Anacomp at 1x earnings?

Sometimes it seems pointless trolling through tiny little no-name stocks looking for value.  A friend sent me an email recently saying that one thing that stuck out to him from the Buffett shareholder letters was that Buffett found drop-dead cheap ideas.  There wasn't any question that the things he was buying at the time were undervalued, it was so obvious all one had to do was buy and wait.  The company in today's post illustrates that there is significant value in unlisted companies, and that that drop-dead cheap companies still exist in today's market.

Explaining why Anacomp is cheap could easily be done on a napkin, if I were to write it on a napkin I'd write:

• Earned $.75 p/s last year, trades at $.75, 1x earnings
• $.61 p/s in FCF, 1.22x FCF
• $27 p/s in NOLs
• Deleveraging, building cash

First off Anacomp (ANCPA) is not a Chinese company, a reverse merger or anything shady as far as I can tell.  For curious readers the company's RFP's are available online, I was able to find some contracts in a government database as well.  The company is simply small and forgotten, trading far on the fringes of the market.

Anacomp is a document management company that's been in existence for 40 years.  The company's business is fairly simple, they scan in documents for customers and provide indexing and online document management services.  This is especially important for customers that are paper heavy, such as the government (who happens to be their largest customer.)  The company provides a valuable service in centralizing document digitalization, storage, and retrieval.  Clients can continue to be paper heavy but offer digital copies if necessary.  The company has two locations, one in Washington DC, the other in Southern California.

With a company trading at 1x earnings not much time needs to be spent determining that they're actually cheap.  Most research time should be spent evaluating what could go wrong, and if the price is low enough to compensate for any problems, known and unknown.

Anacomp is far from perfect, there is plenty of hair on this investment, but go back and read the little thesis again before each hairy item, they look a little less scary each time.  I'm going to go through the biggest issues I see one by one and knock them out.

All earnings, no assets - This isn't the biggest ding against the company, but it's a fairly large one.  The company has $4.3m in cash, and $2.2m in accounts receivable, current assets are $7.1m.  The company's current liabilities aren't all that terrible either at $2.5m.  The company has a pension and some debt that negate any positive value from their assets.  Total shareholder deficit is -$759,000.

The company has something peculiar with regards to their pension, the pension that's zero-ing out assets.  The pension is held for an in-active German subsidiary with a liability of $8.8m.  The pension has $5.8m in assets, mostly bills, bonds and insurance, which is disallowed by GAAP.  It appears that the company purchased annuities for some pensioners, that's what the insurance contracts are.  Under GAAP insurance isn't a valid pension asset, so the company appears to have a $8m pension shortfall even though they have taken care of most pensioners via annuities.  The real shortfall is $3m, although it could be considerably less.  The company's discount rate and expected return are both very low at 3.5%.

Debt - I alluded to this in the above bullet point.  The company has $3.6m in debt related to an acquisition.  It appears the company struggled to integrate the acquisition which led to operating performance problems.  The company had trouble repaying the promissory note on the original repayment schedule.  They were able to re-negotiate and extend the terms twice.  The company is now on track, paying down the debt, and appears able to pay it off with cash on hand currently.

Earnings clarity - The US Government accounts for 99% of the company's business.  According to the notes it appears that sales are locked up for the next two years.  If this is true that the next two years look like the most recent this would mean that the company will have earned over $4m, repaid most of their debt, and would have a positive book value of over $3m in 2015.

The biggest issue investors have is there is no earnings clarity beyond two years.  If the government decides to not renew, Anacomp will be generating losses and looking to hit up the credit markets to survive.  Fortunately this dire scenario presumes that management is completely idle and happy to milk the cash cow for two more years before deciding their next steps.  Since the company's annual report came out there have been a flurry of news items on the company's website.  They inked a five year deal with the VA, earned an award with Northrup Grumman and hired a healthcare executive to sell to health organizations.

Instead of sitting idle management appears to be pro-active in searching out new business opportunities.  I don't know if it'll be enough to replace the current revenue and earnings, but with two years of runway there is plenty of time.

Final Thoughts

The question investors need to ask themselves is whether at 1x earnings Anacomp is cheap enough to compensate for all of the above risk factors?  I think it is, my margin of safety is in the low earnings multiple.  If earnings drop 50% I still own a stock with a P/E of 2.  If earnings drop 75% the stock would have a P/E of 4x.  It would be hard for anyone to argue that at a P/E of 4x a company is fairly valued.

I didn't discuss the NOLs in my post outside of the brief mention in the thesis.  The company won't be paying taxes on any earnings for a very long time, so long that they most likely won't ever use them up unless earnings significantly grow.  The bonus here is that management might find a way to structure a deal so that those NOLs take on tangible value.  If that were the case there is a lot of room for this to be re-valued.

I have no idea what a fair value for Anacomp is, but I know it's not 1x earnings, even 5x earnings seems low.  If the market ever revalues this company, even just a little bit investors could experience some massive gains.  I'm along for the ride on this one..

Talk to Nate

Disclosure: Long Anacomp

I passed on these two, now they're worth considering

Information, investors are starved for information.  What were sales last month?  How many items shipped?  Did costs rise or fall?  The more detail the better, the more granular the better, investors crave as much information as possible.  The biggest hurdle for most investors to investing in small unknown companies is the illiquidity, but that's a false argument for many.  Most investors aren't running millions of dollars, and buying and building a $25,000 position is possible in every stock I've ever written about.  The real hesitation comes from the lack of information, current and frequent information is a security blanket for investors.  It seems unbelievable that anyone could invest in a company that only publishes an annual report once a year.

As a blogger my goal isn't to cover the universe of overlooked stocks with exhaustive write-ups.  While this blog provides a good amount of analysis it also provides something else, something more valuable, detailed information on companies that are so hidden that some don't even have websites.  I view myself as a cross between an analyst and a journalist.  I uncover interesting opportunities and analyze them, yet at the same time I convey a story about the company to readers.  I recognize that maybe 1-5% of my readers might be interested in investing in any given idea, I provide enough for them to get started and hit the main points.  Yet I try to keep the attention of the other 95-99% by explaining why this company is worth looking at, and why certain items are important.

In this post I want to follow up on two companies I wrote about over the past year, both were worth further investigation.  Over the course of the past year the results from both companies are considerably better than expected and each company is probably a better purchase now rather than when I first posted about them.  Without further ado…

CoStar

Back on January 10th I wrote about Costar, a company that produces security related products such as cameras and surveillance systems.  For this post I re-read my January 10th post and I'll be honest I'm not that proud of it.  In a lot of ways I think I disagree with myself from January.  The essence of the post was why I avoided Costar.  The items in the post are all true, and they probably all make sense, but looking back I realize why I really passed on the company.  In early January my youngest son was in the hospital for a period of time, during that time I read the Costar filings on my iPad while he napped.  Trying to focus on an investment idea while a baby is in a perilous situation is not wise.  I don't think I was in the right frame of mind to truly reflect on Costar as an investment, or think clearly about the situation.  Additionally there was the emotional link of this company to sitting in the ICU.  For inquiring readers my son is a perfectly healthy 10mo old now, for that I'm extremely thankful.

I'm glad I took a look again, their annual report is out and the company looks very interesting.  Here are the highlights:

• NCAV of $3.89 against a last trade of $2.06.
• They earned $.41 a share last year
• P/E of 5
• FCF of $1.88 p/s in 2012
• The company used all of their free cash flow to repay debt.

One of the biggest issues I had against the company was their debt, management wisely repaid it and cleaned up the balance sheet.  Additionally sales and earnings are growing.  It appears the company's operating leverage is now working in their favor, sales grew 12% and operating income grew 1459%.

Not much else has changed except that the company is in much better shape financially than they were five months ago.  There is no reason this company should be trading below NCAV, as a stretch they might even be worth book value ($5.55).

Randall Bearings

If there is a poster child for unlisted companies, Randall Bearings is it.  The company is cheap beyond reason, in my post last year I noted that without a LIFO reserve they would have earned $4.04 a share, double the market price at the time.  Over the past year the stock price has also doubled, my $200 position became $400, beer money as some call it, maybe if they're drinking Chimay.

Randall Bearings is a manufacturing company located in Lima Ohio.  They manufacture bronze machined parts.

Here's why they're interesting:

• Book value of $14.20 p/s vs. $4.60 last trade.
• EV/EBIT 4.48
• EPS $2.58 p/s
• P/E 1.78

I passed for a number of reasons the three biggest being, the debt, their reincorporation, and a shareholder lawsuit.

The company's debt situation has become worse over the past year.  The company added $1.55m in additional debt.  The company invested $1.5m into their facilities to position themselves for future growth.  In theory the new debt should pay for itself with increased earnings.  Unfortunately it appears no matter how much the company earns the market doesn't care.

The second item holding me back was the company's reincorporation from Delaware to Ohio.  As a commenter on the last post noted, Ohio has stringent anti-takeover laws.  I have done further research on this point, and talked to someone with a copy of the shareholder register.  From what I understand now there is no possibility for any merger or corporate action unless the CEO himself initiates it.  The CEO and the largest shareholder, which is also the company's largest supplier own more than 50% of the company.

The last issue pertains to a shareholder lawsuit that entangled the company for years.  A shareholder sued the company with a records request lawsuit in the Delaware courts.  The suit dragged on for years with the resolution being that Randall is required by the court to distribute an annual report to shareholders yearly.  More than anything the lawsuit speaks to the quality of management at the company.  When a CEO is willing to use company resources and fight shareholders, who have a legal right to financials it speaks volumes.  

With all these things considered it's still worth noting how cheap the stock is.  The company has $2-4 p/s of earning power on a conservative basis.  Randall is easily a two pillar stock, one where earnings and book value support each other.  It's conceivable that Randall could be worth $15-20 a share.

It seems that management has no interest in unlocking value for shareholders, but that doesn't mean they aren't focused on growing value.  Management has continued to grow book value, and is focused on growing earnings as well.  If shareholders can get comfortable with managers who are only focused on themselves they might be able to ride along for a wild ride.

Final Thoughts

I want to spend a minute talking about the role stocks of these type play in an investor's portfolio.  I am not a believer in investing concentration unless the investor has a control position at a company.  If they don't I believe it's wise to spread investments across many holdings with similar return profiles.  Companies like Randall and Costar could fit in a portfolio where there are numerous other deep value or net-net type investments.  In a portfolio with 10 such holdings it's reasonable to think that one position might reach full value each year.  It might seem crazy to wait 10 years for full value, but if that means a stock might quintuple, maybe it's worth the wait.

Talk to Nate

Disclosure: Long Randall, I might buy Costar shares.

What's holding you back?

Ever find yourself over analyzing a trivial purchase?  We all do this, spend hours reading Amazon reviews and looking at dozens of different models of some item where the difference between models is irrelevant.  What I find fascinating is I will research some product to death before spending $100 to purchase it, then I'll turn around and read a few annual reports and invested thousands into a company.  There are companies in my portfolio where I spent more time researching baby video monitors than I did researching them.  Why is that?

I read a blog post about six months ago where the author praised procrastination.  They stated that anytime someone procrastinates there is an underlying reason that they don't want to proceed.  Maybe the task is boring, or they don't have all the information, but there's always a reason.  I'm not sure if this is true or not, but it was something to think about.  I've continued to think about it within the context of investing.

Many times I have researched a company, had them check out on paper, and then fail to initiate an investment.  If a computer were to follow my criteria and look at these investments the computer would have purchased.  For some inexplicable reason I never proceeded with the purchase because something didn't "feel right."  Often I'd invent a flimsy excuse as to why I passed "a net-net selling Paris Hilton perfume won't do well" (Parlux), of course it's not going to do well, it's selling below liquidation value.  But these excuses helped satisfy me as I walked away from perfectly good investments.

I've recently been thinking about this phenomenon within the context of procrastination.  Of the last few companies I've looked at and purchased two I hesitated on.  As I hesitated I spent a day or two asking myself what exactly was it that was giving me hesitation?  If it was some actual item I could research it further.  In the first case I was concerned by the strange listing situation the company had, but after further reading on the company's history I was satisfied.

I've also had many times where I hesitate on some item, research further and then avoid the investment. Some of these avoided investments end up going to the moon with me sulking in the distance.  The truth is whether or not an investment works out isn't how we should measure if our decision was correct.  Benjamin Graham states that investors are right when their facts and reasoning are right, not their results.

Something I've observed amongst value investors is they use a feeling of hesitation to over-research a company.  You might be asking, how is it possible to over-research something?  I feel that something is being over-researched when the data and details overwhelm the actual investing thesis.  Case in point someone sent me a link to a writeup on a net-net a month ago.  The writeup was probably 10-12 pages long, it detailed all sorts of industry trends, and contained historical results from seemingly the beginning of time.  Towards the end there was a brief mention that the company was selling for less than NCAV.  Instead of spending hours inputting data into Excel they should have started off asking: is this company truly worth NCAV or more, or is it fairly valued?  When a company is selling for less than book value the first two things I want to know are why, and is it even worth book value?  If an elaborate justification is required to show that book value is obtainable I'm most likely not interested.  Somewhere beyond two or three assumptions any prediction becomes worthless.

Before my next paragraph I want to point out the caveat that some investors have a complexity edge.  They can research bankruptcy filings or rat nests of obfuscated transactions and discover a nugget of gold lying on the ground.  I don't have the time or the brain power to handle those things.  So to the types of people who enjoy Trivial Pursuit and can answer who won the mens doubles championship in the 1936, complex situations are probably for you, while this post is for the rest of us.

The tendency to over-research is strong, for many investors over-research is more a form of professional job insurance rather than a desire to understand the underlying details of a company.  Over-research can also lead to confirmation bias, or the bigger problem in my view, analysis paralysis.  People get into binds where they feel that if they can't fully understand a company they can't invest.  Here's a wake up call, no investor can fully understand a company they're invested, if they believe they can they're lying.  Not even the CEO knows everything happening at their company unless it's a one man operation.  Desiring to know every nitty gritty detail about an investment is a faulty attempt to control something uncontrollable.  Investors believe that if they know all the details then they'll make better decisions or their investment ideas won't fail.  No matter how much you know about a company your knowledge can never prevent failure, especially if humans are involved.  Never underestimate the amount of destruction a negligent or careless employee can wreak on a company.

I know this post is rambling, I will cut to the essence of my message:

1. Strive for simplicity, look for investments that are easy to understand and easy to explain.  The reason for investing should not require much justification.

2. Know when enough is enough, at some point research hits diminishing returns.  I am guilty of this, I've burned many nights Googling mid-level managers at potential investments, or reading feel good news stories about company charity donations.  These things have never helped me, except to convince some part of myself that I made a good decision.

3. Identify the cause of your hesitation.  Are you hesitating because there is a missing piece of vital information?  If so go find it.

Investors talk about a circle of competence, I say strive for a circle of simplicity.  Look for simple investments with minimal assumptions.  Look for similar patterns of simplicity that worked well in the past.  Everyone claims to know that simply buying low P/E or P/B or P/FCF or EV/EBITDA stocks beat the market, so why are we complicating things so much?

Talk to Nate

Does it get any more stereotypical than this?

I've come to appreciate that it's not losses that investors avoid, it's dead money.  Investors will line up like pigs for a slaughter for an investment that is almost a sure loser if someone shouts that it has a small chance of tripling or more.  The losses are chalked up as the cost of doing business with investor proclaiming "just imagine if it did triple or quadruple, then it would have been worth it."  A high risk high reward investment will always have people edging each other out to get a piece of the action.  The types of investments that even company management is embarrassed to associate with are the dead money investments.

Show someone a clearly undervalued company with a history of undervaluation and no catalyst and even the most veteran value managers will turn and run the other way.  A strong bias exists against net-nets with the perception that all of them are dead money, whether or not that's actually true.  I remember listening to a podcast with Geoff Gannon and Jon Heller of Cheap Stocks where Jon mentioned that he thought Audiovoxx was a perennial net-net and might never trade above NCAV.  I owned Audiovoxx at the time and remember grimacing when I heard that.  If this guy who was clearly more experienced in this market thought this investment was dead what do I do?  I didn't do anything, within six months it hit a bout of momentum and traded up to NCAV and then well above, I took advantage of the enthusiasm and sold.

I took a walk at lunch today with my friend Dave, the author of OTCAdventures.  At some point the conversation turned to complex investment thesis and Dave pointed out the simplicity of net-nets, something is worth $2 and you can buy it for $1, nothing more, nothing less.

Net-nets exhibit a return profile that's enviable, in theory buying something for 50% off means a double if the asset reprices.  While the returns are nice the attraction to the theory is investor asset protection.  I realize that by purchasing cash boxes and net-nets I will probably never have world beating investment returns.  Investors buying growing companies at 3x EV/EBITDA will beat the pants off my returns without a doubt.  I'm fine with that, my goal isn't to maximize my returns, but to minimize my losses.  All of the money I have invested is money I saved from working, when I look at my portfolio I can see many stressful projects and remember the hard work required to enable the purchase of my portfolio.

All of this sets the stage for the company I want to talk about in this post, Jemtec (JTC.Canada).  Jemtec is a Canadian company that has staked out a fairly unique niche, they lease out GPS transceivers to monitor prisoners and citizens placed under house arrest.  Jemtec goes to show that having a niche alone doesn't guarantee wild profits and a successful business.  The company has steadily lost money over the past few years.  While the company has lost money at an increasingly slower pace it's still a concern.

The company's management has cut expenses as revenue has dropped.  At first glance it appears the company is grossly over compensating executive management until one realizes that the only employees left at the company are executives.

Jemtec could be classified as a stereotypical net-net, a pile of cash, a poor business, no catalyst, and dead money as far as the eye can see.  Investors are justified in running for the exits on Jemtec as the company slowly circles the drain towards a tax losses.

The company trades for slightly more than 50% of NCAV and losses are so steady that management has predicted down to the thousands how much they'll lose next year!  The company is headline bad, but behind the scenes they aren't as terrible.  While the company lost $138k last year they only had an operating cash outflow of $3800.  Considering that the company has slightly more than $3m in cash, they have close to 100 years of runway to figure out what to do next.

In my view the absolute worst case scenario, and the one most investors are scared of is one where management somehow finds a way to squander or run away with the cash.  Considering that management hasn't done this already, rather they've cut costs in an attempt to save the company, I don't think this merits much concern.  The worst case scenario for management is that they're forced to liquidate and return cash to shareholders, if that happened investors would end up with twice the money they initially invested.

The truth is I, and no one else has any idea what happens next.  An investment like Jemtec is impossible to model, there is no model that handles infinite possibilities.  The company is just as likely to wind down as they are to start selling slap bracelets or pet rocks.  That's the beauty of a net-net though, investors are provided asset protection while they wait to be surprised.  Maybe the company will discover a new way to market their product driving earnings.  Or maybe they'll acquire a completely different company that provides earnings, we just don't know.  As long as whatever happens next isn't as terrible as the market expects the company's stock could react favorably.

Talk to Nate about Jemtec

Disclosure: No position

On value investing...

I had the pleasure of getting together with two other value investors in Pittsburgh this evening.  We had a great time discussing a wide variety of topics.  Our conversation drifted from international investments, to nano cap stocks, to how crazy the real estate market is in Pittsburgh.  After I left I was thinking about how great it is to get together with like minded people and speak the same investing language.

To other investors we often make sense, something at "5x EBITDA and below book" is worth looking at, whereas to the non-investing population it doesn't even sound like English.  Maybe it was Munger or some other famous investor who said if you can't explain a concept to a 12 yr old you might not understand it.  In the spirit of that I want to share some analogies I've used to explain investing and how I invest to non-investors.  In all the times I've used my analogy I haven't encountered anyone who didn't have the lightbulb moment and say "oh I get it now."

How I invest

Imagine an area of town with an industrial area, the area is fairly well worn, but not in total disrepair.  There are a number of companies with names no one remembers doing somewhat specialized activities.  The owners of these businesses appear to do well for themselves raising their families in a solid middle class environment.

An owner of one of these businesses decides he's had enough of the stress and daily grind and he wants to sell.  He knows how to make widgets, and isn't much of an investor himself.  He lists his business on a public market.

Investors in town know that the area the business is located is grimy, and when they look at the accounts they see the company isn't all that profitable.  It seems like a lot of work is involved to make such a tiny profit.

I come along and examine the business, I agree with the other investors that they aren't that profitable, but I notice something different.  While they aren't turning a profit they do have a valuable building and the owner has undervalued his warehouse of old inventory.  I purchase the company for less than the property and machinery cost alone.  Once I visit my new purchase I realize what the owner thought was old rusty inventory in the warehouse is actually recently purchased inventory.  The owner was a bit of a pack rat and I start to find envelopes full of cash around the facility he'd stashed for rainy days.  When all is said and done my purchase price for the business is less than the inventory, receivables and cash net of liabilities, I get the building and aging machinery thrown in for free.  The company is marginally profitable, but it's not a big concern considering the discount I already received on my purchase.

To me that's the essence of asset based value investing.  When I've told this story people marvel that these sort of deals actually exist.  I explain they exist in the markets the same place they exist in real cities and towns, not on the main streets, or in the central business district.  Rather these deals are found on the back roads, sometimes far away from town, neglected by everyone often even their owners.

How Buffett invests

Warren Buffett used to invest as I described above but he's changed as he's become more successful.  Buffett buys that restaurant in town that everyone goes to, there are always two hour waits no matter what day of the week or time of the year.  Buffett prefers when these businesses are run conservatively and have strong staying power.  He isn't interested in buying the hottest restaurant this month, he's buying the restaurant that's been hot for a decade.

Buffett will then go on and buy the bank in town, and then the local gas station, and the grocery store, and whatever else is for sale.  Eventually it will be hard for anyone in town to go a day without using one of his products, or services.

How most investors invest

Imagine yourself at a cookout in the summer.  You're standing by the grill and your brother-in-law comes and starts chatting.  He starts talking about how this guy he works with is onto a really great investment.  It's some new technology he doesn't really understand, but it doesn't matter, it's going to sell really well.  Not many people know about it yet so you have to keep quiet.  He thinks it's going to be big, almost everyone in the world needs this product, if they can only capture 1% of that market they'll be billionaires.  It's a good thing you found out about this early so you can get in on the ground floor.  Just imagine being able to pay off the house and pay for the kids college all while sitting on the beach drinking mai tai's.

Final thoughts

I find it fascinating that most non-investors can spot a good local business without a problem.  People instinctively know when someone has a model that's minting money.  Yet a disconnect happens between a local tangible market and the public markets.  Most people wouldn't invest with the wacky science-y guy promoting some new fusion technology down the street, yet they'll pour money into high tech startups.  People are also able to identify when a company has a strong brand and staying power verses a company without it.

I love when people say things like "how did that restaurant go under, it was always crowded?" because it exposes that while people understand a good brand, they don't understand the finances behind a business.  I always say that companies go under for two reasons, too much debt, and mispriced products.  Those two go hand in hand, products priced too low eventually lead to debt problems.  Maybe the restaurant is packed because the prices aren't high enough.

Talk to Nate

Shareholder rights…did you know you have them?

"It is a notorious fact, however, that the typical American stockholder is the most docile and apathetic animal in captivity.  He does what the board of directors tell him to do and rarely thinks of asserting his individual rights as owner of the business and employer of its paid officers.  The result is that the effective control of many, perhaps most, large American corporations is exercised not by those who together own a majority of the stock but by a small group known as 'the management.'" Graham, Benjamin. Security Analysis 1941.

Americans are raised with a strong sense of rights; starting with the inalienable rights of life, liberty and the pursuit of happiness.  These rights extend from the Declaration of Independence to the Constitution and beyond through codified laws.  Americans are quick to proclaim loudly when their rights are infringed upon.  It doesn't matter if these rights are true rights, or presumed rights not backed by law, Americans feel strongly about rights!

There is a strange disconnect between citizenship rights and shareholder rights, a disconnect I don't fully understand.  As a citizen we have rights granted to us by a government, rights that are very hard if not impossible to change.  Citizens only get one vote, and the only way to affect change is to petition an elected official or become one, and even then change is slow.  The same can't be said about corporations.  A shareholder can buy more votes by buying more shares, and if they own enough shares can fire management or take over the company driving change themselves.

Benjamin Graham's quote from the 1940s still rings true today.  Most shareholders are docile, most fail to vote proxies and those who do vote often side with management.  Shareholders with small positions on mega-cap companies might view their votes as futile, even still, why throw away something you purchased?  The types of companies I typically invest in are smaller, some very small where a significant position can be built quickly, and shareholder votes meaningful.

I recently finished a book The White Sharks of Wall Street, which I highly recommend.  The book details the history of a group of modern corporate raiders who began taking over companies in the 1930s up through the 1960s.  These men, including Thomas Mellon Evans, invented many of the modern takeover techniques we know about today, yet their stories have been lost to the sands of time.  Tom Evans was known as a liquidator, he bought companies for less than NCAV or book value and liquidating divisions for a gain.  The author is a financial journalist for the New York Times, which means what could have been dry material reads quickly and is fascinating.  This isn't a textbook, but rather an informative history.  It's worth noting that Tom Evans apparently ran in some of the same circles as Benjamin Graham.

In the spirit of the book I wanted to discuss a number of rights shareholders have that they might not know about.  The rights I'm detailing below are for shareholders of Delaware corporations, which most public companies are.  Companies are governed by the state they incorporate in, and the state they reside in.  Some states have different rules and regulations, with some like Nevada being notoriously shareholder unfriendly, whereas Delaware is very shareholder friendly.  If you plan on undertaking any action against a company you own please find the relevant state first, small nuances can lead to significant differences.

I am not a lawyer which is probably evident by my readable writing, but I wanted to state it anyways.  I have read the Delaware corporate law along with the corporation law for a few other states, they were available free online.  If any of this is wrong please make a note in the comments and I'll edit the post.

Shareholder vote - By law shareholders are entitled to one vote per share unless stated otherwise for a specific series of shares.  This might seem like the simplest of all the rights, yet it's the most powerful.  Shareholders are not restricted to one vote per person as in a governmental election, shareholders can purchase as many votes as they want by acquiring shares.

Companies are required to put directors up for election every so often as determined by the company's bylaws.  When directors are up for re-election the shareholders have the responsibility of evaluating their qualifications and voting, or not voting them in.  If a director isn't qualified shareholders can vote that director out and propose their own director.

Some companies have cumulative voting which is extremely powerful, one holding of mine has cumulative voting.  An example is the best way to explain what cumulative voting is.  Take a director election with five directors up for re-election, a shareholder with one share has five votes, one for each director.  The shareholder can vote yes or no on each individual director, but they get one vote per director.  In a cumulative election that shareholder can take those five votes and direct them all at one director or nominee.  This is important when a minority shareholder has enough votes cumulatively to get a seat, but not enough votes overall to secure a seat on the board.

Annual meeting -  Delaware companies are required to hold a meeting annually.  Not all companies comply, and there isn't anyone policing compliance besides shareholders.  If a company fails to hold an annual meeting a shareholder can go to the Delaware court to compel one.  Case law is very clear on this issue, if a company has failed to hold a meeting the court will compel it almost without question.

An interesting side-note to this section of the law is that Delaware law also requires companies to prepare a list of shareholders who are allowed to vote during the meeting.  The company is supposed to have this list available at the meeting and allow shareholders to view it and copy it if they desire.

Appraisal rights - If a company becomes party to a merger or take over shareholders can obtain what are called appraisal rights.  Appraisal rights give the shareholder the ability to contest the value offered as consideration in the transaction.

For example Company A comes along and offers Company B shareholders $10 per share to acquire the company.  If Company B has $5 per share in earnings shareholders might feel like the price offered isn't fair and exercise their appraisal rights.

When a shareholder exercises these rights their shares become frozen and they are not allowed to vote for or against the corporate action.  If the shareholder votes for or against the action in most cases they invalidate this right.  Filing for appraisal rights needs to happen after the action is announced, but before any vote takes place.

The rights are a bit odd, it's possible a shareholder could exercise them and win with the court saying the shares are indeed undervalued.  The company might then be forced to pay the exercising shareholder a higher consideration.  What's strange is that all of the other shareholders who didn't exercise this right receive the initial consideration they agreed to, even if the court rules they were offered an unfair deal.

Worth noting is a history of long drawn out court battles over appraisal value.  Long court battles mean high lawyer costs, which the shareholder is responsible for alone.  Also worth considering is the valuation methodology that the state uses.  If the state uses DCF and the company is fairly valued on a DCF basis it doesn't matter that they're selling for 1/3 of net cash, the shareholder will lose in court.

Right to inspect books and records - A shareholder is the legal owner of a corporation, just like a homeowner is the legal owner of their home.  Likewise it isn't strange if a homeowner were to walk through their home looking at what they own, yet in the corporate world owners are treated like outsiders on their own property.

As a legal owner a shareholder is granted through law the ability to inspect the company's books and records.  For SEC filing companies this isn't an issue, companies disclosure anything an investor might want to inspect to all shareholders through EDGAR.  For non-filing companies, and private companies things are different.  Shareholders have the legal right to see a company's financials no matter what the CFO says.  I've talked to companies where the CFO flat out lies and claims shareholders don't have this right which is a shame.

The Delaware courts look favorably upon shareholder record inspection requests if a valid reason is given, and if the company hasn't made information available.  The requestor is responsible for paying the costs associated with obtaining this material and at times traveling to the company's headquarters or Delaware to inspect the records.

In addition to inspecting a company's books shareholders also have the right to examine and make copies of the shareholder register.  This is the list of who owns the shares, and how many shares they own.

A company by law has five days to respond to a records request, if they don't respond within five days the shareholder has the right to petition the court to view the records.

How to use?

This is probably the trickiest part of the post.  For all actions besides voting on a company issued proxy action needs to be taken on the part of the shareholder.  A complicating factor is that most shareholders are not in the shareholder register because they hold their shares in street name (at a broker).  If you wish to exercise any of the above rights and you hold your shares in certificate form you won't have any issues, proof of ownership and a letter to the company with your intentions is a good starting point. Some rights, such as a records request have specific requirements such that the request be provided in writing and the requestor sign under oath.

If you are a shareholder in book entry form and wish to undertake any of the above actions cooperation on the part of your broker is required.  The Delaware court does recognize beneficial holders as legal owners, but a letter from the brokerage verifying ownership is required.

Talk to Nate about shareholder rights

Disclosure: I get a small commission if you purchase an item through the Amazon link above.  The prices are the same through my link and when you go directly to Amazon.com.

Anyone can invest in this above average hedge fund

Hedge funds, bastions of wealth, accessible to the rich and famous and well connected.  These purported money machines are so sophisticated that they're off limits to anyone who isn't an accredited investor, supposedly someone who's wealthy enough that they know how to not lose money.  The truth is much different from the myth, most hedge funds, like most mutual funds do poorly.  In aggregate hedge funds and mutual funds are the market, it's impossible for all of them to outperform.  The largest ones have managers who are constantly in the news promoting their views.  Who in finance doesn't know who David Einhorn, Bill Ackman, or Carl Icahn are?

I'm guessing all my readers are familiar with hedge funds, and most probably work at one, but not many can actually invest in one, let alone one with a record of outperformance.  Of course all my hedge fund readers work at outperforming funds, you're all headquartered in Lake Wobegon right?  There actually are many funds that outperform each year, and some outperform for decades.  Most of these funds fly under the radar and away from the news.  Most are not household names like the company in this post.

The selling point for a hedge fund is an investor is gaining access to a vehicle that has the ability to outperform the market through going long and short stocks with a judicious amount of leverage.  To gain access to such a dream machine investors pay steep fees upwards with the standard being a 2% management fee and 20% of profits going to the fund.  In theory the fund will do well enough after fees that the gross fee amount doesn't matter.  This is certainly true for some funds, but others don't do well enough to justify their fees.

Senvest Capital (SEC.TO, SVCTF) is an asset manager based in Montreal Quebec.  The company started off as a manufacturer of electronic theft systems, listing on the TSX in 1971.  Starting in the 1980s and into the 1990s the company morphed from being an electronics company to a holding company for various investments.  Management realized that they were better at understanding business and allocating capital than running an electronics company.

From the early 90s to 1997 the company primarily invested capital through their New York subsidiary.  In 1997 they launched their first limited partnership, Senvest Partners.  Again in 2003 the company seeded a partnership, Senvest Israel Partners.  The funds have done well, Barrons noted in 2011 that Senvest Partners was the best performing long-short fund over the 2008-2010 time period.  Bloomberg cited Senvest Israel as the best performing fund for the five year period ending February 28th 2011.  In a world with thousands of hedge funds remarks like this are significant.

Senvest Capital is a bit of an oddball stock.  Senvest Capital is the asset manager that owns Senvest Partners and Senvest Israel along with a grab bag of other assets.  If this company simply were an asset manager with some outside holdings they wouldn't be any more interesting than any of the dozens of other public asset managers.  The difference is that a large part of Senvest Capital's holdings are in their own funds, and that investors can buy these assets at a significant discount.

Here are the company's assets from their latest annual report:

The three biggest items on the balance sheet are their investments, their investments in their hedge funds (investments in associates), and some miscellaneous real estate investments.  The company has almost no liabilities, they amount to $95m and consist mostly of liabilities related to equities sold short.

The company isn't exactly transparent when it comes to explaining their own investments.  They make the following disclosure:

The company has $184m in listed securities and $32m in unlisted securities.  The notes explain that the unlisted securities are positions in private companies that have no public market.  Inquiring minds are probably dying to know what securities the company holds in their listed portfolio.  Unfortunately the notes in the annual report don't reveal anything, but there is a way to get a peek.  Senvest manages their money through a subsidiary in New York.  The subsidiary in New York is required to file their holdings with the SEC regularly.  While the filing doesn't disclose all of their holdings it does give a good picture as to what they hold.  The link to those filings is here.

Some of the unlisted holdings are non-traded REITs, and shares in non-public banks.

What makes this investment so interesting is how cheap the holding company is, and how well they've performed over the years.  The company is trading at a discount to NCAV, a significant discount.  Shares last traded at C$81.85 against a book value of C$117.50.  A friend who is very familiar with this stock estimates that book value is above $120 p/s currently.

It's almost strange that the management company of outstanding hedge funds would trade at 2/3 of BV.  What's even more incredible is that book value consists of mostly liquid investments, equity securities, stakes in hedge funds, and some illiquid real estate investments.  What I find even more incredible is that Senvest as a company has a history of providing solid returns, this isn't a one time undervalue of a mediocre money manager.  I have a table showing book value and earnings per share back to 2004 below:

From 2004 to 2012 the company grew book value from $22 to $117, that's a compound growth rate of 22.8%.  The company's funds have performed similarly over the same period of time.

Readers will note that earnings per share are very volatile.  The company earns a revenue stream from fees associated with the funds.  Unfortunately the fund fees don't cover all of the company's operating expenses meaning the difference ($10m) is made up from equity holding gains.  Given the company's investment performance over the past eight years making up this shortfall hasn't been an issue.  In years when their company's investments do poorly their earnings take a significant hit, like in 2011.  In years when their investments do well earnings do well too, like in 2012.  The company is trading for a P/E of 3x, although I'm not sure earnings are the best way to value the company.

I've explained the math in the past on investing in companies below book value that are consistently growing book value.  Using this math an investor today buying at 2/3 of BV with the company's 22.8% growth rate is actually earning a 34.5% return on their investment if the future looks somewhat close to the past.

Investing in Senvest Capital isn't a normal value investment, it's more of a mutual fund, value stock, and hedge fund hybrid investment.  An investor gets the chance to own pieces of Senvest's mutual funds, along with some of their private investments, all at a 2/3 discount.  Along with this the common equity investor pays no fees, rather they are a beneficiary of the fees that the company's fund investors pay.  Even with all these things investors are still provided a margin of safety, they're buying at 2/3 of a very tangible and liquid book value.

Talk to Nate about Senvest Capital

Disclosure: Long Senvest