Friday, August 31, 2012

A strike or a gutterball?

I wrote a post a few months back detailing some of my investing mistakes.  I think it's more important to avoid mistakes than it is to find big winners.  My obsession with avoiding mistakes is one of the reasons I seek out large margins of safety when I make a new investment.  The investment I talk about below was a mistake, I probably should have never purchased it, yet I was lucky and in a way it sort of worked out.

Back in 2007 I was screening for stocks and came across Bowl America (BWL.A), I couldn't even tell you the criteria I used to find them, some value screen.  After some Googling I ended up finding an excerpt from the book A Weekend with Warren Buffett: And Other Shareholder Meeting Adventures that had a chapter devoted to the Bowl America annual meeting.  A note, I don't recommend the book, I read the excerpt online, then paged through the book in a book store, not much beyond the Bowl America chapter.  Bowl America seemed like a nice little sleepy company, they run 19 bowling alleys across the Mid-Atlantic and Florida, with a CEO who writes classic shareholder letters.  The company cares about shareholders, the CEO takes a small salary and pays out most of the profits in dividends.  The CEO is the son of the company's founder and runs the company very conservatively.  Here is a quote from the 2007 annual report that I love:

"Bowl America was not the only company that capitalized on the arrival of the automatic pinsetters to create bowling chains. Many of them went public in the late 1950's and 1960's. We are, however, the only one of those companies surviving today. We went public in order to finance expansion. We were bowling people, not stock market people, and our objective was to create a secure profitable bowling company to generate income for our families' futures. We, therefore, valued survival of the company as our top priority. We proudly reported paying off each mortgage. We bought two of our most profitable leased centers so that in the event of a downturn we would never again face rental demands when money was short. We selected dividend payments as the most equitable way of treating each stockholder the same when it came to the rewards of the business."

My thesis for investing in Bowl America broke down into three pieces, the cash and securities, understated real estate, and the business.  At the time of my investment:

  • The company had earned an average of $.76 p/s over the past five years, business was very steady.
  • $2.14 per share in cash
  • $1.04 in an investment portfolio (almost exclusively telecom stocks)
  • Two controlling shareholders in their late 70s (the CEO and his sister).
  • A lot of undervalued real estate
To me Bowl America was a company with a hidden asset, most of the bowling lanes were on the books at the 1950's purchase prices.  Readers not familiar with US accounting might be surprised to learn this fact.  In the US assets can be held at purchase price no matter how long ago they were purchased.

I looked at a competitor and looked at some franchise presentations on how much it would cost to build a bowling alley.  I found a per lane cost, multiplied it by the number of lanes Bowl America had, added in the cash and securities and arrived at $24 a share.  With shares at $15-17 depending on the day it was about a 50% upside, so I jumped.

I've now held Bowl America for a bit more than five and a half years and I'm finally showing a gain on my position.  The company's business fell off a cliff during the downturn and never came back, the share price followed business down dropping 25% and remaining flat.  The only reason I have a gain is due to dividend reinvestment, and a small bit of averaging down two and a half years ago.

I mentioned in the intro that this investment sort of worked out.  I looked at the Russell Value index and the Russell Microcap index and they both have losses over the same time period as Bowl America.  While Bowl America hasn't really done well, in a sense I just get my money back I haven't lost anything either.  Not losing money on an investment right before the financial crisis is significant in my mind.

What went wrong?

One of the biggest bullet points in my thesis was the real estate was undervalued; it still is.  How do I know this? I went online and found assessed values for 50% of the company's holdings.  With my spreadsheet only 50% populated the value exceeded the current carrying value.  A note, if anyone is in Virginia and able to get the missing information I'd greatly appreciate it.  Virginia doesn't offer easily accessible assessment data online.

Edit: Someone emailed me with the Virginia assessment information so the sheet has been updated.


There was also the issue of replacement cost as mentioned previously.  Bowl America paid $5m to build the Short Pump facility a few years ago.  At $5m a pop rebuilding their entire portfolio would cost $95m.  The fallacy of replacement cost is the assumption that facilities are replaced.  An acquirer is buying what exists today, not some theoretical version of the facilities.  A new bowling alley might cost $5m but it doesn't have the charms of the current ones like the ingrained cigarette smoke, the permanent sticky floors from Bud Light, and hoards of greasy cast off bowling balls.  That's why the buildings are worth less than replacement cost.

I thought that by using a replacement cost, both what the company spent, and what it would cost to a new franchiser, I was determining an accurate value from which Bowl America could be measured.  My mistake was replacement cost isn't what a potential acquirer cares about.  They might pay above book value for the assets, but nowhere near as high as what it might cost to build new, the facilities aren't in new condition.  Some have been broken in since the 1950s!

My second mistake was assuming that an aging CEO might want to step down at some point or sell the company.  I didn't think it through Leslie Goldberg's identity is his company.  His father founded the company, he worked as a pin setter as a child, then moved up as he aged.  How could this man give up the business?  I don't blame him either.

My third mistake was not investing with enough of a margin of safety.  I thought the undervalued assets would be my salvation.  Unfortunately land under old bowling alleys owned by a company with a life long President isn't easily salable.  Just because numbers on a page make something appear attractive doesn't mean it's so.

Going forward

I still hold my shares, which have slowly grown with the growing dividend over the past five years.  Most of the reasons for my initial investment still stand, the real estate is still cheap, there are significant cash and security holdings, and the CEO isn't getting any younger (he's 85 now).  I think Bowl America really speaks to having patience with undervalued companies.  It also was a great lesson on the difference between a salable asset discount, and an illiquid asset discount.  It's no surprise that in the past five years I've leaned more towards net-nets or cash boxes with readily liquid assets over land traps like Bowl America.

Usually when I write a post I'll sit down and decide on a theme or message I want the post to convey.  While I didn't have one specifically for this post I hope my experience and mistakes can make others better investors.  Just remember if you're tempted to invest in something illiquid, a stock, or land, or anything make sure it pays cash out regularly.  Without Bowl America's 5% dividend I would have been sunk, instead I've been paid to wait.  Maybe I should sell this position, but I'm inclined to inertia.  I already own it, I know the history, at this point I'll just keep ignoring it.  That is until I get their quarterly earnings in the mail on their retro letterhead.  Maybe it's not retro, maybe it just hasn't been updated in a few decades, seems to be a common theme for this company…..

Talk to Nate about Bowl America

Disclosure: Long Bowl America

5 comments:

  1. What is important is the return on the real estate, not what it is worth. If it takes 10-15 years to realise the real estate value of some alleys, you'll have very little upside. Return on the alleys is currently weak so I don't see any upside from here.

    I would be interested under say $40m market cap, not at current price. This can happen when one shareholder is forced to sell this illiquid stock, but I doubt it will. I'm also taxed more than 40% on dividends so that's not helping either.

    It's good to have a list of such stocks on your watchlist, just in case they get weirdly cheap.

    ReplyDelete
    Replies
    1. Tom,

      I agree, that was a big mistake of mine not buying the real estate at enough of a discount. While undervalued the time I'm having to wait is killing my returns.

      Funny your comment on dividends, I'm in the opposite situation. All my European holdings are taxed highly while I get a break on US stocks, for now at least. The break ends in a few months.

      I believe the CEO and his sister own 60% of the stock so opportunities to buy when someone's dumping might be rare, but they do come along. I think stink bids work on this stock, I'll see a random trade go through a few dollars lower or higher than the last trade every so often. I had a high ask on it for a while, just in case it hit.

      Nate

      Delete
  2. I always try to look at these type of stocks on both an operating basis and a sale/asset value basis (and weigh the possibility of sale). On an operating basis I would not have paid more than $8 for a company with $3 in cash and securities and $0.76 in EPS and no growth (about 6x EPS plus cash). I try to buy at 6x and sell at 10x on most non-growing micro-caps.

    The asset value is deceptive. Unless they had shown a willingness to sell properties if and when that made financial sense, I would ignore the asset valuation.

    ReplyDelete
  3. This somehow reminds me of the current situation at Sears. I have a tough time putting wood behind SHLD because of how I see Lampert's identity becoming entwined with the success of the retail operation.

    ReplyDelete
  4. Good review. Sometimes valuation isn't enough of a margin of safety and dividends/buybacks provide an extra level of protection when there aren't any catalysts

    ReplyDelete