Sonics & Materials, Inc. Tender Offer ($SIMA)

We received this recently regarding Sonics & Materials, Inc. (OTC: SIMA). Some highlights from the tender offer document:

  • Sonics & Materials, Inc. (“Sonics” or the “Company”) is offering to purchase up to 837,580 of its
    common stock (the “Common Stock”) in a tender offer at a price per share of $10.00 in cash.
  • We will purchase up to a maximum of 837,580 shares of Common Stock, which number of shares represents all of the outstanding shares of Common Stock held by stockholders other than Robert Soloff, Lauren Soloff and their respective affiliates, including JBH Sonics, LLC (collectively, the “Soloff family”), and shares held by Sonics. The Soloff family is our largest stockholder, controls our Board of Directors and will not participate in this offer as a selling stockholder. As of the date hereof, the Soloff family beneficially owns 2,563,490 shares of our Common Stock (representing 73.2% of the outstanding shares of our Common Stock).
  • In recent years, the Company has received inquiries from stockholders regarding how the Company plans to use the cash on its balance sheet. While the Board has explored various options, including having engaged an investment banker to present possible acquisition targets (none of which is contemplated at this time), the Company has received several requests from stockholders that the Company use its available cash to repurchase its issued and outstanding shares not held by the Soloff family. In connection with this offer, the Company recently retained Access Value, LLC (“Access Value”), an independent third-party valuation firm to determine the fair market value of the our Common Stock. Access Value has determined that the fair market value per share of Common Stock as of March 31, 2021 was $6.11 on a minority, non-marketable basis and $9.60 on a minority, marketable basis.
  • Sonics designs, manufactures and sells (i) ultrasonic bonding equipment for the welding, joining
    and fastening of thermoplastic components, textiles and other synthetic materials, and (ii) ultrasonic liquid processors for dispersing, blending, cleaning, degassing, atomizing and reducing particles as well as expediting chemical reactions. To further address the needs of its customers, the Company also manufactures a spin welder and the vibration welder, both of which are used for the bonding of thermoplastic components. The Company was incorporated in New Jersey in April 1969, and was reincorporated in Delaware in October 1978. Robert S. Soloff, its chief executive officer and founder, invented the ultrasonic plastic welding process early in his career. He has been granted numerous patents in the field of power ultrasonics and is considered to be a pioneer in the application of ultrasonic technology to industrial processes. The certain patents granted to Mr. Soloff in the field of power ultrasonics have expired and the technology related to them is now in the public domain and is used in part in the development and manufacture of the Company's products. Lauren Soloff, Robert Soloff’s daughter, has worked in the business since 1994. In 2019, she became president of the Company.

The tender offer document shows unaudited financials for the nine months ended March 31, 2021. The company made $2 million (net) on $18.5 million of sales in just nine months. Book value at the end of March was $35 million and current assets net of all liabilities were $31.7 million.

At $10 per share (the tender offer price), the market cap is $34 million. However, the enterprise value is much less, because of all the cash on the balance sheet. 

You might wonder how a company with $9.32 in net current assets could have a fair market value of $6.11. Here is the reasoning applied by the Access Value appraisal report:

Based on the LOCD [lack of control] market indications and the analysis of key factors of control noted above, a 19.0 percent LOCD was selected to convert the control basis of value to a minority basis of value in the market approach and the asset approach to valuing the Subject Interest. [...]

An LOMD [lack of marketability] of 38.0 percent was selected for the income approach, which reflected public market liquidity; and a 30.0 percent LOMD was selected for market approach and asset approach, which reflected control liquidity in the private markets.

If I owned Sonics & Materials shares, I'd be on guard on the future for the controlling shareholders to try to squeeze me out at a ridiculously low "appraised" valuation.

SEC Rule 15c2-11 Restricted Securities

Last September, we wrote about a proposed SEC rule change that threatened to make it more difficult to trade in opaque micro cap companies. 

Over a hundred people wrote in to comment, almost all in opposition, including well-known investors, firms, and funds like: Mitchell Partners, the OTC Markets Group, and the Oddball land company Aztec Land and Cattle Company, Ltd..

TD Ameritrade just sent an email to clients with a 162 page list of OTC stocks (embedded below) that they are going to restrict from trading because of the new SEC Rule 15c2-11. Here is how they are describing their new policy:

On September 28, 2021, new amendments to Rule 15c-211 under the Securities Exchange Act of 1934
go into effect to enhance investor protection and improve issuer transparency. These amendments
restrict the ability of market makers to publish quotations for those companies that have not made
required current financial and company information available to regulators and investors.

Ahead of the regulatory enforcement date, TD Ameritrade will only accept orders to liquidate positions - (i.e. no new buy orders) starting in mid-August 2021. Please note: After the amendment officially goes into effect on September 28, 2021, it may be more difficult to liquidate these securities. Quoting and market liquidity may also be very limited.

The list is below as of June 30, 2021 and is subject to change at any time.

The TD Ameritrade list includes such Oddball companies as Hanover Foods (both HNSFA/HNFSB), Pardee Resources, PD-RX Pharmaceuticals, Queen City Investments, Pinelawn Cemetery, ACMAT Corp, Advant-e Corp, Aztec Land & Cattle, Avoca, and Boston Sand & Gravel. 

It includes some banks, but not very many.

We will be continuing to cover this regulatory change in the Oddball Stocks Newsletter. If you haven't yet, give us a try.

Tda 101550 by Nate Tobik on Scribd

Just Published: Issue 35 of the Oddball Stocks Newsletter!

We just published Issue 35 of the Oddball Stocks Newsletter. If you are a subscriber, it should be in your inbox right now. If not, you can sign up right here.

Remember that we have made some back Issues of the Newsletter available à la carte, so you can try those before you sign up for a subscription: Issues 19, 20, 21, 22, 23, 24, 25, 26, 27, 28, 29, 30, and 31.

We also published a Highlights Issue in February 2020. The Highlights Issue is available here for purchase as a single Issue.

We just lowered the price of most of our back Issues to $99 from $139. If you are curious about them, there has never been a better chance to try them.

If you have been curious about the Newsletter, the Highlights Issue is the perfect opportunity to try about two Issues worth of content (much of which is still topical and interesting) at a low cost.

"Friendly Hills Bank Plans Dubious Branch Acquisition" $FHLB

Dave Waters writes:

The economic rationale for this branch purchase is dubious at best. Moreover, Friendly Hills is a chronic under-performer that has shown no ability to manage its own assets successfully, let alone the cast-offs of a successful bank.

Also see our recent posts, Shareholder Vote at Friendly Hills Bank and A Story of Two CEOs.

Friendly Hills Bank ($FHLB): "A Story of Two CEOs"

We did a post last month about the upcoming shareholder vote at Friendly Hills Bank (FHLB) regarding the proposed acquisition of three branches, all from Southern California Bancorp (BCAL). A Friendly Hills shareholder wrote in today with his analysis of the situation, which we are sharing below.

The key thing to understand is that the proposed acquisition is a "story of two CEOs": one CEO is buying three branches that the other CEO owns and wants to get rid of. 

What you worry about is an adverse selection problem: how can the buying CEO make sure that the price he's paying is low enough when he's buying an asset from someone who knows it better (asymmetric information problem) and wants to get rid of it. 

Is the Friendly Hills CEO familiar with one of the all-time most important economics papers, "The Market for Lemons"? Since the assets come with expense commitments, it is even possible that he should be getting paid to take them!

Friendly Hills BANK Story ... by Nate Tobik

Double Bottomline Corp. Reaches Definitive Agreement to Purchase Community Savings Bancorp, Inc. ($CCSB)

Press release yesterday: 

Double Bottomline Corp. ("DB") and Evan M. Stone have reached a definitive agreement with Community Savings Bancorp, Inc. (OTC: CCSB), and its wholly-owned subsidiary, Community Savings, a federal savings and loan association, to acquire Community Savings Bancorp, Inc. ("CCSB"), the registered savings and loan holding company for Community Savings. The aggregate merger consideration for the transaction is $9.5 million, subject to adjustment as provided in the definitive agreement. CCSB currently estimates that, without any adjustments, this will result in approximately $22.76 per share to the current holders of CCSB common stock. However, the estimated per share consideration may be subject to significant adjustment based on a variety of factors, including, but not limited to, transaction costs and whether the organization obtains CDFI status, as defined below. As a result, CCSB shareholders should not assume they will receive $22.76 per share upon closing of the transaction. Community Savings operates a full service location in Caldwell, Ohio. As of March 31, 2021, CCSB reported $59.58 million in total assets and total equity capital of $7.79 million. 

We wrote about Community Savings Bancorp in Issue 16 of the Oddball Stocks Newsletter (March 2017) when it was trading for $13.25. It had just de-mutualized at that point and was trading at a big discount to book value. Here was how Nate explained the idea in that Issue:

Following the conversion their equity to assets is about 18%, and their Tier 1 ratio should be about 40%. These are very high levels. The significant excess capital explains the paltry 0.2% return on equity (“ROE”). The bank barely ekes out a profit with a 97% efficiency ratio. The bank only has $32m in loans with the rest of their assets sitting in cash or investment securities. This is truly the epitome of a bank net-net if there ever was one.

Many people will think about all of this for a second and wonder why anyone would pay book value for this dog. After all, there are any number of people who believe that unless a bank can earn something like a 10% ROE they aren’t even worth book value. With that in mind, there are really a few reasons you might want to consider investing in this bank.

The first reason is that by consummating the conversion management took the first step towards realizing value, both for themselves and for shareholders. In most cases mutual banks convert either as a way to grow or as a way to cash out. There are banking regulations that prevent newly converted mutuals from selling within three years of their IPO date, but they are permitted to engage in value accretive actions before then. On the first anniversary of their IPO they can buy back stock, and on the second anniversary they can pay a dividend. Once the third anniversary rolls around they are afforded the opportunity, if they wish, to sell and cash out. The statistics on newly demutualized banks selling after the three year mark is encouraging. Over 80% of demutualized banks have been sold to another institution within five years of their IPO. If you’re looking to buy a bank hoping that it will be acquired at a tidy premium (ideally after you’ve made your purchase) then mutuals are fertile ground.

But what if the bank doesn’t want to sell? Remember that the 2 primary reasons to convert are to raise capital for growth or as a means of cashing out. So, if the bank isn’t going to sell and cash out, by process of elimination we are left with a growth strategy. With a larger asset base the bank is in a better position to make additional loans and grow, although it remains to be seen in Community Savings Bancorp’s case. This is because management hasn’t demonstrated any ability to grow beyond drifting up and down with the local economy.

The good news is that the bank’s management has skin in the game along with investors. They purchased 10% of the shares offered in the IPO for approximately $360k in the aggregate. This might seem like a nominal sum to many ritzy investors, but it is significant considering the CEO makes a base salary of $120k and got $20k in bonuses last year.

Community Savings never performed well as a bank, but what mattered in the end was purchasing at a big discount to tangible book value.

Shareholder Vote at Friendly Hills Bank ($FHLB)

Friendly Hills Bank is a small bank in Whittier, California (a city in Los Angeles County) that was founded as a community bank in 2006. The shares are OTC-listed (ticker FHLB) and trade for around $11, which is not much greater than the IPO price a decade and a half ago.

What caught our eye recently is that Friendly Hills is having a special meeting on June 22nd in order to hold a shareholder vote on a proposed acquisition of three branches from Bank of Southern California. The other thing that we noticed was a couple of smart bank investors (like @TimyanBankAlert) on Twitter mentioning Friendly Hills and the acquisition:

We follow @OurBank3 on Twitter, a bank investor account that has the motto: "The shareholders are the rightful owners. Management has a fiduciary responsibility. Proud #SHT member-Shareholders who Hate value Traps". So far we agree on banks wholeheartedly! So if this account has a beef with this proposed acquisition, we thought that we should dig a little deeper.

Let's first back up and understand Friendly Hills a little better. As of March 31, 2021, this is a bank with $214 million in assets, $127 million in loans, $171 million in deposits (L/D only 74%), and $20.7 million in shareholder equity (all tangible). In 2020, FHLB had comprehensive income of $1.4 million, which was a 7.4% return on equity and a 77 bps return on average assets for the year. However, for Q1 2021, the net income was only $240k which is a 4.7% annualized return on equity.

Unusually for a bank of this size, Friendly Hills is not a residential lender. Their loans are 70% commercial real estate and 30% commercial and industrial. The average interest coupon is 4.2%. Since their loans/deposits are so low, they have a significant amount of investment securities, more than half of which is of ten year or greater maturity. The bank is overcapitalized with Tier 1 RBC of 18.8%.

You can see the efficiency ratio trend for Friendly Hills as calculated by Complete Bank Data:

Book value per share for FHLB is $10.34 vs the recent trading price on May 27th of $10.95 per share, so it is trading for 106% of TBV. This is not exactly a screaming bargain when Oddball Stocks has recently written about a basket of small banks that are earning higher ROEs and trading for about 80 percent of tangible book.

Also, Friendly Hills management has a lackluster (at best) history of value creation. As you can see from a long term chart of the share price it has gone nowhere since the IPO. (And it has never paid a dividend.) The current president of the bank has been in place since the founding. We found an LA Times article from 2013 with his complaints about how small banks are over-regulated. 

It looks as though he and Friendly Hills stumbled right out of the gate after the bank was founded, losing a significant amount of money during the 2008 credit crisis. The bank originally raised about $17 million in equity, and by the end of 2010 the bank had accumulated a deficit of $5.2 million and was down to $11.8 million in equity ($7.29 per share). Even today, the bank has only $3 million of retained earnings since inception.

Now Friendly Hills wants to buy three branches from a local competitor (one each in Orange, Redlands, and Santa Fe Springs) for $1.17 million (plus assumption of the lease liabilities for the branches) that have $92 million in deposits. Here is what we wonder about with this proposed transaction:

  • Why does a bank with only 74% of its deposits lent want to buy more deposits? Don't they need loans and not deposits?
  • The pro-forma financials (disclosed on p34 of the special meeting proxy) show that in Q1 2021, these three branches would have been responsible for $432k of additional non-interest expense. So, in addition to the purchase price of $1.17 million, there is going to be commitment to a fixed overhead burden: lease payments, compensation, etc.
  • Are going to stick with their long-term securities portfolio strategy and term out / increase the tenor (time until maturity) of the $92 million that is coming in? It seems like this acquisition could result in pressure to earn back this incremental overhead burden by taking either more interest rate risk or more credit risk, plus more leverage from the additional $92 million of deposits on the existing equity base.
  • Is acquiring more branches really the right move for any bank in a country that is staggeringly over-branched (especially given changes in customer habits and technology)? Plus, is there an adverse selection problem in buying branches that a local competitor wants to get rid of? Is this an example of a smarter bank dumping an albatross on a bank that is "slow to realize their branch networks are a drag"?
  • Was there a better deal to be done here? If Friendly Hills shareholders turn this down, can Bank of Southern California really do just as well, or might the deal get sweetened?

We noticed in the proxy statement for the special meeting is that there is a significant outside shareholder who happens to be the largest shareholder of Friendly Hills. The officers and directors of FHLB as a group own 21.1% of the company, with the plurality of this held by the Chairman William Greenbeck and the CEO Jeffrey Ball. But the largest shareholder, Frank Kavanaugh in Newport Beach, owns 26.2%, which is more than all of the insiders combined. (The other shareholder disclosed in the proxy is AllianceBernstein which owns 9.6%.)

The 21% owned by management seems like good ownership skin in the game, but unfortunately a lot of this stock was essentially given to them and not purchased:

Stock Option Grants to Executive Officers
On December 31, 2018, we granted incentive stock options under the 2017 Equity Incentive Plan to our executive officers. We granted an option to Jeffrey K. Ball, President and Chief Executive Officer, to purchase shares in an amount equal to 2.5% of our issued and outstanding shares, or 50,000 shares, an option to our Chief Operating Officer, to purchase shares in an amount equal to 0.5% of our issued and outstanding shares, or 10,000 shares, an option to our Chief Financial Officer to purchase shares in an amount equal to 0.3% of our issued and outstanding shares, or 5,000 shares, and an option to our Chief Credit Officer to purchase shares in an amount equal to 0.3% of our issued and outstanding shares, or 5,000 shares.

The incentive stock options, which we granted to our executive officers in 2018, vest at the rate of 20% per year, beginning on December 31, 2019, which is one year after the date of grant. The options shall all remain exercisable, subject to earlier termination upon the happening of certain events, until December 31, 2028, ten years after the date of grant. The exercise price of the incentive stock options granted to our executive officers is $6.80 per share, which is equal to or in excess of the fair market value of the shares of our common stock on December 31, 2018, the time of the grant of such stock options. We did not grant any stock options or other stock awards to any of our executive officers in 2020.

Stock Option Grants to Directors
On December 31, 2018, we granted nonstatutory stock options to our non-employee directors under the 2017 Equity Incentive Plan. The nonstatutory stock options granted to our non-employee directors in the aggregate is equal to 4.5% of our issued and outstanding shares or 89,750 shares. The non-employee directors’ option grants vest at the rate of 20% per year, beginning on December 31, 2019, which is one year after the date of grant and the term of each of the option grants is ten years from the date of grant. The exercise price of the nonstatutory stock options granted to our non-employee directors is $6.80 per share, which is equal to or in excess of the fair market value of the shares of our common stock at the time of the grant of such stock options. We did not grant any stock options (or other stock awards) to our directors in 2020.
So that is really brutal from a shareholder perspective. The end of 2018, you may recall, was a big market crash. And how did FHLB insiders respond? Why, they gave themselves options to acquire 8.1% of the bank at 80 percent of tangible book value, and less than 70 percent of the IPO price a dozen years earlier.

Something else brutal about management is that FHLB has never bought back stock when it was cheap. The share count now is higher than it was a decade ago, even though the bank has excess capital and even though the stock had traded at big discounts to tangible book. After having been in business for a decade and a half under the same management, you get a pretty clear view that management doesn't allocate capital well (which should worry us about the branch acquisitions) and is opportunistic about transferring value to themselves (with the 2018 options grants).

We found that the largest shareholder Kavanaugh made a change in control filing with the Federal Reserve in December 2018 to acquire shares of FHLB. At the end of 2018, the shares had collapsed down to around $6-7, so this may have been a very astutely timed buy. (Yet notice that he, an outside shareholder, was paying cash for his stake, while the insiders were being granted cheap options.)

Really good things can happen for shareholders if someone with significant ownership skin in the game - that they paid for - comes in and pushes things in the direction of shareholder value maximization. This is "reading the tea leaves": remember how SouthFirst in Alabama was acquired last year? The only clues to long-suffering outside shareholder that things were moving in that direction were (a) unhappy minority shareholders with big ownership positions and (b) right before the sale, the termination of the golden parachutes for execs.

If you want to dig in further on Friendly Hills, we have uploaded some helpful documents on Scribd:

And if you like small banks and shareholder activism, be sure to try the Oddball Stocks Newsletter. We've been talking about almost nothing but small banks since last summer, and we are always very interested in shareholder activism and small bank activism.