Thursday, May 31, 2012

What's going on with Solitron??

There are a lot of junky companies selling below NCAV in the US, but not many worth an actual investment.  Solitron stands out from the pack with $2.48 a share in net cash and shares selling below 2/3 NCAV.  I want to quickly review the investment case and look at their results over the past year, but more importantly I want to talk about a few things I'm seeing in the annual report that really trouble me.

Background

For an in-depth look at Solitron take a look at the three part series I did last summer (part 1, part 2, part 3).

Solitron is an electronics manufacturer in Palm Beach Florida.  They make small components like diodes and capacitors, things you used to be able to buy at Radio Shack.  Solitron's devices are found in satellites, rockets, and aeronautics in general, the government is a large customer, along with other defense companies.

The company has been consistently profitable since their emergence from bankruptcy in 1993.  Their profits aren't always steady or consistent, but they've been consistently lumpy profitable.  What makes Solitron attractive is they have consistent profits in addition to a share price that is below NCAV and discounted NCAV.  I have included a picture of the NCAV worksheet below.

Quick Thesis

  • Solitron trades at $2.80 against a NCAV of $4.13 and discounted NCAV of $3.39.
  • The company earned $.30/sh in 2012, and $.5/sh in 2011
  • The company has a $6.8m market cap, and $7.59m in cash on their balance sheet.
  • Cash flow of $.38/sh with an ongoing capex requirement of $.06 per share.
  • Free cash flow of $.32/sh, all free cash is invested into Treasury bonds growing the cash horde.
  • USEPA environmental obligations which restrict the payment of dividends have been settled as of the filing of the 10-k.
Here is the NCAV worksheet:



Troubling Aspects

Solitron looks like the golden boy of net-net investments, what could be so wrong?  There have been the usual concerns in the past, like government spending, and the bankruptcy restrictions.  The bankruptcy restriction has been lifted, and the government spending concerns are ongoing.  The issues I highlight are a bit bigger, and serious roadblocks to intrinsic value being realized in a timely manner.

Problem 1

The biggest hurdle to value realization in my mind is management's actions.  A fund or partnership the Laurison Group purchased a 15% stake in Solitron this past year.  In response a new paragraph appeared in the 10-K, here's the beginning of it:


It seems strange the company would adopt a rights agreement when liquidity is ample.  Further down there are details of the rights offering.  The rights only come into effect if a given investor increases their position to over 20% of the outstanding shares, so in other words the company adopted a poison pill. Specific details of the rights offering can be found here.

I hate seeing management entrench, especially when they haven't done much of anything to increase shareholder value.  The CEO only owns 28% of the stock, yet is running the company like his own private business.

With the rights offering in place the company has taken a merger off the table as a possible value realization outcome.

Problem 2

Another curious line appeared:



Why is Solitron worried about increasing liquidity?  Their cash flow funds working capital needs easily.  They actually can't find reinvestment opportunities for all of their excess cash so they invest in Treasury bills.

I think the last thing Solitron needs to worry about is liquidity, they can take the company private at todays price with cash on hand, and would have enough cash left over to fund next years cash needs.


Problem 3

The third problem is a corporate governance problem, why are there only three directors, and why has the company let their terms expire without new director nominations?


The director situation smacks of a good 'ol boy club mentality.  My guess is Mr Saraf knows Mr Davis and Mr Schlig very well outside of Solitron.

I would really like to see new directors nominated, and a few independent directors tossed into the mix. A fresh set of eyes on the board could do wonders for unlocking shareholder value.

The company hasn't held an annual meeting in years, or filed a proxy either, neither good signs.  How are shareholders supposed to elect directors to manage their company?

So where do we go from here?

The troubling aspects of Solitron are indeed bad and with some other companies I'd pass on the investment due to these factors alone.  I haven't passed on Solitron because the company is selling at such a discount that these factors and a whole lot more are being compensated for in the current share price. With that said I don't think they're insurmountable hurdles either.  If Solitron elected new directors, paid out a significant dividend, and maybe even bought back shares I think investors would be rewarded.  In short management needs to look out for the true owners of the company, shareholders instead of looking out for themselves by implementing poison pill amendments.

If you are a holder of Solitron and would like to see some of my suggested changes above implemented please drop me an email or leave a comment, it can be anonymous.  I'm looking to see how much shareholder support exists for some of these ideas.

If any readers are part of the Laurison Group, or are affiliated with Alexander Toppan or John Stayduhar please email me at the "Talk to Nate" link below.  

I'm not sure where this investment is going to go next, but it might be time for shareholders to spur management to action.

Talk to Nate

Disclosure: Long Solitron, opportunistically adding to my position below $3

12 comments:

  1. Hi Nate

    I'm quite concerned by the combination of:
    a) the amount of SEC correspondence about financial reporting
    b) the numerous NT 10-Ks and NT 10-Qs
    c) the fact that Mr Saraf is the CFO and Treasurer, in addition to being CEO.

    While obviously impossible to say anything definitively, these are good indicators of a business with poor internal controls.

    I have seen a company up close that had such poor management accounting and internal controls that it quite literally had no idea how much each unit of stock cost to produce. That is quite scary! And it also brings in to question a lot of the accounting figures.

    That the company has gone so long without an annual meeting is astonishing (or perhaps not).

    Cheers
    Jonathan

    ReplyDelete
  2. And just to elaborate a bit...

    - 17 notification of inability to timely file (NT) forms going back to 1995
    - 3 letters from the SEC in 2005, 2007 and 2009 regarding the financial statements.

    Cheers
    J

    ReplyDelete
  3. Good post Nate.

    I had an investment in a similar situation CCA Industries (CAW).

    When Sardar Biglari invested, the price shot up and I got out.

    My experience has been that things are tough to change and management uses company resources to defend themselves so further destroying shareholder value.

    Good luck with your efforts.

    Buffett was really onto something when he said look for management that loves the business and is fair.

    I wonder why companies like this one is listed. May be because someone cashed out and would like to buy the business back on the cheap later.

    Only here no one is buying...

    ReplyDelete
    Replies
    1. That's a really interesting point Tim. I think that sometimes, the value potentially depends on just how much stock you can actually acquire. If you own 20%, but can't get them to ever issue a dividend, then it could be worth 0. But if you own 51% and eventually have full control to allocate capital very well, then you will be able to realize much more value. In this sense, I think the value (if it relies on activism) could depend on how large of a stake could be made.

      So for the average net-net, I would be willing to participate, but only if I can buy a controlling position and have power to liquidate enough of it to make this all worthwhile.

      Delete
  4. Thanks for pointing out Nate. I do hold some shares of SODI and would love to see some change in mgmt attitude towards shareholders.

    Let me know if I can be of any help !

    ReplyDelete
  5. Obviously also not happy with this...

    ReplyDelete
  6. Nate,
    My investors and I own 1.2% of the company and we feel exactly the same way you do.
    I'd be happy to help.
    Thanks for writing a great blog.
    juan

    ReplyDelete
  7. Nate,

    I'm a shareholder and feel the same way you do.

    Guy

    ReplyDelete
  8. Hi All,

    One reason they may have done this is because the USEPA liabilities "clear up" next year. This would set Solitron free to buy back shares and/or pay a dividend and/or sell the company. This will put management under pressure. Activists will be swarming and blogs will be filled.

    FWIW, I believe the business is worth significant money as a going concern (not as an independent, listed, company). A controlled sale (Raytheon?) may be better for shareholders than a fire-sale liquidation. In any case, bidders (if any) will pay less if management is under pressure to sell.

    I can think of dozens of ways mr. Sharaf could have ripped of shareholders before now. He hasn't. Why should this time be different?

    Given:
    1) There's a reasonable explanation for the behavior.
    2) I have seen no evidence of previous misconduct by mr. Sharaf

    I'm not too worried by this.

    regards,
    Batbeer2

    ReplyDelete
  9. Any comments about the $475k payment being made to the Police and Fire Retirement System of City of Detroit from the bankruptcy proceedings from the early 90s? The filing says that this is a final payment to settle the creditor claim. Did you know about this? Also, are there others sitting on their books?

    Filing below:
    http://www.otcmarkets.com/edgar/GetFilingHtml?FilingID=8887984

    Also, any clue who James R Schembs from 10853 8th Ave NW Seattle WA 98177 is? He has been filing 13Ds and on Dec 5th owns 170,768 shares (7.5%). He lists himself as a Financial Analyst, and the address is a residential area of Seattle.

    Filing below:
    http://www.otcmarkets.com/edgar/GetFilingHtml?FilingID=8950721

    Great site.

    ReplyDelete
    Replies
    1. Yes, aware of all of this, send me an email blog name oddballstocks at gmail dot com

      Delete