I recently came across a company about to file for dissolution and liquidation, Gleacher & Company. Until a little over a year ago it was a broker dealer with fixed income trading and investment banking operations. I presume, without doing all the homework involved, it began to run out of capital after losses during the 2008/9 financial crisis. In any case, last year at the end of May the old management, including both the operating management and a majority of the Board of Directors, stepped down or was replaced. A chief restructuring officer was brought in from Capstone Advisors and, after a period of reviewing strategic alternatives including acquisitions, a business combination, the sale of the company or liquidation, new management concluded that liquidation was in the best interest of shareholders. A proposal to liquidated the business was approved by the Board in March of this year and a vote was scheduled for the May Annual Meeting, where it was overwhelmingly approved. The dissolution certificate will be filed at the end of June and the company’s shares likely delisted thereafter.

I’m always interested in liquidations because, well, most investors aren’t. Generally fund managers shy away or simply can’t invest in liquidations as 1) the company falls outside their defined investment universe, or 2) the shares are too illiquid (especially if the company delists), or 3) the timeframe is too unclear (often liquidations take 3 years or more), or the market cap becomes too small, etc. So there is generally an exodus out of the stock when a liquidation is in the offing.

In addition to being a stock shunned by a large proportion of potential investing universe, liquidations have other endearing characteristics. One of these is that management has to actually tell shareholders what they think company is worth! Most times they give a range of projected liquidation distributions, and in general, my experience is, management is extremely conservative when they provide these numbers. Of course management isn’t omniscient, and the estimates are only their best (conservative) guess as to what the payouts might be; adverse things can and do happen that negatively impact the ability of management to deliver projected payouts. But think about it. Usually in a liquidation scenario new management has been brought in to wind down the company. What possible incentive do they have to OVER-estimate future payouts? Much better to under-estimate and over-deliver than the other way around as this obviates any potential lawsuits that might assert management misled investors as to the value of the company. In the case of Gleacher, new management was indeed brought in last year to determine the best strategy to adopt to maximize shareholder value: restructure, sell or wind down the company. As part of this analysis management prepared estimates of likely liquidation proceeds which were presented to the Board along with the suggested liquidation strategy. These were subsequently incorporated these into the Proxy statement provided to shareholders for their approval at the Annual Meeting: an initial distribution of $3.23 per share shortly after filing the dissolution certificate with subsequent distributions of between $6.47 and $11.32 per share. Now, I really like to invest in liquidations when the stock is trading at or below the low-end of management’s estimate of total distributions. That, however, is not the case here, and in fact I’ve rarely come across this situation, as estimates are, as I said before, VERY conservative and market pricing generally reflects this. When an opportunity like that presents itself, take it! It’s like shooting fish in a barrel. Our current liquidation, unfortunately, requires a bit more analysis as the shares are currently trading at $11.45, almost 20% above the low-end of management’s total payout estimate of $9.70. On the positive side, shares are trading somewhat below the middle of the management’s range, say at the 36th percentile, where 50% would be the exact middle. What makes this situation interesting is that 2/3 of total assets are in already in cash, and shares are trading below book value ($12.27 as of 3/31/14). So lets take a deeper dive and see if we can get comfortable with potential valuation upsides and downsides.

First, let’s take a ‘big picture’ view. Below is the schedule included in the March 31 10Q detailing the estimated initial liquidating distribution payable to shareholders.

Estimated Initial Liquidating Distribution to Shareholders (000s except per share amounts) Total per share Cash and cash equivalents (incl. segregated cash) $62,466 $10.10 Expenses and Cash reserves (est.) Cash operating expenses (excluding comp) after March 31, 2014 ($9,296) ($1.50) Compensation ($3,664) ($0.59) Reserves for claims and contingencies ($29,506) ($4.77) Estimated cash to distribute to shareholders $20,000 $3.23 Assumed shares outstanding 6,184

The above calculation simply takes current cash plus segregated cash less estimated operating expense and compensation during the liquidation period, $13 million, less a reserve for any and all contingencies. Of course, I don’t know exactly what these ‘operating expenses’ include as neither the 10Q nor the proxy provide any detail for this line item. I will assume they include fees for Capstone’s Chief restructuring officer (not an employee of the company), office space and as-needed professional fees, Board of Director fees, and other expenses that I have not been able to identify. The Compensation line includes salary and retention payments for the General Counsel ($1.8 million) and Controller ($1.1 million) plus support staff through 2014. As you will notice there is no line item in the above analysis for other assets which might be monetized. This, along with potential savings in operating expenses during liquidation, will be our primary upsides.

Let’s look at the largest of the expense line above, the Reserves. What exactly are these reserves? A footnote to the 10Q defines them as follows “DGCL 281(b) requires the Company to pay or make reasonable provision for the payment of all claims and obligations (including all contingent, conditional or unmatured contractual claims), claims that are subject to pending actions, suits or proceedings against the company and claims that have not arisen or been made known to the Company but are likely to arise or become known within 10 years of dissolution.” It then goes on to specify them for Gleacher as follows: “The Company and its subsidiaries have set aside reserves associated with (i) ClearPoint, (ii) claims made by Thomas J. Hughes (our former Chief Executive Officer) and John Griff (our former Chief Operating Officer), (iii) potential tax exposures and (iv) general reserves for other potential claims.” I am assuming that general reserves include net accruals not yet paid as of 3/31/14, i.e. those liabilities showing on the company’s 10Q 2014 balance sheet that have no offsetting assets associated with them. The assumption is based on exclusion, as the definition of ‘operating expenses’ is those expenses “..incurred after March 31, 14”.

Below is my breakdown of what the expense, compensation and reserves line items might include:

(In thousands) Cash operating expenses (excluding comp) after March 31, 2014 ($9,296) Capstone Advisors ($4,950) Capstone – office space ($216) BOD ($650) Other (mostly professional fees) ($3,480) Compensation ($3,664) General Counsel & Sec. ($1,817) Controller ($1,117) Other/support staff ($731) Reserves for claims and contingencies ClearPoint ($7,500) ($29,506) former CEO/COO claims ($7,900) Legal fees related to CEO/COO ($1,000) Other accrued compensation B/S ($532) Restructuring reserve B/S ($2,023) A/P and Accrued expenses B/S ($2,346) Other accrued payables B/S ($647) Accrued taxes net B/S ($2,954) NY State tax claim and other general claims ($4,604)

Let’s look to where the upsides might be from the above schedule before we move on to other assets that might be monetized.

It’s possible but unlikely that Capstone will charge less than its entire fee (do you see any incentive for this?), but the Board could be terminated early if the assets are place in a liquidating trust, though I won’t include this. However, savings most likely will be achieved in other (unidentified) operating expenses (most likely professional fees): I will assume 50% of these can be saved. Regarding compensation, it is unlikely that savings can be achieved here as both the General Counsel and the Controller were offered retention contracts which were signed in the 4th quarter of 2013 and run through the 4th quarter of this year, so these are primarily contractual payments which can only be reduced if the company is sold between now and the end of summer (quite unlikely at this point). The ‘Reserves’ line item hold the greatest potential upside. The Company has accrued nothing for potential indemnification regarding the ClearPoint transaction under GAAP so I conclude that any liability is unlikely. Likewise, the Company accrued nothing for the CEO and COO claims regarding compensation due on a ‘change of control’, which the company denies. These claims will be heard before FINRA this summer, but I will conclude that it is likely to result in no monetary payment to these former officers (let’s hope not as they are the characters that presided over the firm’s demise!) Together, these two items make up more than half the Reserves! Other items in the Reserves that I can identify include balance sheet liabilities. These are primarily accruals which, except for the Restructuring accrual, show little promise of upside. The Restructuring accrual relates to payment of vendors for termination of contracts, and here, since little has been paid over the past 6 months, I estimate we might see a 50% savings as a potential upside, though not necessarily likely. Then I’ll estimate that 50% of the other unidentified claims is likely with a further 50% possible..

Potential upsides from liabilities Total per share Cash operating – other 50% $1,740 ClearPoint indemnity 100% $7,500 CEO/COO compensation claims 100% $8,900 Restructuring reserve 50% $1,012 Other general claims 100% $4,604 Total from liabilities $23,756 $3.84

Next let’s consider upsides from the monetization of unencumbered assets. I am going to categorize these into two buckets, likely and possible. In the likely category I would put receivables and deposits from clearing organizations (in fact these may have already been collected), insurance receivables, management fees from the Employee investment fund and Homeward transition fees. I will also include the Investment in FA Technology Ventures LP (FATV) at carried, ‘fair market’ value. Possible upsides would include the receivables of loans and advances and ‘other’, receivables related to potential tax liabilities collateralized with assets from former Gleacher shareholders net of payables to same, the amount of Investments for the Employee Investment Fund greater than payables due to employees for same, that portion of Financial Instruments related to deferred compensation plan which is greater than liabilities for same (subordinated debt) and some portion of prepaid expenses that might be recovered (50%).

The FATV Investment merits further attention as it is the largest non-cash asset on the balance sheet and the one with the greatest potential upside. Initially I was a bit confused as to valuation because of the wording in the 10K and 10Q. First, what is the FATV investment? It is a limited partnership which owns part or all of 6 private companies (not specified in the SEC filings) which is managed by a subsidiary. Gleacher owns approximately a 23% interest in the partnership, and the Gleacher subsidiary that manages the partnership (I presume the general partner) receives a management fee which has been accruing, I assume because the partnership has no income. The 10K and 10Q state that the partnership is scheduled to terminate on July 16, 2014, but makes no mention of what will happen when this termination takes place. Will each limited partner own outright an interest in the companies currently managed by the limited partnership? What is stated is that only 1 of the 6 companies is near a liquidity event (either a public offering or, more likely, a sale). Is it possible that management will look to liquidate their interest in the other 5 companies before a liquidity event? This is unknown, but could mean a significant reduction in the value of the investment. Not only are these logistical questions outstanding but I was also confused initially about how to interpret the line item on the Gleacher balance sheet. The confusion arose because at one point the FATV investment is described in the SEC documents as follows: “The Company has an equity-method investment in FATV of approximately $18.2 million”. So this made me believe that the $18.2 million represented not the fair market value of the investment but the total cash invested in the partnership plus the company’s pro-rata share of earnings and losses since the investments were made. However, footnote 1 in the 10K defines the line item ‘financial investments’ as follows: “The Company’s financial instruments are recorded within the Statement of Financial Condition at fair value. ASC 820 “Fair Value Measurements and Disclosures” defines fair value as the price that would be received upon the sale of an asset or paid upon the transfer of a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date and establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.” And, in note 10 a breakdown of the Investments line item is titled “Fair value information regarding the Company’s investments”. And, indeed, the 10K and 10Q include guidelines regarding the ‘fair market’ valuation’ of the partnership interest. So I have to conclude that indeed the ‘Investments’ line item (interests in the FATV partnership) are indeed carried at fair market value based on the level 3 criteria laid out in the 10K and 10Q. But looking at these guidelines one has to consider that the ‘fair market value’ presented is, in fact, understated. This we won’t know for sure until there is some liquidity event. But given the criteria for venture capital investment, 5x EV/EBITDA and 55% discount for illiquidity, one must conclude that there is considerable upside to this valuation. If a liquidity event were to come along we might see the illiquidity discount shrink or disappear. For the purposes of this analysis I have estimated that the 55% discount could shrink to 20% which would give up to a 77% increase to the valuation.

per share Potential upsides from assets Total Likely Possible Receivables from Clearing Org. $2,585 $0.42 Receivables – insurance $262 $0.04 Receivables – EIF mgmt fees $267 $0.04 Receivables – other $184 $0.03 Receivables – Gleacher shareholders net $474 $0.08 Investments – FATV at carrying value $18,226 $2.95 Investment – FATV at 20% discount to pc $14,176 $2.29 Investments – EIF net of liabilities $324 $0.05 Recumbent of prepaid at 50% $1,348 $0.22 Monetization of office equipment at 20% $20 $0.00 Monetization of other non RE assets $383 $0.06 Total $38,249 $3.45 $2.73

Summarizing these projected and potential distributions I come up with:

Projected Distributions Total Per Share Initial liquidation distribution $20,000 $3.23 Potential upside from liabilities $23,756 $3.84 Likely upside from Assets $21,340 $3.45 Subtotal $65,096 $10.53 Possible upside from Assets $16,909 $2.73 Total $82,005 $13.26 upside from current price 16%

Gee, that’s doesn’t look like a particularly enticing investment opportunity, does it? An upside of only 16% from today’s market price per share? I haven’t even come up with enough upsides to arrive at the high-end of management’s valuation range. What am I missing? I don’t know, but something obviously. Let’s look at the list of investors to try to determine if Mr. Market is just being his usual stupid self, or if there are some sophisticated investors who might know just a little more than I do.

Ownership shares % ownership MatlinPatterson FA Acquisition LLC (a) 1,778,413 28.76% Stone Lion Capital Management (c ) 574,490 9.29% Scoggin Worldwide Fund (a) 550,516 8.90% Mendon Capital Advisors Corp (a) 502,300 8.12% Farallon Capital Mgmt (d) 442,300 7.15% Hudson Bay Capital Mgmt LP (b) 242,178 3.92% Total Identified 4,090,197 66.15% Total Shares outstanding 3/31/14 6,183,654 (a) identified in 2014 Proxy Statement (b) identified by Yahoo Finance as of 3/31/14 (c ) 13D filed 6/5 with increased ownership of 2,352,903 (d) from 13D filed 5/12

So, indeed there are some large sophisticated investors with substantial positions in Gleacher. MatlinPatterson (MP) has been represented on the Gleacher Board for a number of years and substantially shepherded the company through the Board and management transition last year. In total 6 large investors control about 2/3 of the outstanding shares. That should provide some comfort to a small investor who might coat-tail these more sophisticated guys. But wait, something funny just happened! Stone Lion Capital who initially took a position in April (and therefore at prices not substantially different from today’s) increased their stake to 2.4 million as of June 5th. Wow! But there’s something funny about this. The number of shares Stone Lion added between their April and June filings is EXACTLY the number of shares that MatlinPatterson (MP) owns. Huh? It looks to me like the largest investor, and the one closest to the company as it has representatives on the Board, just sold out to another fund. MP clearly bought their investment at prices higher than today’s yet here they are selling out for a loss! It makes me think that perhaps the IRR MP projected from holding on to their Gleacher shares when the company moves into liquidation didn’t quite make the hurdle rate the company requires. That’s not exactly a good sign. But the fact that another fund bought into the liquidation should be some consolation.

Another consideration I haven’t discussed is timing, i.e. when the liquidation distributions might be made. This is secondary to the total distributions but important when calculating expected IRR. We know the initial distribution of $3.23 will most likely be paid out in the month following the filing of the certificate of dissolution (June 30th), so that would be during July. Of the major components of the Reserve, the CEO/COO litigation will probably be resolved by year-end or sooner (the hearing before FINRA being scheduled for this summer), and the ClearPoint reserve not before the 3 year anniversary of the transaction, February 22, 2016. Then there is the FATV monetization; the SEC documents mention that one of the 6 private companies is in the initial stages of negotiations which might lead to a liquidity event and that this company is a significant portion of the value of the partnership interest. So we might expect a second distribution of $2.00 to $3.50 sometime in the 1st quarter of 2015, lower if the liquidity event doesn’t happen, higher if it does. There could be a 3rd distribution in the first quarter of 2016 when the ClearPoint indemnity expires and liquidation expenses are more fully calculable. Then I might expect a final distribution on the 3rd anniversary of the dissolution certificate filing with possibly a liquidation trust established if the FATV investments cannot be monetized before that point.

One final note that potential investors should consider. The Proxy Statement lays out quite clearly that once the dissolution certificate is filed holders of the stock may become liable for any debts or obligations the company may have or incur above and beyond the assets it holds. Yes, that’s right! your liability is not limited to the amount you invest in purchasing the shares: they might come after your for more money if the liquidation cannot cover its obligations, say because it loses the litigation with the former CEO and COO. Buyer beware!

All in all this is not too exciting a liquidation. I initially took a very small position, but after a more thorough analysis and reflection I don’t see enough upside to justify the risk so I sold the shares I had bought. I could be wrong and the FATV investment could be worth substantially more than I can determine from the information available, or the liquidation could happen much more quickly that I think (I can see it dragging out for a number of years with a potentially significant portion of the distributions happening in year 3 and beyond), but those are things I just can’t know. In other words, this may be a pitch right over ye olde home plate, but I’m just not swinging…better to keep my powder dry for another day.

As always, I look forward to any insights my readers might provide, and remind you that I’m not providing any kind of investment advice here: you’ll need to do your own analysis and reach your own conclusions regarding the Gleacher liquidation.