Thursday, March 26, 2009 2 comments ++[ CLICK TO COMMENT ]++

Anyone think Ambac will survive? Added Alliance Semiconductor (PK: ALSC) to watch list

Does anyone out there believe that Ambac will survive? I am specifically referring to the insurance company (and not the holding company).

Well, I ran across an interesting investment opportunity thanks to a write-up on ValueHuntr. A potential opportunity lies in the liquidation of a company called Alliance Semiconductor (PK: ALSC). Needless to say, anything that is uttered in the same breath as Ambac is a very high risk investment.

I'm not going to do a thorough write-up here (if you are interested read the ValueHuntr post, along with my long comment I left on that blog) and will simply summarize the situation.

Overview

Alliance Semiconductor, a tiny microcap worth less than $10 million, is undergoing liquidation. It has managed to liquidate everything except about $60 million of Auction Rate Securities (ARS). Unfortunately, the ARS market locked-up last year and the company was unable to sell its ARS. To make matters worse, the ARS securities were issued by entities called Anchorage Finance Master Trust and Dutch Harbor Finance Master Trust. These two trusts were created to provide emergency funding for Ambac whenever Ambac needed it. Not surprisingly, Ambac exercised its option last year and tapped $800 million in funding, and in return, it issued preferred shares to the trusts.

The preferred shares are issued by Ambac Assurance, the insurance subsidiary of Ambac. This makes them have a higher claim than the common shares of Ambac. Ambac Assurance cannot pay dividends to the holding company without paying these preferred shareholders first (there are some exceptions which allows the insurance company to pay money to cover operating expenses and debt costs.) I'm not an expert but my guess is that these preferred shares are subordinate to policyholders (always #1 for insurance companies), insurance company bondholders, and possibly holding company bondholders. The preferred shares will be senior to holding company shares of any sort.

Standard & Poors rates the preferred shares as BBB, but who knows how accurate these ratings are.

The preferred shares have no market and it never may. If there is no market, it will be extremely difficult for Alliance Semiconductor to monetize them. They will either sell them at a distress value to anyone that wants to buy them; or they will wait until a market develops, which can take many years (and may only happen after Ambac's future is certain.)


Right Now It's Up To Management

Alliance Semiconductor will, in the end, own those preferred shares. It is not clear what Alliance Semiconductor's management will do. There is a risk that management will unload the preferred shares at distressed values (basically close to nothing.) They will do this if they just want to wind down the operations and could care less about the value of the holdings.

Another possibility is that management will pass on the shares to shareholders.

They can also keep Alliance Semiconductor alive and collect the interest on preferred shares, and pay them out to shareholders periodically.

I have no idea what they are going to do. Whatever it is, anyone investing in the liquidation are hoping that the value is much higher than the share price they paid. There is a risk of management doing something stupid but it's hard to say.


Potential Return On Dividends

The preferred shares pay some low interest (something like LIBOR + 2%). It is not cumulative and Ambac doesn't have to pay that but it will suffer some big penalties if it does not pay (I think the preferred shareholders can elect two board members until dividends are paid for 4 quarters--I need to double-check this.) So, I think Ambac will only refuse to pay if it is well on its way to being taken over by the insurance regulator (basically equivalent to bankruptcy.) The amount Ambac pays is less than $20 million and the company, from all that I know of it, can easily cover it. However, one should still factor in the possibility of Ambac not paying anything to the preferred shares.

This low rate may actually be really high for Alliance Semiconductor shareholders. I have to double-check the numbers, but if Alliance Semiconductor owns, say, $50 million (easy to use number; actual number is slightly higher) then a 2% return (say LIBOR is zero) will be $1 million per year. Given how the market cap is less than $10 million, that's a 10%/year return (it's actually slightly higher for those buying today given how the current share price is lower.)


Distress Liquidation

If the preferred shares are sold at distress values to anyone off the street, it may fetch as low as 20% of par value. Ambac's exchange-traded bonds (AKF, AKT) are trading at less than 20% of par value (but these are bonds of the holding company whereas the preferred share are from the insurance company.) So a rough price, if you assume the pref shares will yield something simliar to the holding Co bonds is around 20% of par value. It can even be lower but I really think management will be acting incompetently if they tried to sell it for anything lower, especially if it still pays dividends.

If you think you will only get 20% then the book value needs to be chopped down by 80%. This yields a price of around $0.36 (using ValueHuntr's estimated liquidation value). This is only a 44% upside from current prices.


Looks Like a Low Return for High Risk?

A 44% return for an illiquid penny stock with many risk elements doesn't seem so great. Why would I even consider this?

Well, if you do think that Ambac will survive, or at least that the preferred shares can be sold near their par value, you have massive upside.

If you think you can recover the full amount listed on the balance sheet (i.e. can get 100% of par value), then, using ValueHuntr's numbers, you are looking at an upside of around 628%! Transaction costs, liquidation costs, management expenses, may cost a few percent of that. If you think you can only get half of the value, you are still looking at 300%+.

I don't know what management is going to do but if they transfer the shares to the shareholders, and if takes 5 years (a reasonable time to figure out if Ambac is truly insolvent) you will still probably receive a 25% to 100% per year return.

Having said all that, the investment in Alliance Semiconductor may end up as a zero if (i) management does something stupid, and/or (ii) Ambac ends up bankrupt without paying anything to the preferred shareholders.


The shares are thinly traded and if anyone is considering buying them, use a limit order and check with your broker ahead of time to see what the commissions will be. This is the type of investment that gives an edge to small investors (professional investors really can't invest in this company given its microscopic size.) I'll be watching this to see what happens. One should never invest based on the potential upside (this may turn you into a gambler) so the real question here is what the downside is.

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2 Response to Anyone think Ambac will survive? Added Alliance Semiconductor (PK: ALSC) to watch list

Jim
March 30, 2009 at 10:34 PM

Hmm. Why not just buy the exchange traded Ambac bonds? AKF trades at $3.81. If Ambac survives, then it goes to the $25 par and you've made more than 6x. On top of that, the annual coupon is $1.48. If you get five years of coupons that's another $7.40 bringing your total return to 8.5x. That seems to compare favorably to the potential upside on ALSC. And both are tied to Ambac's survival.

Anonymous
January 7, 2011 at 9:49 PM

I have a web site where I cover stocks and exchange traded funds under ten dollars. I am a astute value investor.  I would like to comment about alliance semiconductor forget about this stock why not buy somthing like sanmina sci corp symbol  SANM the company Corporation provides integrated electronics manufacturing services worldwide. and does 7 billion in annual sales but has a market cap of just 1 billion and 600 million dollars in cash. and is very profitable. the stock trades around 12.00 dollars I think the stock could get to 100.00 dollars a share over the next five years. 

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