And From Behind Me, Rafael- IDT, At It Again, Spins Off HQ And Biotech Stakes

IDT (IDT) is a serial spinner. Over the life of this blog alone the telecommunications company helmed by former hot dog stand operator/current billionaire Howard Jonas has spun off oil & gas assets (Genie Energy, GNE), ringtones (Zedge, ZDGE) and intellectual property/spectrum assets (Straight Path Communications). Quite an odd assortment of assets for a telecom company, but it seems to have worked out for shareholders. Despite Genie and Zedge suffering declines as independent companies, Straight Path, which was acquired by Verizon for over $3b last year, was a massive home run.

It seems the company hasn’t exhausted its hodgepodge of assets yet and the newest spin from IDT, Rafael, is coming soon. On March 5th, IDT shareholders will receive 1 share of Rafael for every 2 IDT shares owned. Rafael is expected to trade under the ticker ‘RFL’ and a when issued market is already in place.

So what exactly is Rafael? The most recent Form 10 tells us that ‘Rafael is comprised of IDT’s real estate holdings, its interests in Rafael Pharmaceuticals and Lipomedix, two clinical and early stage pharmaceutical companies, and $50$60 million in cash, cash equivalents, marketable securities and/or interests in hedge funds.’

Sounds simple right? Alas, nothing ever is simple when it comes to IDT. Even the cash is complicated with some amount tied up in hedge funds and $10m actually held within ‘CS Pharma’, an entity they control but don’t own 100%:

We hold our interest in CS Pharma through our 90%- owned non- operating subsidiary, IDT- Rafael Holdings, LLC, which holds a 50% interest in CS Pharma. Accordingly, we will hold an effective 45% indirect interest in the assets held by CS Pharma, including its cash and cash equivalents.

In other words, that $10m isn’t really all Rafael’s.

The company’s pharma interests are broken down between two companies: Rafael Pharmaceuticals and Lipomedix. Interestingly, Mr. Jonas has been very focused on the pharma space and in 2017 said that Rafael (then Cornerstone) was taking up ‘90% of his time’. The latter company is ‘a development- stage, privately held Israeli company focused on the development of an innovative, safe and effective cancer therapy based on liposome delivery.’ The company owns ~50.6% of the outstanding shares which it purchased for $2.4m over the past few years.

Rafael Pharmaceuticals is ‘a clinical stage, oncology- focused, pharmaceutical company committed to the development and commercialization of therapies that exploit the metabolic differences between normal cells and cancer cells’ and plans to be the ‘premier cancer bioenergetics/metabolism firm designing drugs to attack the proteins and enzymes reconfigured, re- regulated, and repurposed in cancer and responsible for the unique metabolic features of tumors.’  The company is currently engaged in a number of Phase 1 and Phase 2 clinical trials so there has been some progress.

Naturally, the ownership is more complicated here and IDT’s interests in the company are actually held via warrants and debt instruments:

We own our interests/rights in Rafael Pharmaceuticals through a 90%- owned non- operating subsidiary, IDT- Rafael Holdings, LLC. IDT- Rafael Holdings holds a warrant to purchase a significant stake in Rafael Pharmaceuticals, as well as other equity and governance rights in Rafael Pharmaceuticals, and owns 50% of CS Pharma, a non- operating entity which holds convertible debt and other rights to purchase equity interests in Rafael Pharmaceuticals.

What exactly are those ‘interests’?

  1. $10,000,000 of Series D Convertible Notes [these pay 3.5%] of Rafael Pharmaceuticals held by CS Pharma.
  2. A warrant to purchase up to 56% of the capital stock of Rafael Pharmaceuticals – the right to exercise the first
    $10,000,000 worth of the warrant is held by CS Pharma; and the remainder is held directly by IDT- Rafael Holdings.
  3. We also have certain governance rights, including appointment of directors

Here is the current conversion data and some other data on the warrants and notes:

As of the date of this Information Statement and based on current shares of Rafael Pharmaceuticals issued and outstanding, we would need to pay approximately $71 million to exercise the warrant in full and approximately $56 million to purchase a 51% controlling stake. On an as- converted and fully diluted basis (for all convertible securities of Rafael Pharmaceuticals outstanding), we would need approximately $122 million to exercise the warrant in full and approximately $98 million to purchase a 51% controlling stake in Rafael Pharmaceuticals.

Some more:

Currently, if IDT desires to raise additional financing from unaffiliated parties in connection with IDT’s exercise of its warrant or other current rights to invest in Rafael Pharmaceuticals (but not including the Rafael Pharmaceuticals rights held by CS Pharma), it first must give the other CS Pharma holders the opportunity to provide such financing on a pro rata basis. The exercise price of the warrant is the lower of 70% of the price sold in an equity financing, or $1.25 per share, subject to certain adjustments. The minimum initial and subsequent exercises of the warrant shall be for such number of shares that will result in at least $5 million of gross proceeds to Rafael Pharmaceuticals, or such lesser amount as represents 5% of the outstanding capital stock of Rafael Pharmaceuticals, or such lesser amount as may then remain unexercised. The warrant will expire upon the earlier of December 31, 2020 or a qualified initial public offering or liquidation event of Rafael Pharmaceuticals.

As it stands right now, the company doesn’t have the resources available to exercise the warrants and convert its interests in the company. I haven’t dug into the science, but presumably, if there is progress between now and 2020 then it shouldn’t be a problem to raise the capital…hopefully in a shareholder friendly manner. Of course, the company could raise money by leveraging or selling its real estate portfolio, but it’s unclear how much value is actually there. Alternatively, after the Straight Path windfall, Mr. Jonas could fund the development himself.

Of the two components, the real estate seems relatively straightforward and includes IDT’s HQ in Newark, a data center and part of a building in Israel:

The commercial real estate holdings consist of the building at 520 Broad Street in Newark, New Jersey that houses IDT’s headquarters and its associated public garage, an office/data center building in Piscataway, New Jersey and a portion of a building in Israel that hosts offices for IDT and certain affiliates

Of course, the major tenants right now are all other Jonas-held companies so there is some risk there. In fact, in 2017 it seems they amended the leases to lower the rates for Jonas companies thereby bringing the forecasted related party revenue to only 51%. There is some potential in the real estate as well. The building on Broad is only ~24.3% leased (which includes IDT and Genie) and the data center ~28% leased. Unfortunately, the buildings aren’t in the best shape and in order to really attract new tenants the company would need to put in a significant amount of capex (and thus, cash):

Depending on market conditions and the success of our efforts to lease additional space, we anticipate making significant capital improvements to our real estate portfolio, including but not limited to, renovating common areas such as lobbies and bathrooms as well as building wide HVAC systems. If we are successful in leasing additional space in our buildings, we would likely expend additional funds for improvements to the tenant’s space. We estimate costs of $30- 50 per square foot on tenant improvements, which will be determined by our agreement with the tenants and dependent on many factors, including condition of the space, rental amount, lease length and other leasing criteria. The total estimated capital expenditures including building upgrades, tenant improvements and leasing commissions will be approximately $24 to $45 million comprised primarily of tenant improvements

The Form 10 digs into the current leases in a bit more detail for those interested, but one would need to evaluate the prospects of bringing in non-Jonas tenants and the related timing given the requirement for ‘tenant improvements’. This sum of the parts analysis of IDT doesn’t assign much value to the real estate. At first blush, the real estate seems like an odd inclusion, but it does seem to fit the pattern of other IDT spinoffs which couple a relatively stable, cash generating operation with a high risk, potential home run. For example, in addition to plenty of tight oil reserves in the US & Israel, Genie also has a retail energy business. Straight Path had a patent troll operation (which worked until patent reform was passed) along with its 5G spectrum assets.

The management team is full of IDT veterans, but aside from Howard, the Chairman, there doesn’t appear to be any members of the Jonas family (a feature of prior spins). As with all IDT companies, Howard Jonas is firmly in control though and company decisions are usually made with the largest shareholder in mind. Although Mr. Jonas will own only 20.5% of the Class B common, he will actually control 70.9% of the aggregate voting power. An example of potential self-dealing includes this nugget from the Form 10:

On September 19, 2017, IDT approved a compensatory arrangement with Howard S. Jonas related to the right held by IDT- Rafael Holdings to receive additional Rafael Pharmaceutical shares (“Bonus Shares”) upon the achievement of certain milestones. Under that arrangement, IDT and the Company transferred to Howard Jonas the contractual right to receive “Bonus Shares” for an additional 10% of the outstanding capital stock of Rafael Pharmaceuticals that was previously held by IDT- Rafael Holdings, which is contingent upon achieving certain milestones. This right was previously held by IDT- Rafael Holdings, subject to its right to transfer to recipients that IDT- Rafael Holdings, in its sole discretion, felt merit because of special efforts by such persons in assisting Rafael Pharmaceuticals and its products. IDTRafael Holdings distributed the rights to its members and we transferred the portion we received to Howard Jonas. If any of the milestones are met, the Bonus Shares are to be issued without any additional payment. Howard Jonas has the right to transfer the Bonus Shares, in his discretion, to others, including those who are instrumental to the future success of Rafael Pharmaceuticals.

He was able to buy 10% of IDT-Raphael and then pass himself ‘Bonus Shares’ that was previously owned by the entity being spun off to shareholders. Nice move! Additionally, Mr. Jonas controls other instruments providing additional ownership in Rafael Pharmaceuticals:

Separately, Howard Jonas and Deborah Jonas jointly own $525,000 of Series C Convertible Notes of Rafael Pharmaceuticals, and The Howard S. and Deborah Jonas Foundation owns $525,000 of Series C Notes of Rafael Pharmaceuticals.

In the end, if Rafael Pharma succeeds, all shareholders will be winners. The question is if IDT’s current shareholders will want to go along for the riskier ride or sell off the shares post spin. Given the most recent success of Straight Path, it wouldn’t be surprising to see some bet on IDT spinning gold again. We will be watching the post-spin trading closely.

Disclosure: Author holds no position in any stock mentioned.

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