Bonal: A failed merger and an unbelievable high ROE

A sudden press release, screams of undervaluation; the dreaded take-under.  How can investors protect themselves?  Often they can't and they're at the mercy of management or controlling shareholders with ulterior motives.  Mistakenly many investors believe take-unders are a feature of small or micro-cap stocks.  The storyline goes:"I won't invest in a tiny company because management will steal it" is probably the most touted strawman argument for avoiding tiny stocks.  Take-unders aren't a feature of small stocks, they're a feature of any stock with a less than genuine controlling shareholder.  For evidence of this just take a look at Michael Dell's offer to purchase his namesake company, if that's not a take-under I don't know what is.

A take-under rarely falls through giving investors a second chance, like the one Bonal International (BONL) shareholders are receiving.  For anyone looking for a great background on the company I'd recommend reading the post at OTCAdventures.  If you don't read OTCAdventures yet I'd highly recommend adding it to your weekly reading.  I'm friends with the author who unfortunately needs to remain anonymous due to his job, otherwise I'd post it here to get the word out.  If you're ever in Pittsburgh drop me or him a line, we'd love to meet up to talk cheap value stocks.

The quick two minute synopsis on Bonal is that they sell a patented metal stress test technology.  The technology was patented by the Chairman and now CEO (story on that later) decades ago.  The level of current patent protection is ambiguous, they might have a newer related patent, but I'm not sure.

As a result of their patents, their sales, or their niche the company has incredible margins, and has recently been growing substantially.  Here is a glimpse at their current results:

The company is earning 20% and greater returns on equity.  This is even more impressive when one realizes that most of equity is made up of cash and investments that aren't actually needed to generate any of their income.  I have a field called ROE-adj on my spreadsheet showing the company's return on equity employed to generate the returns, the numbers are unbelievable.

The company is selling for close to 2x book value, but given that they lease their premise, and don't have many fixed assets this isn't an unreasonable multiple.  The correct way to view Bonal is as an income stream.  On that note they're trading for close to 10x earnings which is probably a low multiple for such a profitable company.  The company has earned $.18 per share this year so far, if things continue on track it isn't a stretch to assume they could make $.20 per share.  At a 10x multiple on earnings, plus the excess cash of $.56 per share the company's value is close to $2.50 at the low end.  Additionally the company pays a generous dividend giving the stock a current yield of 15%.  

Given what we know about the company's growth and margins it should come as no surprise to hear that shareholders were outraged when they received an offer on Feb 8th to merge with DePierre Management & Manufacturing for $.86 per share, plus a special dividend of $.20-30 per share.  Backing out cash the deal valued the company at about 3x earnings.

It seemed like there was no way for the deal to fail with the founding family owning 65% of the company, except that it did, so what happened?

It's important to realize that the controlling shares don't reside with any one person, they're spread across a trust and five relatives.  Together these family members own 65%, but individually no one controls more than 24% of the shares.

I believe the key to understanding why the deal failed is buried in the press release announcing the deal itself.  Towards the end of the release there is a small paragraph mentioning that two Board members resigned, and the CEO was relieved of his duty and is now in charge of the marketing department.  The Chairman and former CEO has reassumed the role of CEO.

I want to put forth a theory that could explain this, it seems reasonable to me, but I don't have any solid evidence to back this up besides conjecture.  My guess is three of the Board members didn't want to do the deal and were working to stop the transaction.  Somehow the Chairman forced two of them to resign and demoted the third removing them all from the Board.  By doing this he was able to vote to accept the transaction with whatever yes men were left.  The transaction itself is a bit suspicious, the company agreeing to merge happens to have the exact same address as Bonal itself.  This appears to be a Chairman take-under that's going private.

Private shareholders were rightfully surprised and incensed at the proposed merger, and along with the three ousted Board members there were enough votes to block the merger from taking place.

The strange turn of events places the company in a very unique position.  The Chairman clearly wants control of the company back, yet minority shareholders, and other family members are unwilling to sell the company at the price he's willing to pay.  Right after the company announced their take-under they also announced record quarterly earnings.  Earning momentum is headed in the right direction, and as long as the results are sustainable this is a fast growing little company.

I'm not sure where things go from here, but at this point minority shareholders appear to be in control.  This is a story I'm going to continue to watch.

Disclosure: No position


  1. You're theory makes sense. However, it seems strange that the family members did not talk this over before taking action on a merger. There is something strange about these events...

    1. I agree, there's something strange and unsettling about all of this. There are so many details that would have been nice to have, like where was financing coming from for the purchase? And how exactly did the votes go?

      There's a lot more to this story than we might ever know. I'm concerned that the current CEO appears to have forced the previous one out and was pushing for the merger. How will he do running the company?

  2. Maybe I have seen too many episodes of "Arrested Development", but I can envision the Chairman going behind minority shareholders' backs, offering the other discontent large shareholders a private side-deal, and stealing the rest of the company for pennies...

    1. I think that's a risk here, if the Chairman offered something large enough to sway the votes he could try this again. But if that were the case shareholders might have a lawsuit. I can't imagine the Chairman offering $3 per share to select shareholders then offering $1.20 to the rest of shareholders, that would be a slam dunk in court. If he makes a higher offer to anyone it would have to be extended to everyone.

      I also wonder about the three board members who are gone, I'm sure there's some animosity there and I doubt they're suddenly friendly with the Chairman now. Even if they receive a nice deal they might be so mad at the Chairman that they refuse it.

      All speculation of course, but it does make sense.

  3. Hi Nate,
    Thanks for an interesting post. In it you note that
    "The company is selling for close to 2x book value, but given that ... this isn't an unreasonable multiple. The correct way to view Bonal is as an income stream."
    My question: how would you generalize this statement? In other words, what are your general rules for deciding which multiple to pick, and can you suggest any references on this?

    Thank you.

    1. Good comment, I don't really have any rules except that in Bonal, and a few other cases there really aren't many assets to value.

      Bonal's book value is made up of some machinery and office furniture and supplies. I don't ascribe much of any value to the office stuff, old cubes are nearly worthless, same with old computers and boxes of paper and binders. That leaves us with just the machinery. They sell a very specialized product and I'm not sure there is much value in the machinery outside of what they use it for. Sure they might have general things like toolboxes and wrenches, but those aren't worth much. The bulk of their purchases are for the machines that make their equipment.

      The company also leases their space so they have no building or land with value. By going through book value I've basically deduced that there is no asset value to the company. But the curious thing is for their specialized machinery they are making real and sizable returns. Given the lack of assets earnings are all we're left with to value the company on.

      Does this make sense?

    2. Great little read. Question: how do you value their IP of their metal treatment process? Does that just get factored into their future cash flows or can that be valued as an asset?

  4. I looked into this after seeing it on otcadventures. My first impression was that they don't believe the company really belongs to the shareholders, and they'd rather spend it on gold plated office furniture (look at how much PPE is office furniture) or even better just steal the whole company for 2x earnings. On the other hand they pay a pretty decent dividend compared to earnings.

  5. Hi Nate

    Thanks for this good post

    I'm *very* new to this game. I'm so new, that I would have blurted all the straw man arguments against nanos ... and would even do that now !

    With that preamble :
    1. do these nano's have anything to do with SEC and filings or ?
    1.1. 'cause I can't find anything on the SEC site about Bonal

    2. Is there something other than the company's own website and company's own annual report to go by, when some outsider wants to know about this company

    thanks in adv

  6. $3m mkt cap and they own 60%. are u kidding? he probably spanked the "board members" at the family dinner. we could prob buy the whole thing.