes all of SFG (and then some for any litigation related expenses paid by HoldCo), we estimate Syncora is worth $0.42 /share.

Additionally, for those concerned with short-term trading price levels, we think the current price level offers very attractive asymmetry given the COVID-related low for the security was ~$0.28 /share, which suggests the shares have only ~10% downside should Syncora re-test its March 2020 lows. 

Disclaimer

The views expressed herein are for informational purposes only, and are not intended to be, and should not be, relied upon as an investment recommendation in connection with any investment decision for any purpose or for legal, accounting or tax advice.  This information does not constitute an offer to sell, or the solicitation of an offer to buy, any security.  The author makes no representation as to the accuracy or correctness of the information contained herein and expressly disclaims any liability to any person from relying on such information.  The information and views contained herein are provided as of the date this summary was posted and present the views of an investor that currently holds a long position in the company’s securities.  The author has no obligation to update any of the information provided herein.  The author reserves the right, in light of, among other factors, its ongoing evaluation of the company’s financial condition, business, operations and prospects, the market price of the company’s stock, conditions in the securities markets generally, general economic and industry conditions, its business objectives and other relevant factors, at any time, to decide to purchase, sell, or engage in any other transaction involving, the company’s securities as it deems appropriate.   Past performance is neither indicative nor a guarantee of future results.  There can be no assurance that an investment in the company will be profitable or that the assumptions regarding future events and situations will materialize or prove correct. 

Catalyst

The continued wind-down of the company through the sale of its remaining assets and the discharge of its outstanding liabilities followed by distributions of its cash.