Two very different un-researched companies

I'm combining two companies into this post because each company doesn't have enough to fill a post on their own yet they are interesting enough to discuss, these are true oddball stocks.  If people seem to like this format I'll probably continue it as I journey through my 2003 Walkers Manual of Unlisted Stocks.

Before I start both of these companies are small (although on different spectrums one $9m, other $1b) unlisted stocks and illiquidity can be a problem.  Both companies below are fairly illiquid although Ash Grove Cement is a bit more liquid than OPT Sciences.  DO NOT USE A MARKET ORDER WHEN ATTEMPTING TO BUY!

I also want to mention that Ash Grove doesn't list their financials online or to the SEC.  If you want to get an annual report you need to buy one share, fax the company proof of shareholding and they will mail you a copy of the 2010 report.  I would expect the 2011 report to come out sometime in March.  I went through this process and it's pretty easy and quick.

OPT Sciences (OPST.Pinks)

Price: $11.80 (Last trade 12/19/2011)
Market Cap: $9.15m
Shares: 775,585

OPT Sciences manufactures anti-glare coatings for glass and LCDs.  Their main customer is the aviation industry who uses the coatings on airplane instrument panels.  There isn't much to discuss regarding the actual business, it's pretty straightforward.  If the aviation industry is doing well OPT Sciences is doing well and visa versa.  All orders are customer made to specification meaning that sales vary quarter to quarter, delivery time is between four to twelve weeks.

What got me interested in OPT Sciences is that the company is selling for a discount to it's net current asset value, or in other words this is a net-net stocks.  I have my net-net worksheet below:

The big risk with OPT Sciences is that their two largest customers make up 69% of sales.  Additionally their delivery timeline is the customer's timeline and not based on their ability to manufacture.  The second risk is that 66% of the shares are owned by the Arthur John Kania Trust further limiting the float and any chance for a shareholder to stir up the pot.

Investment highlights
-$12.34 in gross cash per share, $11.59 of net cash
-Manufacturing facilities owned free and clear, no debt
-$4.7m in sales 9 months ending July 30, $4.9m in sales 2010, $4.8m in sales 2009
-$.77 EPS 9m 2011, $.59 EPS 2010, $.35 EPS 2009
-23% ROE with excess cash removed
-35% ROIC in 2010

This is an impressive little company, most of their 2010 and 2011 results are from pent up demand following the 2008 and 2009 downturn.  Even if earnings shrink there is still a considerable margin of safety considering the investor is able to purchase for less than liquidation value.

The only problem with OPT Sciences is that liquidity is very limited and it doesn't seem that there's any sort of value creation catalyst.  The company states they are unlikely to pay a dividend in the future so for now that cash is locked away tight.  My guess is that at some point the trust that owns a majority of the shares decides they want a bit of liquidity and the company starts to pay out earnings and possibly cash as a dividend.  If I could ever get an order to fill I'd be happy to own a bit of them and sit back and wait.

Ash Grove Cement (ASHG.Pinks)

Price: $128.03 (12/21/11)
Market Cap: $1.048b
Shares: 8,190,061

Ash Grove Cement as its name implies is one of the largest portland cement producers in the US.  The company has facilities spread across the western US and is headquartered in Kansas City.  The cement business is pretty simple, buy aggregate, add sand, crush it and distribute as cement mix or add water and distribute as cement in a truck to a construction site.

What got me interested in the company was seeing that they had a ~$200m market cap and over $1b in sales back in 2008.  The market cap figure listed was wrong on the site I was looking at but it was too late at that point, I didn't realize this until I got a copy of the annual report.  The company had quite a run of sales going from $682m in 2001 to $1.2b in 2007.  Sales dropped off from during the financial crisis falling to $872m in 2010 tracking the fall in housing.

Cement production is pretty resource intensive with high fixed costs which have really hurt the company the past few years.  The gross margin in 2009 was 21% and 15.8% in 2010, net margin was 7.9% in 2009 and 4.28% in 2010.  In the annual report management warned that they expect conditions to be even worse in 2011.  In the winters of 2010 and 2011 the company idled their plants because inventory storage was full and it was unlikely that it would be worked down over the winter.

The balance sheet is interesting, the company is selling for far less than book value, the depreciated value of the PP&E is $167.85 a share alone.

Investment highlights:
-EV/FCF 8.5x
-EV/EBIT 15x
-11x interest coverage
-1.7% weighted average rate on the long term debt, it seems some of this is due to state sponsored bonds.
-$30.29 a share in cash and cash equivelants
-$206.13 book value
-Pays a $1.76 per share dividend
-Earned $4.56 in 2010 per share and $8.44 in 2009

Ash Grove Cement might be a good investment if the housing market starts to recover or demand for cement picks up.  The company has the balance sheet to wait out a long recovery, they've been in business for 130 years and even in this dry stretch have been able to operate profitably.

If you're interested in any further information drop me an email.

Talk to Nate about either company

Disclosure: Attempting to buy shares in OPT Systems, no position in Ash Grove Cement

Hidden Champion Basler

Basler (BSLX.Germany)

Price: €11.27

I want to look at another hidden champion in this post.  I previously examined Corticeira Amorim in this post, and this post.  Hidden champions are companies that are usually market leaders in a niche industry or technology.  Hidden champions by their very nature are businesses with moats, often due to a few factors, technological advantages, cultural advantages, and worldwide distribution.  It's no accident that hidden champions are the top of their field.  Most hidden champions are private companies, only about 9% are publicly listed.  Considering the small relative float, and the superior execution level these companies exhibit it's rare to find them selling cheaply.  What got me interested is that with the European crisis many hidden champions have seen their prices fall along with the broader market, and I think we might be in a rare period when some of these companies can be picked up at reasonable prices.  So now onto the current hidden champion Basler.

Basler is an optics company located in Northern Germany near Hamburg.  The company makes a variety of different cameras for industrial applications.  The cameras Basler sells are focused on three main markets, the industrial segment, traffic segment, and medical segment, the key is that these aren't consumer cameras.

The cameras are interesting, they come in all shapes and sizes but the company specializes in small fast ethernet cameras.  The cameras only need to be connected to an ethernet cable, the cable can be up to 100m in length.  The ethernet powers the camera (Power over Ethernet technology) and also sends the video back to a computer.  The cameras are tiny and have some impressive stats.  I picked one from the Area Scan category as an example, the camera is 42mm x 29mm x 29mm (1.65in x 1.14in x 1.14in), it can capture color video at a resolution of 1294 x 964 pixels at 30fps and send the video back over Gigabit ethernet.  If you're having trouble picturing the size the lens is about the same size as a beer bottle cap.  Basler makes both the camera hardware and software to accompany it.

I briefly mentioned possible applications above.  To dive a bit deeper Basler breaks out camera application into three categories:

Industrial - Cameras in this category can be put on a production line and used as sensors.  For example a camera might check a food assembly line for foreign objects in a package.  If the camera is applied to the print industry it could be used for quality control, or sorting.

Medical - A camera in this category can be used in surgery or highly demanding medical devices.  The company mentions microscopy as one use.  I had a knee scoped a few years ago and now I'm wondering if a Basler camera was used.  Complete random aside, if you're considering a scope I'd highly recommend it, I'm back to running, skiing and biking without any issues or pain.

Traffic - Basler cameras can be applied to traffic in three different applications, traffic control, traffic enforcement and tolling.  Traffic control is a monitoring application, used by a local transportation department and often shared to local news websites as "traffic cams".  Enforcement is the dreaded red light cameras, and tolling is something like EZ-Pass an automated toll system where a device resides in the car and there's no need to stop and pay a toll the driver just passes straight through.

At this point it might be appropriate to ask how Basler is a hidden champion.  The company is considered a leader in the vision technology field.  They were the first to incorporate Gigabit ethernet into their cameras and they're helping to define the USB 3.0 video camera standard.  The company has over 50 models of cameras and are considered the highest quality in the field by clients.  In addition the company has more than 20 years of experience in their current niche.  I would say these things qualify Basler as a hidden champion, a leader in a niche category, a high quality producer, and a culture that has experiencing operating at this level for years.

Recent Performance

The company had a record year in 2010 where they surpassed the 2007 high water mark for sales.  According to the annual report they expect single digit growth in the industrial market and double digit growth in the medical and traffic markets.  The company expects to grow at a steady 5% rate for the foreseeable future.  In the first nine months of 2011 revenues are running ahead of 2010 with expected revenue in the €54m range.  If the recent margins remain stable the company should have EBIT come in at €8m with net income slightly higher due to tax benefits.

In the half year results Basler reports that their sales breakdown into the following geographic areas:
43% Asia
35% Europe
22% North America

It should be noted that Basler has sales offices in the top optics locations worldwide.  They also have sales offices in areas where customers are concentrated.

Examining the financials

When I looked at Basler's current results I was favorably impressed, the company has a nice return on invested capital, and great margins.  I wanted to get a historical perspective to see if the company had always operated at this level, or if it's recent.  I put together this spreadsheet with some relevant information from the past five years.

The first thing that stood out to me was that ROIC and ROE are really only above average recently.  Additionally there seems to be a break right around 2009 where something changed dramatically.  So I went digging and the answer was found in the 2009 annual report.  It seems that Basler was rocked by the financial crisis reporting a sizable loss in 2009.  The crisis and dire conditions caused the board and management to re-evaluate the business.  Consequently they sold off a lower earning core division and streamlined operations (presumably by firing employees).  The result of this was that the company lowered their break even point from  €51m to €36.5m.

The changes management took in 2009 seem to have been prudent and the right course of action looking back two years later.  Sales picked up in the camera business and due to the increased operating leverage earnings received a nice boost and subsequently ROIC and ROE rose as well.

One thing an enterprising reader of my spreadsheet might notice is that I included Basler's leases in my calculations.  The company leases all of their facilities, and a substantial portion of their assets are leasehold improvements.  I don't like the structure of something like this because the company doesn't own what they've developed. I'm sure it could be argued that all they're leasing is a building space and in theory they could move their equipment and setup somewhere else if they needed to.  The problem I have with this is that the company is at the mercy of their lessors.  The lessor knows considerable improvements have been made and it gives them leverage to raise the lease price cutting into Basler's results.  I'm not privy to the decision making behind this, but it seems that Basler has operated this way as far back as I can find results.  The notes mention that Basler has the option of buying out the buildings at the end of the lease.  The rate on the lease is 6.34%, I have no idea if this is a competitive rate in Germany, it's slightly higher than their outstanding notes but lower than their bank rate.

One last point I want to mention is on the tax front.  If you notice the company actually gets a boost to net income in 2010 from a tax refund even though they were profitable.  This seemed like a potential red flag but I found buried in the notes that Basler has €17m in a tax loss carry forward that they're working down.  I don't know exactly how these work in Germany but I'd estimate they have a year or two of this left.

What can go wrong?

After reading so much about this company I started to feel like I was wearing rose colored glasses.  I'm a sucker for their technology it's really cool stuff, and a lot of financial metrics looked great.  I needed to step back and evaluate, so I took a look at a few things, the first was earnings quality.  Earnings quality is excellent, with a very low amount of accruals, and net income confirmed with solid cash generation.

I also looked at cash flow, the company is a consistent cash flow generator.  They do have to re-invest a substantial amount back into development but they have continually thrown off free cash flow.  The free cash has been used to pay back bank debt and pay dividends among other things.

Other red flags or points of queasy-ness did emerge for me.  The biggest is that a few people in management have made loans to the company at market rates.  I'm not sure why this is necessary but it leaves me uneasy.  On the flip side the same people also own significant shareholdings.  I just can't imagine a situation where management offers to loan the company from their own personal fortune.  I should note these loans do seem to be paid back, but it's a constant revolving door.  As one loan is repaid another one is extended.

Of course the biggest thing that can go wrong is for Basler's sales to drop off.  Basler doesn't have a margin of safety in the traditional sense that I like.  Most companies I take a look at have a large slug of assets protecting my downside.  Yet at the same time Basler is a great company with a nice moat that no net-net could ever dream of.  In a sense the margin of safety is the moat, the competitive position Basler holds in their market.  The risk here is that if sales do drop the shares can fall hard, back in 2009 when they reported a loss the market cap was €19m half of what it is today.


I'm not sure if the following items are catalysts but I think they're good things that can only help the company.

The first is Basler authorized a 10% buyback, so they'll buyback up to 350,000 shares on the open market.  This could be a great way to support increased trading volume in the company.  The justification for the buyback is fascinating.  The board said the shares are at a very low level and they want to buy them when cheap and hold on so at some future point when they're more richly valued they can use them in an acquisition.  The bad news in this is that the buyback won't be canceling any shares.  I'd prefer a buyback to shrink the piece of the pie I own.

The second item is that the company has formally instituted a dividend policy as of last year.  They declared that there is a fixed dividend component of €.20 a share and a variable component both together totaling 30% of net income.  The dividend paid for last year which should be similar to the amount this year gives the shares a modest 2.5% dividend yield.

What's a good price?

Past readers of the blog might have noticed that I didn't include a section discussing why the company is cheap.  Partially the reason is I'm not sure if they're exactly cheap.  On a pure metrics basis of say EV/EBIT they seem cheap sporting a ratio of 4.32.  But once you add back in those pesky leases the EV-adj/EBIT bounces up to 6.4x.  Another measure of value the P/E ratio stands at 4.6x seems crazy cheap, but if you back out the tax advantage to earnings the stock is at 6.23x which is close to the DAX P/E and reasonable considering the illiquidity.  So all things considered Basler is basically trading at a market multiple with the DAX.

With some of the metrics behind us I think it's fair to conclude that the stock is attractively priced, but probably not cheap.  If I wanted to find a reason this is at €11.27 and not €18 I think it's found squarely in two things, the market cap and associated illiquidity and the fact that it's family owned.  This is a €39m company we're talking about that only traded 5500 shares last year.  Put another way only 16% of the company traded.  This is way too small for many funds to invest in, and even if they wanted to invest the volume isn't there.

The second issue is that the company is 51% owned by the founding family.  Often family controlled companies scare away institutional money.  Strangely enough I find myself researching and investing in a lot of these family companies across Europe.  My rational as an individual is that often a controlling family won't do anything that could put their fortune at risk.  This often means a company might not run at the optimal level, yet it gives me comfort that my investment is safe.  Of course all this presumes that management isn't looting the company from shareholders which doesn't seem to be the case.  Salaries are modest and low compared to US standards.  The one outstanding question are those loans the officers keep making, I'm not sure what to make of them.

Why I can't bring myself to buy

I wrote the bulk of this post over two days and as I started I kept thinking that this is a great company I'd love to own, my feelings slowly changed as I wrapped things up.  Everything seemed great at first, a reasonable price, great returns and significant earnings momentum.  Basler seemed to be a fat pitch a great company at a really good price.  But for some reason after I finished researching and typing this post the thought of buying Basler shares just didn't sit well with me.

I thought this over a lot Sunday afternoon and I think I know why I'm unsettled.  The first thing I started to think about was my downside risk, I discuss this above.  The next thing I kept thinking about was what happens to me as an investor if the market never realizes that Basler is relatively cheap, where am I in five years?  At first I thought no problem I could invest and let them compound my money for me at nice rates.  In a few years I would own a piece of a company who's book value had increased at 15% or so for the holding period.  The problem I realized is that while the company has a really nice ROE and ROIC the invested capital is mostly debt, leases and intangibles.  The problem is even if I held for 5 years and ROE averaged 15% for those five years as an investor I wouldn't have anything tangible that increased.

The problem is the company needs to constantly re-invest in R&D to maintain their competitive advantage.  This investment is recorded as intangibles on the balance sheet, the problem is this isn't something that can be easily realized or maybe realized at all.  In a sense the earnings are a product of the intangibles, but the intangibles might not have much value themselves.  The R&D is a necessary expense, they can't sell off their intangibles if times get tough, the intangibles are the business.

The other problem is the biggest asset is the company's leasehold improvements.  I realize that there is value to these improvements yet at the same time it's not like the company could sell their facilities if they needed to.  They could probably sell some equipment, but definitely not the land and buildings.  And unfortunately for Basler land and buildings are re-usable and retain value whereas specialized technology for camera production does not.  Looking forward in five or ten years the land and building will probably be the same value or more, the camera technology not as much.  I'm willing to be ten year old camera manufacturing equipment is on eBay for pennies on the dollar.

So my final conclusion was that for me to realize a return with Basler I would be relying on two things outside of my control, multiple expansion and continued earnings momentum.  If earnings stay strong and continue, and the margin expands an investor would do well in Basler.  The problem is if neither of these things happen my fear is an investor will find themselves a few years down the road in the exact same spot as now, invested in a company with great metrics but nothing tangible to show for it.

I would love to be persuaded otherwise, leave a comment or send me an email!

Talk to Nate about Basler

Disclosure: No position in Basler, long Corticeira Amorim

A small cap pure timber play, Keweenaw Land Association

Keweenaw Land Association (KEWL.Pink Sheets)

Price: $76 (12/13/2011) - note this is an extremely illiquid stock, small trades can really move the stock price.

A bit back I did a post on investing in Timber and got some great emails from readers regarding other companies that are more pure timber plays.  One of the companies mentioned was Keweenaw Land Association a smaller company traded on the pink sheets.  In my last post on Queen City Investments I mentioned pink sheet stocks often having a story that follows them, Kewneenaw doesn't disappoint in this regard.

Keweenaw doesn't report to the SEC but they do offer quarterly reports on their website along with their audited annual report.  The company isn't "dark" by any means, they are transparent with shareholders and tout the cost savings from non reporting as an investment advantage.  There are actually a few presentations on their site showing the potential cost of becoming a REIT and filing.

Company Background

Keweenaw has a long history, it began as a land grant after the Civil War.  The company owns 159,831 acres of land of which 153,074 is timberland in the Upper Peninsula of Michigan and northern Wisconsin along with 405,985 acres of mineral rights.

For much of it's history Keweenaw made money on mineral royalties and timber harvests.  For years the company harvested more timber than they grew.  In the 1960s the company made a decision to manage the woodland in a more sustainable manner, and began this aggressively in the early 1990s.  Now the company grows more timber than they harvest and focus on increasing the asset value of the timber holdings.

Activist Story

As I mentioned above almost no pink sheet stock escapes without having some sort of story to tell, Keweenaw is no different.  The story here is a bit unique, there are two shareholders Ron Gutstein and Scott Frisoli who for the past few years have been offering shareholder proposals and director nominations at each election.

The shareholder proposals seem to change each year, in the beginning there was a laundry list of suggestions to unlock value including the following, a snowmobile theme park, wind power generation, a REIT conversion, elimination of the dividend, and a buyback.

The proposals haven't been for naught, the company has put together some great presentations explaining why it isn't in the best interest of shareholders to convert to a REIT.  They also commenced buyback and eliminated the dividend.  The dividend was eliminated with the purpose of channeling the money back into growing the business.

Here is a letter from Ron Gutstein with some of his proposals back in 2009:

For each letter and proposal Mr Gutstein submitted David Ayers wrote a rebuttal and posted it on the company website.  Some rebuttals are quite elaborate with presentations and lots of good information, others are simply a few lines.

For all this back and forth the company claims to have spent over $300,000 defending themselves.  Keweenaw tries to paint Mr Gutstein and Mr Frisoli as corporate raiders who will come along and gut the company with financial engineering.  Some of the shareholder proposals are a little out in left field, but others have a lot of merit.

For all the defense management has put into the proxy fight they aren't exactly shining defenders of shareholder value either.  Management likes to discuss how they've increased the asset value of their holdings with organic (literally and figuratively) growth.  For all this growth management seems to have a plan to grow on a much later scale, this past proxy season they increased the authorized shares from 2.5m shares to 10m shares.  Management has stated that they might need extra shares to raise capital and expand.  The expansion would be good for themselves as they'd be able to draw a larger salary and run a bigger company but would utterly dilute current shareholders.  Amazingly enough the current holders voted for this measure.  Based on the current outstanding shares (1.29m) raising the full amount of capital would reduce shareholders ownership by almost 90%, a staggering number.

I think management would probably be quick to dismiss a massive dilution, but their actions say otherwise.  The previous amount of outstanding shares was 2.5m meaning that 1.21 shares were available to be issued which at current market prices is around $94m.  For some reason management believes they need to raise more than $94m for "General corporate purposes" to grow the company, which in turn will cut current holders' stakes in half or less.

Gutstein and Frisoli have been reducing their demands each year while at the same time trying to secure a board seat.  I think in a situation like Keweenaw having a vocal investor is actually helpful in highlighting issues that might not be much visibility due to the non-reporting nature.

One last thought before moving onto the valuation, reading these letters and the corresponding shareholder reaction reminds me of what Ben Graham says about shareholders in Security Analysis "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."  This could not be more true than with Keweenaw, in reading some message board posts most shareholders voted for the dilution and consider Ron Gutstein a thorn in the companies side.  It blows me away that people would voluntarily vote to reduce their stake in a company up to 90%


Keweenaw has worked very hard to help investors understand how to value a sometimes complex investment, on their website they have a file called "Understanding KLA Asset Value and Operations".  The company commissioned appraisals in 1998, 2000, 2003 and 2006 of the land value, and the timber value.

The appraisal valued the company in two different ways.  The first was on a single transaction basis, this means they looked at comparable timber sales and estimated what the company would fetch in the market if everything was sold at once.  The second was a discount cash flow based on selling the timber down over a period of seven years.  This method assumes that the company sells down their trees for both pulp and lumber at 06 market prices and then adds in a raw land value.

There is also some discussion in the report about the value of the land if it was sold for non-timber uses in parcels, but no work is taken to peg a value for that.  Obviously liquidating a company in this manner would be difficult and costly.

The last item relevant to a valuation is the mineral rights.  The appraisals didn't include mineral rights, but the company touches on the possible value briefly.  From 1891 to 2006 Keweenaw recognized $78m dollars in mineral royalties, which translated to 2006 dollars is $552m.  The company claims there are still significant copper, iron ore, and silver deposits on the land but at the time they're not economical to recover on a large scale.

With regards to mineral rights, there are two companies currently interested in mining operations.  One company has permits and could begin exploration soon, the other has leased the land, but there isn't any further information on them.

So piecing this together, at the price the market is valuing Keweenaw at $640 per acre of standing timber.  This is down from the 2006 appraised value of $836 an acre, and more in line with the 2003 assessed value of $668.  I wasn't able to find any charts going back to 2003 but I did find some going back to 2006 regarding timber prices.  Sawtimber prices have fallen from the $40s to the low $20s while pulp wood has remained slightly steady at just under $10 a ton.

Considering current wood prices, and the composition of timber offerings I think Keweenaw is probably fairly valued on a standing timber basis.  If we look at a liquidation value, or add in mineral rights they are probably slightly undervalued.  The problem is they don't have any intention of liquidating so a liquidation valuation isn't appropriate.  With regards to mineral rights it's yet to be seen if anything can be extracted, all of the easy minerals are gone, I think the market is correct to peg the mineral rights at or near zero.

One thing worthy of a mention, the company does have earnings and cash flow that I've largely neglected in this post.  The reason is that neither the market, the company, or competitors operating in this market value standing timber on the basis of cut earnings.  The money earned from timbering is used for administrative expenses and reinvested in the properties.

Final Thoughts

I think Keweenaw is doing a lot of the right things to manage their resources appropriately, they've worked to increase the quality of the wood, they're selling off non-core rural lots for residential use, and they're working to maximize the mineral assets.  At this point I think Keweenaw is probably fairly valued, the stock price seems to be accurately reflecting a $600-$700 per acre price for the standing wood.  The company would argue they're worth more due to the mineral rights, but my view is that if the mineral deposits were as rich as they say then someone would be mining already.  I think the fact that mining isn't taking place at any level reinforces the claim in the appraisal that the deposits might be large, but they're extremely hard to get to at this point.

I think Keweenaw could probably be best looked at as a pure play on raw timber lands with the minerals adding a bit of a potential upside in the form of a free option.  If the minerals are extracted it will provide a really nice boost, but if nothing happens the company's valuation doesn't change.

I really like Keweenaw and their approach to managing the forest and their properties, but I just can't get past the potential dilution.  I realize that a dilution possibility exists for almost every equity investment, but Keweenaw management has stated that they intend to dilute, it's just a matter of the magnitude of the dilution.  Increasing the shares 10x is a major concern, and for the time being will keep me from being a shareholder.  It's worth keeping the company on the radar, and if this is an interesting investment maybe holding off until after the dilution.

I'd love to hear thoughts and comments on Keweenaw.  If anyone has experience in small cap pink sheet activism I'd love to hear about that as well.

Disclosure: No position

Investigating an unlisted stock

Queen City Investments (QUCT.Pink Sheets)

Price: $992 (12/4/2011)

I've been engaged in an email conversation with a reader about some pink sheet stocks and one stock he mentioned was Queen City Investments.  The stock is like most pink sheet stocks in that they aren't required to file anything with the SEC making the hunt for information frustrating but often rewarding.

Pink sheet stocks have long fascinated me because it seems like a cult following will emerge around these companies.  A cult following is often a cruel irony, passionate shareholders in unlisted companies are usually minority holders without many rights whereas apathetic shareholders of listed companies have a lot more rights which they work hard to neglect.  A second feature of pink sheet stocks is they usually have a interesting story to go with them.  Rarely have I ever dug into a stock on the pinks and not encountered some sort of storyline that is essential to understanding the investment.  Oddly enough this seems limited to OTC/Pinks for some reason. I've never had to understand why some land deal to a brother-in-law's great aunt in 1978 was essential to an investment thesis for a listed company but often stories like this will manifest themselves in pink sheet stocks.

I think there's a common misconception that unlisted stocks are all penny stocks.  The unlisted market has everything, the typical junior miner penny stocks and on the other side community banks trading for $4,000 a share.  The downside is that for most unlisted stocks (unless they're temporarly part of a pump and dump) liquidity is limited or even non-existant.  Queen City Investments falls into the limited to impossible camp when it comes to liquidity.  As far as I can tell the last time Queen City traded was on November 1st with 10 shares.

One unlisted stock with a cult following and quite a back story is JG Boswell.  Boswell has been written up extensively from an investment point of view by Jon Heller over at Cheap Stocks.  If you're interested in understanding the history of the company and some history of California there's the 400pg book "The King of California" that dives into the nitty gritty details of the companies back story.  The book is great, the characters are colorful and entertaining, if you're interested in water rights, Central Cali, or Boswell I'd highly recommend it.  Like most pinks Boswell's investment thesis rests on a complex story which in part has roots in water rights granted in the 1930s.

Queen City Investments is a parent company to three different companies, a trust company, a California cattle ranch, and some commercial real estate holdings in California.  The appeal to the company is that it's asset rich, loaded with cash, securities, and land that's potentially undervalued.  What's nice about Queen City is that they aren't only a pile of assets they also have earnings from the trust management company.  Queen City was spun off from the Farmers and Merchants bank a number of years ago, the company is closely held by the Walker family.

There really isn't much to talk about in terms of the business operation because it's almost impossible to find information on the business.  The annual report I was able to dig up contained a few terse statements about the three holdings and not much else.  The best information I could find about the company was actually on the yahoo message boards.  Some posters have details on the cattle ranch which is approximately 25,000 acres, and some of the specific commercial holdings in LA.

All this leads to the question, how does one find information on these unlisted stocks?  For Queen City Investments I was able to dig up the 2010 annual report and proxy with some creative Googling.  Some unlisted stocks freely publish their financial reports on their website.  Personally I'd prefer investing in a company where I can easily find quarterly, or at least twice a year statements including an annual report.  I have the links to the Queen City reports below under Resources.


I think the best way to approach Queen City Investments is to first show what a buyer is getting per share:

Liquid Assets
51.76 share cash
399.93 securities
37.80 in repo T bills

16.64 notes receivables
18.54 Locust LLC property
8.65 a share in cattle
294.86 a share in land

59.60 in notes payable
16.64 line of credit

125.34 total liabilities

Having these values gets us much closer to determining the value of the operations:

48.36 per share in earnings
43.35 in CFO
15.36 CFI, no capex to speak of

10 in dividends paid

Take all of this and break it apart and we find for the operations:

Current price: 992 current price
Remove the cash: 502.51
Remove the cattle, commercial property and land: 163.82
Add back in 50% of the debt (some of the debt presumably is tied to the property): 201.94

This means that the trust company is trading at 4.17x earnings
or 4.65x cash flow.

So a buyer at current prices can get the land and cash at book, and a trust that manages $2b in assets for 4.17x earnings or 4.65x cash flow, quite attractive!

A second way to look at this is building off the land value and working backwards.  From my searching I was able to find California ranch land selling in the $1500 an acre range.

An investor buys two shares ($1,984 paid), they receive

1 acre of ranch land valued at approx $1500
Cash and securities totaling $978.98
A bunch of commercial property and some cattle thrown in for free
And a trust business that throws off $48.36 a year in cash flow for free

Even if the commercial property and trust is hard to value exactly looking from the land perspective it's pretty clear this stock is undervalued.

So what's the catch?

This is the type of investment a value investor dreams of, tangible assets selling for nothing.  Of course with something like this there has to be a catch right?  Most investments that look this appealing on a listed exchange have some big hairy problem, usually not so for unlisted stocks.  There are two big problems stocks like this, the first is it's nearly impossible to buy shares, any quantity.  The company is closely held and current investors just aren't selling.  If we wanted to presume that a 10% position would allow someone influence enough to realize value building the position ($4.7m) would literally take years of buying 100% of every share offered in the market.

The second problem is closely related to the first in that this is a closely held company.  The Walker family has run Farmers and Merchants Trust and their associated companies for generations, they apparently like the comfort of being overcapitalized and it's unlikely they will suddenly have a change of heart.

Buying into Queen City Investments thinking that Mr Market will wake up and revalue suddenly is foolish, shares like this can and do stay cheap for years or even decades.  Value is often unlocked by corporate actions, a merger, or a buyout and often the controlling family is in no hurry to take action, instead they're content to plod along and collect dividends.

In the end Queen City is fascinating to look at, and a great example of the price of transparency and liquidity.  I don't own any shares or plan to buy any, but I'd love to hear from shareholders, or anyone who has more details on Queen City.

Annual report:
The 2010 proxy:

Talk to Nate about Queen City Investments

Disclosure: No position.  If you click buy the book mentioned above I will receive a small commission from  The price through the link is no different than if you visited on your own.

A sum of the parts..Renault

Renault (RNO.France)

Price: €26.35 (11/29/2011)

This is an unusual finding for me, a large cap trading at such a discount.  I'm not adverse to buying large caps, my portfolio has a few, but I tend to avoid writing about them because a lot of ink is already spilled following the largest companies.  In the case of Renault I haven't been able to find much about this except for a brief mention in this past weekend's Barrons.


In the late 90s the automotive industry was experiencing a consolidation wave, instead of merging Renault decided to form a new type of alliance with Nissan.  Renualt bought 34% of Nissan's outstanding shares with the agreement that Nissan would purchase part of Renault when financially able.  Nissan had hit a financial rough patch and had a near bankruptcy experience in 2000.  Nissan recovered and purchased 15% of Renault in 2001.  Eventually Renault increased their stake in Nissan to 44%.

The idea behind the alliance is that both companies can operate independently and retain their branding yet share key strategic technologies.  The cross shareholding structure encourages both companies to act in the best interest of themselves and the partner company.  A partnership structure like this seems very strange to US investors, but it was actually very common in Japan in the 60s and 70s but less so today.  A company would purchase shares of suppliers and distributors creating an incentive to work together.  At times the crossholdings could also lead to a certain nepotism where a company would use their preferred supplier even if the supplier had a higher price and worse execution.

Outside of the Nissan stake Renault also owns stakes in Volvo AB which is a truck manufacturer, and a stake in AvtoVAZ which is a Russian car company.  Renault looks at both holdings as strategic alliances but not to the same level as the Nissan holding.

As a note when looking at Renault's statements they use the equity method under IFRS to consolidate their statements, if anyone is unfamiliar with this method here is a great link.

Sum of the parts breakdown

Renault has a holdings in three public companies, Nissan, Volvo AB, and AvtoVAZ, since all of the holdings are public it's easy to piece together the current value of what Renault owns.  I have it broken down the values and translated to Euro in the following spreadsheet:

What's pretty clear right away is that the total of Renault's public equity holdings is twice the current market cap and amounts to €49.78 a share.  If we assume that Renault's market cap is an accurate reflection of their current operations alone and add back their holdings the total is €74.38.

A discount to such a tangible asset value is rare especially for a large cap.  Just a simple analysis like this is really enticing, this is the elusive $1 for $.50, but with a caveat.  The problem is the liquid assets most likely aren't realizable (I discuss below), and in a down market the value of all the holdings will shrink because Volvo, Nissan and AvtoVAZ are all automakers.

I think the better way to look at this investment is an investment in Renault with a sizable margin of safety.  At this point I'm not comfortable enough with my own understanding of Renault's operations to make an investment.  I think this is more of an investment in Renault with downside protection than an asset play.

Why does this exist?

In a lot of my recent posts I've been asking the question "why is the stock cheap?" as a way to examine if the stock is deservedly cheap.  The reasons for the Renault cheapness I think are a bit more straightforward and probably even more warranted.

The first thing is that Renault has no intention of liquidating the Nissan stake to unlock value.  Renault looks at the Nissan holding as a strategic relationship, where selling off Nissan would almost be like spinning off a subsidiary company.  I think the market reaction would actually be negative regarding a share sale instead of something positive that unlocks value.  I think this is true especially considering the fact that both parties talk about how great the relationship is to their related businesses.

The second reason I think this disparity exists is that the market judges both Renault and Nissan on their own respective operations.  The joint holdings have existed for more than a decade meaning this isn't some sort of hidden asset.

I'm not sure if either reason is a good reason for Renault to be selling at such a discount, I'd actually be interested if someone out there knows how long this condition has persisted.

Talk to Nate about Renault

Disclosure: No position

Adams Golf has a margin of safety and a catalyst

Adams Golf (ADGF)

Price: $5.54 (11/25/22)

Note: This post appeared in some RSS feeds prematurely because I accidentally hit the wrong button while working on it.  This is the completed version, sorry for the confusion.

Adams Golf is a small golf manufacturer located in Texas, they make the full range of clubs and associated accessories such as bags and hats.  I haven't ever played on an Adams club, so I went online looking for reviews.  Most agreed with the statement that the irons were about average and the hybrids were really nice clubs.  I wouldn't mind adding a hybrid to my set, so if a very generous reader out there wants to buy me a Adams hybrid I will be sure to put it through a few rounds of "testing".  I talked to some relatives who are more "in the know" with golf gear, and their opinion was that Adams Golf made some decent stuff.

The attraction to the stock is that it came up in a list of stocks selling below NCAV.  Here is my back of the napkin investment thesis for Adams Golf:

-A NCAV of $4.94 with a tangible NCAV of $2.77 against a price of $5.54
-EV/EBIT of 4.8
-EV/FCF of 14.5
-No debt
-Room for margin expansion, current net margin 5.53%, net margin in 2006 was 11.84% and 2007 9.94%.

Balance Sheet

The balance sheet is what got me interested in Adams Golf, here is my net-net worksheet:

A few things stand out, the first is that for a manufacturing company Adams Golf has a very small amount of property plant and equipment.  The reason for this is that the manufacturing facilities are leased and found under contractual obligations.  The facility operating lease is up in 2013, so there is a potential that costs could slightly tick up for the facility.

The other aspect is that inventory and receivables make up the bulk (80%) of NCAV, this is expected for a manufacturing concern.  Both inventory and receivables as a percentage are at reasonable levels compared to past history. 

The balance sheet is good, I think all of the values on the worksheet are reasonable in a liquidation scenario.  Golf clubs tend to sell relatively quickly, and even models a year old sell pretty easily.  The difference between a 2010 and a 2011 club isn't all that great no matter what the marketing people would want you to believe.

Business Quality

For any business selling below NCAV we have to assume there's a problem, if there isn't a problem the stock probably isn't selling cheap.  The case with Adams Golf is a little interesting, I think there are a few reasons the stock is selling cheaply.

The first and most benign is that the company has a history of lumpy profitability.  In the last ten years they've been profitable 60% of the time.  The company has a high degree of operating leverage so when they hit a high volume the profits and cash roll in.  On the other hand a slight downtick in volumes can result in a loss.  The lumpy profits means uncertainty on Wall Street, and Wall Street hates uncertainty giving Adams a lower multiple.

The second reason is that Adams was involved in a class action lawsuit related to their IPO in 1999; they ended up losing with a verdict of $16.5m issued against them.  Insurance paid out $11.5 million, and Adams paid out $5m which was accrued in 2010.  In addition there is still a patent infringement lawsuit outstanding which is currently in discovery.  The outcome of the lawsuit is uncertain, and if it goes against them a negative verdict could require either a payment, a club sales halt , or a redesign of certain models, all costly solutions.

The third reason is that management isn't exactly viewed as shareholder friendly.  For the past ten years shares outstanding has been steadily increasing due to executive compensation.  Compensation that isn't always deserved considering the company has only been profitable 60% of the time, and had free cash flow 50% of the time.

The following picture gives a nice overview of the past ten years.  I show the cash flow (operating, capex, and free cash flow), in addition to the book value.  I also show the ROIC with the positive ROIC in bold.  

What the spreadsheet reinforces is that when times are good and volume comes in ROIC can be high, very high (60% in 2004).  ROIC for the past twelve months isn't all that high, but it is positive.  Considering that Adams is coming out of a downturn there is a lot of room for improvement.


What makes Adams Golf a very interesting investment is that a few large shareholders are starting to agitate for action.  Two shareholders who own around 35% of the outstanding shares submitted a 13D/A pledging to do the following:

(a) appear at each such meeting or otherwise cause the Covered Shares to be counted as present thereat for purposes of calculating a quorum; and
(b) vote (or cause to be voted), in person or by proxy, or deliver (or cause to be delivered) a written consent covering, all of the Covered Shares:
(i) in favor of an increase in the authorized number of directors of the Company and the election as directors of the Company of each of: 
-Roland E. Casati; and
-such additional persons as the Gregorys may nominate or support for election as directors at such meeting (understanding that it is the current intent of the Gregorys to not vote in favor of the election as directors of Oliver G. (Chip) Brewer III or Russell L. Fleisher at such meeting);
(ii) in favor of an increase in the authorized number of directors by up to two (and possibly more if necessary in response to actions that the Company might take);
(iii) in favor of a stockholder proposal to declassify the Company’s Board of Directors;
(iv) in favor of the Company’s proposal to ratify the appointment of BKD, LLP as the Company’s independent auditors for the year ending December 31, 2012; and
(v) as instructed by the Gregorys on all other matters presented to a vote of the stockholders at such meeting.

Here are two more relevant links: brief post discussing the activism
A letter to the major shareholders which initiated the action

After the filing the price moved up a bit, but there is still a lot of room to move, especially if the company starts to move in a more shareholder friendly direction.

I think Adams Golf has a lot of potential, especially for margin expansion and some possibly shareholder friendly moves.  I think the current assets also provide a nice bit of downside protection.  I haven't invested in Adams Golf yet but I'm watching this situation closely.

Talk to Nate about Adams Golf

Disclosure: No position

Why Sycamore Networks?

Sycamore Networks (SCMR)

Price: 19.39 (11/20/11)

I want to apologize for the slowdown in posts, I've been working on finishing (remodeling) our basement which has sucked up pretty much all of my free time.  I'm just about done framing, so I only have a bit of electrical and drywall left, hopefully I'll hit my goal of completing by Christmas.  Until then I'm hoping to get a post out once a week or so.  

Onto Sycamore Networks..

This is a stock I first saw discussed in a Marty Whitman shareholder letter (my wife has the Third Avenue Value fund in an IRA) as a net-net the fund had purchased.  I took a look but the stock wasn't selling below NCAV, and I didn't see any other attraction at that time.  This weekend I saw an article in Barrons that mentioned Seth Klarman's hedge fund had started to purchase shares in Sycamore Networks and I decided to take a look again.

After digging into the 10-K I can't figure out why Marty Whitman or Seth Klarman have invested, the thesis is somehow beyond me.  These are two very smart investors, so I'm presuming that I have somehow overlooked something hidden that's really big and important, if you know what that is please email me or leave a comment at the end of the post.

The business

Sycamore Networks builds specialized switching equipment that helps reduce network congestion.  The company sells products for the fixed line market, mobile, and broadband networks.  There are a few problems Sycamore is trying to solve, the first is general network congestion, this is where the traffic amount is larger than the bandwidth available.  The second is peak demand, a network might be able to handle traffic for most of the day but if there is a spike due to some external event network traffic might grind to a halt, as an example I remember trying to get to on 9/11, no matter how many times I hit refresh nothing would load in any reasonable speed.  

The sweet spot for Sycamore is a customer who wants to stretch their existing network a little bit more without having to upgrade the infrastructure completely.  In a computer network there are a few important pieces, the wires, the routers, repeaters and switches.  The wire in the ground might be able to support 600Mbps or even 1Gbps the limiting factor with regards to maximum speed are the endpoint switches and repeaters.  To upgrade a network segment all of the switches and repeaters need to be upgraded to the higher standard.  This can be costly considering in some situations repeaters are buried underground, or in hard to access locations.  Secondly if a provider upgrades the network there is no guarantee clients will be willing to pay for increased speeds in an amount that will cover the upgrade cost.

Sycamore helps this by working to streamline traffic on a congested segment.  The company website has all sorts of great marketing spin videos explaining their secret sauce but it boils down to a simple technology, QoS or Quality of Service.  Each packet sent from a computer over a network has a priority code, normally each packet is treated equally. A packet containing banking information is given no higher priority than a packet destined for YouTube.   Video and gaming are very high demand applications, but often low priority.  A video can drop a frame or two and it will be almost indiscernible to the user, whereas a dropped packet from a website might mean the site won't load at all.

QoS isn't anything extraordinary, the Linksys router I have in our basement has a very rudimentary version of it allowing me to statically state that web traffic is more important than Kazaa, or video game traffic.  The shortfall is there isn't much configuration available, and the routing is based on the port, not the content of the packet.

What makes Sycamore devices valuable is the software installed can intelligently determine what is inside of a packet and prioritize dynamically.  This means if a network segment starts to become highly congested packets destined for YouTube can be de-prioritized and web traffic prioritized.  Or on a telephone network calls can be routed differently to avoid busy signals.

I'll be the first to admit the technology is cool and very innovative.  I'm sure Sycamore has a building full of very bright people up in Massachusetts figuring out these problems, and it seems like there's demand for a product like this with broadband usage exploding and mobile data usage growing quickly.

The history

The company IPO'ed back in 1999 during the height of the dot-com boom, they did a follow on offering in 2000.  It seems that they've been working down the IPO cash ever since.  This is where the mystery of the attraction starts to begin for me.

Since the IPO the company has never recorded an operating profit, only once they recorded a profit which was due to other income.  The company was cash flow positive 2006, 2007 and 2008, and had a meager amount of free cash flow in each of those years.

The one bright light I can see in this stock is that gross margins have been increasing which is good, the problem is R&D expenses track pretty well with gross profit.  That means that by the time SG&A comes along the company is already in the red.  

Valuation details

I don't really have much to add here, the numbers speak for themselves, so I'm just going to dump out some stats.

-P/S 11.3
-EV/Sales 3.3
-Gross Margin: 52.8 TTM
-Book Value 15.71
-Revenue Growth: 3yr -25%, 5yr -11%, 10yr -18%
-NCAV of $15.34, Net Cash of $14.63/sh

None of these numbers jump out at me as a screaming buy outside of the high cash value per share.  The problem is the company is constantly eating into the cash balance each quarter as sales fail to cover expenses.


I can understand the appeal of Sycamore Networks as a story stock, broadband and mobile data are growing rapidly and the company has a solution that can save carriers a lot of money.  The problem to me is that broadband has been growing since 1999 at a fairly rapid clip, and the company has never been able to turn an operating profit, and they've only been cash flow positive in three of the last ten years.  And the last ten years have been prime years for data growth  If Sycamore hasn't been able to capitalize in the past when conditions were ripe what will be different going forward?

The one thing I do get is the high cash balance, but there are other router and networking companies with high cash balances selling at cheap valuations.  

I guess my confusion lies with the fact that two renowned value managers have positions in this stock.  I recognize they're far more intelligent than I am, so I'm presuming I'm missing something.  If you have any ideas on what I'm missing please send me an email or leave a comment.  

Disclosure: Long Third Avenue Value fund, and by proxy long Sycamore Networks.

What was cheap gets cheaper

Vianini Industria (VIN.Italy)

Price: €1.27 (11/8/11)

I posted about Vianini Industria previously, it was one of my first posts about international net-net's.  Since the post I'd kept my eye on it, but not very closely.  A few days ago I received a comment on the post which made me revisit the stock.  Here's the comment:

Mauro said...
Hi Nate,

it has been years since I'm following this stock and I've decided to buy it today...
now VIN is at 1.15,about €35mln in market cap. VIN holds now €30mln in cash, about €26mln in good stock shares(who are on their lows) and total liabilities about €7mln,so no debt... not to mention all the credits,physical assets that it owns.
In the June2011 semester report there's a little note saying that there's an additional €46mln in fixed assets which have been totally depreciated,thus not resulting on the book: about €11mln of these are buildings and land. With a very very conservative calculation,I think that this €46mln can have a value of around €10-15mln to add on the book...
with my analysis VIN's value is around €80-90mln,thus between 2.6-3.0 per share.

VIN is a deeply undervalued stock but should be considered because:
-the company is relatively stable and the losses it had are made by financial loss with it's stock portfolio
-the assets are tangible and very liquid
-in economic crisis people want to trade liquid stocks to get out quickly,so only the bigger ones...thus the small ones get dumped without much thought
-after years of inactivity the company is in work progress to install a huge solar power plant,thus a way to invest the huge cash it has and hopefully producing a decent income(and dividends)...and of course it will be more visible to investors.

My concerns when I looked at the company previously were the quality of earnings, and margin of safety.  I want to take a look at both of those items seven months later.

Asset Value

This is really the main driver for the investment, Vianini Industria is selling at an incredible discount to it's asset value.  Here is my net-net worksheet:

Right away the first thing that hits me is that the discounted NCAV is almost double the current price, this is rare.  What's even rarer is the composition of assets that the company has.  On the balance sheet €60m is in cash and publicly traded securities, liquid assets that could be sold today and fair value realized.  The securities are holdings in two companies Assicurazioni Generali SpA and Cementir Holding SpA, both Italian securities.

Taking this right off the bat we have a stock with €60m in cash and securities with €7m in liabilities (none of it debt), or a net-cash position of €53m against a market cap of €38m.  The company is selling at a discount of about 28% to the net cash value.  

What I really like about Vianini Industria is something Mauro pointed in the comment was that the company has some hidden assets.  The details are found on page 29 of the HY report in note 1.  The note discusses the property plant and equipment account, following the discussing of the balance sheet values is the following translated text, "The following are the values of tangible assets fully depreciated but still in use.
Cost                           30.06.2011
Buildings                          11,771
Plant and machinery         33,282
Industrial and commercial  2,509
Other assets                          340
Total                               47,902"

This is an interesting note, basically the company has €47m in assets that are being used to create cement products that aren't reflected on the balance sheet at all.  These assets consist of the the land the cement plants sit on throughout Italy and the cement facilities themselves.  Even though these assets don't have an actual balance sheet value they have a very real world value, these are the assets the company is using to generate it's non-financial returns.

In my net-net worksheet I only give these assets a value of about 10%, but that's probably on the low side.  In reality the assets are probably worth a bit more, my question would be who is interested in the properties and equipment.  I'm not sure how many other cement companies are operating in Italy that would be interested in swallowing the Vianini Industria operations.  Secondly the land appears to be in some very rural places, so I'm not sure if a ready buyer would emerge quickly.  Discounting 90% takes all of this into account and gives a wide buffer for error.

Overall on an asset basis Vianini Industria is very attractive, and selling at a deep discount.

Earnings Value

When I previously looked at this company one of the things that concerned me was that most of the company's earnings was from financial income, or dividends of holding companies verses operating earnings.  The operating earnings record is quite poor and very lumpy as seen below.

For the trailing nine months EBITDA is barely positive, and after taking a depreciation charge operating earnings are negative.  This was a big concern I wasn't able to overcome previously, but my thinking has changed some in the past seven months.

First and foremost I always want a stable margin of safety, the last thing I want to do is invest in a company that is destroying the margin with a large cash burn or terrible acquisitions.  I don't see either with Vianini Industria.  The operations of the company are very poor, but the difference is made up with dividends from other cement holdings.  In addition the company has a high amount of operating leverage, meaning if the cement market starts to have an upturn earnings could shoot up dramatically for the company.

The company currently has a backlog of about €8m in projects, with the possibility of €9 more in extensions.  The company also has started supplying cement to a new energy plant which Mauro mentioned and is mentioned in the HY report.  Taken together this is about another year or year and a half of earnings at the current pace before new works needs to be found.

I would prefer that the company earn a 15% ROE and have great operations but that's unrealistic considering I'm able to buy the assets for less than 50%.  With Vianini Industria I'm buying the assets, and my hope is that the operations aren't acting against me, which they aren't.  

Margin of Safety

The margin of safety for Vianini Industria is very obvious, the company has a large amount of liquid assets in excess of its market cap, additionally they have some hidden assets, and a business that isn't eating at the asset value.

I keep trying to think of the worst case scenarios for Vianini Industria in an attempt to kill the stock.

The cement business hits a downturn - This is already true, I guess it could be even worse and there is a complete stop to railroad construction in Europe.  I believe this is already priced into the stock, and additionally even at low levels of production the company is squeaking by and just barely covering costs.  Secondly most of the company's earnings don't come from the cement operations, they come from dividends of other cement companies.

Their equity cement holdings could eliminate their dividends - This is a risk, although considering the market environment and they fact they're still operating and able to pay a dividend currently I think it's probably fair to say they'll be able to continue in the future.  Even if the holdings cut their dividends 50% Vianini Industria will be able to record a profit.

All cement production in Europe ceases - This is truly the worst case scenario, Vianini Industria would be operating at a loss, and so would the equity holdings.  In this case if they didn't cut any staff or costs they have enough cash to survive a complete halt for five years.

The Caltagirone family takes it private or takes the cash and securities - This is probably the biggest risk, the family holding the company takes it private at some low multiple.  The family already has control of the company, and the company supplies the other family companies.  While this is a risk I see it as a unlikely risk.

If none of those scenarios play out the company has enough cash to weather a very long dry spell in the cement business.  I feel that I'm adequately protected against a loss by buying the assets at such a big discount, additionally once earnings turn around I think the stock could begin to rise quickly.

Why is it cheap?

There are some obvious reasons why Vianini Industria is cheap, and the reasons are pretty good, I'm just going to list them out.

  • The company is 66% controlled by the Caltagirone family, only 33% of the float is public.
  • The actual business is pretty bad, low margin, loss making, terrible return on equity.
  • The stock has a small market cap, and is priced around €1, not much institutional interest.
  • There are a lot of related party transactions with other family controlled companies, it's possible Vianini Industria isn't getting the best prices for their goods, or they are overpaying for materials and supplies.
All of the above reasons are perfectly valid, and if I was looking at Vianini Industria as an investment into the cement making business I would probably avoid it.  The key to this stock is that the value doesn't reside in the business, it resides in the assets, and the hidden assets.

The question I asked when looking at Vianini Industria is do I think that cement production will completely halt in Europe for five years?  That's my worst case scenario, and the scenario where this is a losing investment.  I don't think that will happen, I have an adequate margin of safety protecting my investment and the company has the resources to wait out the downturn.

Disclosure: Long a small stake in Vianini Industria looking to increase it over the next few days.

Einhell Gruppe AG

Einhell Gruppe (EIN3.Germany)

Price: €35.64 (10/31/11)

I stumbled upon Einhell through a screen I recently ran at  I wanted to find stocks that had decent long term operating stats but had been dragged down in Europe as part of the debt debacle.  I ended up with a good list of stocks that aren't superstars, but are consistent operators that have probably been unfairly dragged down.

The first I want to look at is Einhell a Germany tool manufacturer, I'd love to go to Lowes and personally examine the quality of the tools, but they sell their tools everywhere but North America.  Einhell manufacturers all sorts of power tools for remodeling, such as circular saws, reciprocating saws, drills, sanders, lawnmowers, small greenhouses, and air conditioners.  The company's sales are pretty evenly divided between power tools and lawn equipment.

The company's philosophy is to sell quality tools to the recreational user.  I would think a recreational user is the type of person who has to cut at 2x4 maybe two or three times a year for simple projects.  Although I can't examine any of the products myself I'd probably equate Einhell to something like Harbor Freight Tools.  Harbor Freight is great, you can buy anything there cheap and it seems like a panacea until you use the tool more frequently than it was built for and realize it probably would have been wise to pay up in quality.  This isn't to say that those sorts of tools don't have a place, they do, and the place is in most people's workshops.  The reality is that most tools are used infrequently outside of hard core DIY'ers, and professionals.


I was able to find 10yr stats for Einhell via MSN Money, so I want to take a look at the company in light of it's historical results, and I also want to consider the margin of safety for an investor.

I want to speak for just a minute as to why the company is selling at such a cheap valuation.  Einhell has fallen in general with the German market, this is the first and main reason for the depressed valuation.  The second reason is with a depressed market there are fears that consumer goods companies will fall as consumers stop purchasing non essential items.

Einhell sells 38% of their products to the domestic German market, they sell 79% of their products in the EU, and the rest in Asia and Australia.  Even with the European debt crisis the company recorded an increase in revenue at the latest interim statement.  Sales have been growing overseas enough to counter domestic declines.  I believe this finally changed in the most recent quarter, but we'll have to wait until November to see how bad the decline is.

Investment Thesis

I think the thesis for Einhell can be summed up quite nicely in the following stats showing that on a number of different metrics Einhell is selling cheaply:

In addition the company has about €139m in working capital against a market cap of €54m which makes it a net-net.  I didn't screen to find any net-net's, these companies are just somehow attracted to me which I thought was an interesting coincidence.

Since Einhell qualifies as a net-net I through the worksheet would provide a good overview of the current balance sheet.

The composition of the balance sheet is heavily weighted towards inventory and receivables which is understandable for a consumer products company.  Liabilities are composed mostly of bank debt and accounts payable.  There is also a provision account of €14m, this account is mostly held for warranty repair work.

Looking at the net-net worksheet I would say the Einhell balance sheet qualifies as a quasi margin of safety.  In a liquidation scenario with discounted receivables and inventory the company would probably fetch around €7 which is a lot lower than the current market price.  The company also doesn't have much cash on the balance sheet.

10yr Balance Sheet

I recently discovered that MSN Money provides ten year income and balance sheet statements for a lot of different international stocks, so I pulled in the ten year stats for Einhell.

A few things stood out to me when taking a look at the historic balance sheet.  The first was that NCAV has been growing at about a 10% clip over the last decade.  A growing NCAV isn't a bad thing if the growth is due to increasing cash balances or a growth in the equity account, this isn't the case with Einhell.  The growth in NCAV is due to increases in receivables and inventory over the years, a growth in both accounts should be expected to stay roughly in line with a growth in sales.  In the case of Einhell sales have been lumpy for the past decade and current assets have consistently grown, this is a caution flag for me.

The second thing that stands out is that Einhell isn't too heavily indebted.  The company has made further progress on this front reporting that they paid down €20m right after the H1 statement.  I would estimate that the current debt load is in the €25m range or so, which is very manageable.

The last thing to note is the increase in shares outstanding in 2003.  Dilution is always a concern for equity investors and can destroy a margin of safety quickly.  The cause for the 2003 dilution seems to stem from the major loss Einhell experience in 2002.  My guess is their capital ratio went negative and they were required to raise capital to remain in compliance with their listing.  

10yr Income Statement

The historic income statement paints a much better picture of the company than the historic balance sheet.  Einhell is a pretty consistent company, they've had sales in the range of €234m to €417m over the last decade and margins have remained pretty consistent.

In terms of current operating performance Einhell is a bit on the high side of history which is good, the H1 EBIT margin came in at 6.7% and net margin at 4.9%.  It's questionable if those margins can stay high considering the possible downturn in revenue for H2.

Cash Flows

When I took a look at the cash flows for Einhell that's when the thesis started to break down for me.  A company can be wildly profitable but if the cash isn't coming in the door the profits are just a fiction.

Einhell has been very profitable in 2010 and H1 2011, yet when I look at the cash from operations it's been negative the entire time.  Where did the cash go?  The cash all went into increases in working capital, mainly inventory and some receivables.  The shortfall from CFO is accounted for in the dwindling cash balance.

I wasn't able to get a ten year outlook on cash flows, so I had to settle with the five year lookback that provides.  Einhell seems to be pretty volatile when it comes to cash from operations, and in turn free cash flow generation.  They seem to run in streaks where they will build up working capital and then wind it down.  In some years working off inventory provided a nice boost to cash.  The problem is this isn't a sustainable pattern.  I would rather see a company with consistent inventory balances and consistent cash flow verses a bonanza year and then a few lean years.

When I saw the spotty cash flow record I decided to put Einhell's numbers into my accruals worksheet which is basically a quality of earnings spreadsheet.  The accrual numbers for Einhell aren't pretty:

I like to see accruals to be in the 8% and below range for most companies.  At times there can be exceptions but in the case of Einhell this spreadsheet just confirmed my fears from the cash flow statement.

Where is the margin of safety?

I really like Einhell, I don't really like the lack of cash to back up the accounting profits.  The company is selling for less than working capital yet I kept asking myself if a true margin of safety exists.  I think it does, and I think the margin exists higher up the capital structure at the bank debt level.  I would buy Einhell bonds all day, there is adequate interest coverage, and good asset protection.  At the equity level I just don't have the same level of confidence.

Bottom line

Einhell is a company I'd consider owning if the quality of earnings improved, some of the asset balances declined and the cash started flowing.  I am planning on keeping my eye on the company for Q3 results at the end of November.  What I originally thought was going to turn out to be a great investment turned out to be more of a dud with some future potential.  In the case of Einhell the investment decision didn't rest on any problem with the business, it rested with more of a problem with the financials.

Talk to Nate about Einhell

Disclosure: No position

Gencor, selling below net cash, but is there more than meets the eye?

Gencor (GENC)

Price: $7.00 (10/25/2011)

I saw this idea posted over at the ST Report, plugged the numbers into my net-net worksheet and realized this is a company selling for less than net cash in the US.  I have to admit, at first glance when I saw this I was excited, it seemed like the type of company I like to hold, selling for less than cash and profitable.

Basically every single net-net has a problem, it could be a small problem that looks big, or a big problem that looks small.  The trick is identifying companies where the problem appears big but is really small or manageable.  The first red flag for me was that Gencor didn't appear to have an obvious problem, when I see this I get worried.

I want to examine this stock by looking at both the bull and bear case.

Bull Case

The bull case is pretty simple, the company is selling for less than cash and marketable securities net all liabilities.  Here is my net-net worksheet:

In addition to having a fortress balance sheet the company has a good record of profitability.  Here is a look at their profits and a few select margins for the past ten years:


One criticism against the history of profitability is that a lot of the profits come from the marketable securities and operating profits are a bit spottier.  I can accept this argument, but since this is a net-cash stock we're discussing I think any profits are acceptable.

So in summary the stock is extremely cheap, and has a positive ten year history of earning money.  For the past ten years the balance sheet has only grown stronger.

To put a conservative value on the stock I think it's fair to take the cash and securities at face value and add a 8x multiple to earnings.  Taking this approach we have EPS of $.71 at 8x ($5.68) plus the $7.61 in net cash giving a value of $13.29, almost a double from this point.  This is a true dollar selling for fifty cents!

Bear Case

One thing I've really been concentrating on when examining investments is looking at why a company is cheap, and what sort of margin of safety exists.  In the case of Gencor the margin of safety is the discount to the liquid assets, and the fact that the market is valuing the operations at nothing.

The first thing I did was go Googling for why Gencor was cheap and most of the reasons I saw on the internet tied to the fact that the operating company had a spotty history of profitability and the business was a generally poor one.  I can accept this argument but I think it's a bit too simplistic.  There are many poor businesses selling with high multiples, there are even many more businesses that have never turned a profit that are selling well above asset value.

I believe there are multiple reasons behind the valuation discount at Gencor, I want to break each down individually.  First off I want to state that the bear case has been made much simpler thanks to American tax payer dollars, the SEC has asked extensive questions of the company all recorded through EDGAR. Some of the questions are basic, others dig into nitty gritty accounting details.  

1) What exactly is happening with the CFO? - This might not be the most important issue, but it raised the biggest red flag for me, in the past three years the company has had a total of five people in the CFO position, two actual CFO's, two interim CFOs, and one acting CFO.  

Here is a table breaking down the personnel changes:

I should also note that the company failed to file an 8-k on multiple occasions when a CFO or acting/interim CFO left.  

It's odd to me that none of the interim CFO's became full time, and the length of tenure is frightening.  I don't know many people who are hired at a company and feel that in five or six months they've made such an impact that they're ready to move on.  Usually people who move on quickly do so because they realize they are not a good fit at the company, or they feel they're unable to fulfill the role.  

There could be a perfectly valid reason for each CFO leaving, but in total there appears to be a pattern here that's concerning to a potential investor.

2) What is the purpose of the cash? - For any company that is cash rich there is always the possibility that management could squander the cash on failed acquisitions or just plain bungle things destroying shareholder value(MSFT...).  

In a response to the SEC the company states that "The “Acquisition Fund” is an amount of cash accumulated over years by the Company and intended to support its operations, as well as to be used in and when an appropriate acquisition becomes available." 

A response like this is concerning because my margin of safety is the fact that the company can liquidate and return cash in excess of my purchase price.  If the company is planning on using the cash to purchase another company my margin of safety could be destroyed by bad capital allocation.  This is a big risk, and while an acquisition hasn't happened yet it doesn't mean that it's impossible either.

3) Is Gencore an investment company? - In a few of the letters the questioning from the SEC revolves around the idea that Gencor should be classified as an investment company.  The company responds saying they have an engineering bent, and are focused on driving operations.  The SEC response is that while it's nice Gencor is focused on operations a potential investor isn't getting an engineering company they're actually purchasing an opaque securities portfolio.

What's interesting on this point is the SEC says they disagree with the company's classification and basically say they aren't going to argue the point further.  This is a potential risk, investment companies have much different and more stringent regulations than public companies.  Any sort of action by the SEC to classify Gencor as an investment company might force management to unload the marketable securities portfolio; a possibility is a dividend, or a terrible acquisition.  Based on the companies stated purpose for the cash I'd wager a shotgun acquisition is more likely.

4) Questionable receivables accounting - Each of the above items I was able to somewhat justify away but when I hit this item it killed the thesis and shed some light on a possible reason why the company has been through five CFO's recently.

The company claims in filings that "the majority of company sales require payments of cash before shipping" and then go on to claim that approximately 47% of accounts receivable are flagged as a doubtful accounts.  

So right now something should be clicking saying that if customers are required to pay in cash upfront how can 47% of receivables be in question?  I'm not exactly sure, and the company never fully explained it to the SEC's satisfaction either.  Either the majority didn't actually pay upfront in cash, or 100% of the non-majority hasn't paid at all.  Given that 47% is less than a majority I'm leaning towards the notion that most or all of the non-prepaid customer have paid a dime.

That brings us to the next issue which is the status on the doubtful accounts.  Gencor claims to extend credit to clients in the form of receivables financing.  What this means is that a customer can contract for a job and not pay until the job is done, or after the job is done and pay a small interest charge to Gencore.  For Gencore this is considered an account receivable, and as noted above most of those receivables financed are outstanding and according to the filing notes are 90 days past due.  The company states that they are slow to write down bad debts because they continue to hold out hope that the client will eventually pay.  And if they think the client will pay eventually it shouldn't be considered a bad debt.

The logic of this defies me, the company seems to believe the if a client hasn't paid in 180 days but claims the check is in the mail that the receivable is money good.  

Edit: I forgot to put this in the article originally but from the most recent annual report the auditors did not review internal controls whereas in the past they had.  Management was asked by the SEC to include a note to this effect and to certify according to management that the internal controls were sound.

I know there are more items lurking in the accounting, and a few of them are detailed here, here and here in the SEC letters.  But after hitting the four above items I decided to move on from Gencor.  I recognize the company is cheap but I think there are very good reasons for the cheapness, and I think the margin of safety is an illusion with Gencor.

I'm interested in hearing holes in my thinking or answers to the bear questions.  

Disclosure: No position