Thursday, April 25, 2013

On value investing...

I had the pleasure of getting together with two other value investors in Pittsburgh this evening.  We had a great time discussing a wide variety of topics.  Our conversation drifted from international investments, to nano cap stocks, to how crazy the real estate market is in Pittsburgh.  After I left I was thinking about how great it is to get together with like minded people and speak the same investing language.

To other investors we often make sense, something at "5x EBITDA and below book" is worth looking at, whereas to the non-investing population it doesn't even sound like English.  Maybe it was Munger or some other famous investor who said if you can't explain a concept to a 12 yr old you might not understand it.  In the spirit of that I want to share some analogies I've used to explain investing and how I invest to non-investors.  In all the times I've used my analogy I haven't encountered anyone who didn't have the lightbulb moment and say "oh I get it now."

How I invest

Imagine an area of town with an industrial area, the area is fairly well worn, but not in total disrepair.  There are a number of companies with names no one remembers doing somewhat specialized activities.  The owners of these businesses appear to do well for themselves raising their families in a solid middle class environment.

An owner of one of these businesses decides he's had enough of the stress and daily grind and he wants to sell.  He knows how to make widgets, and isn't much of an investor himself.  He lists his business on a public market.

Investors in town know that the area the business is located is grimy, and when they look at the accounts they see the company isn't all that profitable.  It seems like a lot of work is involved to make such a tiny profit.

I come along and examine the business, I agree with the other investors that they aren't that profitable, but I notice something different.  While they aren't turning a profit they do have a valuable building and the owner has undervalued his warehouse of old inventory.  I purchase the company for less than the property and machinery cost alone.  Once I visit my new purchase I realize what the owner thought was old rusty inventory in the warehouse is actually recently purchased inventory.  The owner was a bit of a pack rat and I start to find envelopes full of cash around the facility he'd stashed for rainy days.  When all is said and done my purchase price for the business is less than the inventory, receivables and cash net of liabilities, I get the building and aging machinery thrown in for free.  The company is marginally profitable, but it's not a big concern considering the discount I already received on my purchase.

To me that's the essence of asset based value investing.  When I've told this story people marvel that these sort of deals actually exist.  I explain they exist in the markets the same place they exist in real cities and towns, not on the main streets, or in the central business district.  Rather these deals are found on the back roads, sometimes far away from town, neglected by everyone often even their owners.

How Buffett invests

Warren Buffett used to invest as I described above but he's changed as he's become more successful.  Buffett buys that restaurant in town that everyone goes to, there are always two hour waits no matter what day of the week or time of the year.  Buffett prefers when these businesses are run conservatively and have strong staying power.  He isn't interested in buying the hottest restaurant this month, he's buying the restaurant that's been hot for a decade.

Buffett will then go on and buy the bank in town, and then the local gas station, and the grocery store, and whatever else is for sale.  Eventually it will be hard for anyone in town to go a day without using one of his products, or services.

How most investors invest

Imagine yourself at a cookout in the summer.  You're standing by the grill and your brother-in-law comes and starts chatting.  He starts talking about how this guy he works with is onto a really great investment.  It's some new technology he doesn't really understand, but it doesn't matter, it's going to sell really well.  Not many people know about it yet so you have to keep quiet.  He thinks it's going to be big, almost everyone in the world needs this product, if they can only capture 1% of that market they'll be billionaires.  It's a good thing you found out about this early so you can get in on the ground floor.  Just imagine being able to pay off the house and pay for the kids college all while sitting on the beach drinking mai tai's.

Final thoughts

I find it fascinating that most non-investors can spot a good local business without a problem.  People instinctively know when someone has a model that's minting money.  Yet a disconnect happens between a local tangible market and the public markets.  Most people wouldn't invest with the wacky science-y guy promoting some new fusion technology down the street, yet they'll pour money into high tech startups.  People are also able to identify when a company has a strong brand and staying power verses a company without it.

I love when people say things like "how did that restaurant go under, it was always crowded?" because it exposes that while people understand a good brand, they don't understand the finances behind a business.  I always say that companies go under for two reasons, too much debt, and mispriced products.  Those two go hand in hand, products priced too low eventually lead to debt problems.  Maybe the restaurant is packed because the prices aren't high enough.

Talk to Nate

Monday, April 22, 2013

Shareholder rights…did you know you have them?

"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.  The result is that the effective control of many, perhaps most, large American corporations is exercised not by those who together own a majority of the stock but by a small group known as 'the management.'" Graham, Benjamin. Security Analysis 1941.

Americans are raised with a strong sense of rights; starting with the inalienable rights of life, liberty and the pursuit of happiness.  These rights extend from the Declaration of Independence to the Constitution and beyond through codified laws.  Americans are quick to proclaim loudly when their rights are infringed upon.  It doesn't matter if these rights are true rights, or presumed rights not backed by law, Americans feel strongly about rights!

There is a strange disconnect between citizenship rights and shareholder rights, a disconnect I don't fully understand.  As a citizen we have rights granted to us by a government, rights that are very hard if not impossible to change.  Citizens only get one vote, and the only way to affect change is to petition an elected official or become one, and even then change is slow.  The same can't be said about corporations.  A shareholder can buy more votes by buying more shares, and if they own enough shares can fire management or take over the company driving change themselves.

Benjamin Graham's quote from the 1940s still rings true today.  Most shareholders are docile, most fail to vote proxies and those who do vote often side with management.  Shareholders with small positions on mega-cap companies might view their votes as futile, even still, why throw away something you purchased?  The types of companies I typically invest in are smaller, some very small where a significant position can be built quickly, and shareholder votes meaningful.

I recently finished a book The White Sharks of Wall Street, which I highly recommend.  The book details the history of a group of modern corporate raiders who began taking over companies in the 1930s up through the 1960s.  These men, including Thomas Mellon Evans, invented many of the modern takeover techniques we know about today, yet their stories have been lost to the sands of time.  Tom Evans was known as a liquidator, he bought companies for less than NCAV or book value and liquidating divisions for a gain.  The author is a financial journalist for the New York Times, which means what could have been dry material reads quickly and is fascinating.  This isn't a textbook, but rather an informative history.  It's worth noting that Tom Evans apparently ran in some of the same circles as Benjamin Graham.

In the spirit of the book I wanted to discuss a number of rights shareholders have that they might not know about.  The rights I'm detailing below are for shareholders of Delaware corporations, which most public companies are.  Companies are governed by the state they incorporate in, and the state they reside in.  Some states have different rules and regulations, with some like Nevada being notoriously shareholder unfriendly, whereas Delaware is very shareholder friendly.  If you plan on undertaking any action against a company you own please find the relevant state first, small nuances can lead to significant differences.

I am not a lawyer which is probably evident by my readable writing, but I wanted to state it anyways.  I have read the Delaware corporate law along with the corporation law for a few other states, they were available free online.  If any of this is wrong please make a note in the comments and I'll edit the post.

Shareholder vote - By law shareholders are entitled to one vote per share unless stated otherwise for a specific series of shares.  This might seem like the simplest of all the rights, yet it's the most powerful.  Shareholders are not restricted to one vote per person as in a governmental election, shareholders can purchase as many votes as they want by acquiring shares.

Companies are required to put directors up for election every so often as determined by the company's bylaws.  When directors are up for re-election the shareholders have the responsibility of evaluating their qualifications and voting, or not voting them in.  If a director isn't qualified shareholders can vote that director out and propose their own director.

Some companies have cumulative voting which is extremely powerful, one holding of mine has cumulative voting.  An example is the best way to explain what cumulative voting is.  Take a director election with five directors up for re-election, a shareholder with one share has five votes, one for each director.  The shareholder can vote yes or no on each individual director, but they get one vote per director.  In a cumulative election that shareholder can take those five votes and direct them all at one director or nominee.  This is important when a minority shareholder has enough votes cumulatively to get a seat, but not enough votes overall to secure a seat on the board.

Annual meeting -  Delaware companies are required to hold a meeting annually.  Not all companies comply, and there isn't anyone policing compliance besides shareholders.  If a company fails to hold an annual meeting a shareholder can go to the Delaware court to compel one.  Case law is very clear on this issue, if a company has failed to hold a meeting the court will compel it almost without question.

An interesting side-note to this section of the law is that Delaware law also requires companies to prepare a list of shareholders who are allowed to vote during the meeting.  The company is supposed to have this list available at the meeting and allow shareholders to view it and copy it if they desire.

Appraisal rights - If a company becomes party to a merger or take over shareholders can obtain what are called appraisal rights.  Appraisal rights give the shareholder the ability to contest the value offered as consideration in the transaction.

For example Company A comes along and offers Company B shareholders $10 per share to acquire the company.  If Company B has $5 per share in earnings shareholders might feel like the price offered isn't fair and exercise their appraisal rights.

When a shareholder exercises these rights their shares become frozen and they are not allowed to vote for or against the corporate action.  If the shareholder votes for or against the action in most cases they invalidate this right.  Filing for appraisal rights needs to happen after the action is announced, but before any vote takes place.

The rights are a bit odd, it's possible a shareholder could exercise them and win with the court saying the shares are indeed undervalued.  The company might then be forced to pay the exercising shareholder a higher consideration.  What's strange is that all of the other shareholders who didn't exercise this right receive the initial consideration they agreed to, even if the court rules they were offered an unfair deal.

Worth noting is a history of long drawn out court battles over appraisal value.  Long court battles mean high lawyer costs, which the shareholder is responsible for alone.  Also worth considering is the valuation methodology that the state uses.  If the state uses DCF and the company is fairly valued on a DCF basis it doesn't matter that they're selling for 1/3 of net cash, the shareholder will lose in court.

Right to inspect books and records - A shareholder is the legal owner of a corporation, just like a homeowner is the legal owner of their home.  Likewise it isn't strange if a homeowner were to walk through their home looking at what they own, yet in the corporate world owners are treated like outsiders on their own property.

As a legal owner a shareholder is granted through law the ability to inspect the company's books and records.  For SEC filing companies this isn't an issue, companies disclosure anything an investor might want to inspect to all shareholders through EDGAR.  For non-filing companies, and private companies things are different.  Shareholders have the legal right to see a company's financials no matter what the CFO says.  I've talked to companies where the CFO flat out lies and claims shareholders don't have this right which is a shame.

The Delaware courts look favorably upon shareholder record inspection requests if a valid reason is given, and if the company hasn't made information available.  The requestor is responsible for paying the costs associated with obtaining this material and at times traveling to the company's headquarters or Delaware to inspect the records.

In addition to inspecting a company's books shareholders also have the right to examine and make copies of the shareholder register.  This is the list of who owns the shares, and how many shares they own.

A company by law has five days to respond to a records request, if they don't respond within five days the shareholder has the right to petition the court to view the records.

How to use?

This is probably the trickiest part of the post.  For all actions besides voting on a company issued proxy action needs to be taken on the part of the shareholder.  A complicating factor is that most shareholders are not in the shareholder register because they hold their shares in street name (at a broker).  If you wish to exercise any of the above rights and you hold your shares in certificate form you won't have any issues, proof of ownership and a letter to the company with your intentions is a good starting point. Some rights, such as a records request have specific requirements such that the request be provided in writing and the requestor sign under oath.

If you are a shareholder in book entry form and wish to undertake any of the above actions cooperation on the part of your broker is required.  The Delaware court does recognize beneficial holders as legal owners, but a letter from the brokerage verifying ownership is required.

Talk to Nate about shareholder rights

Disclosure: I get a small commission if you purchase an item through the Amazon link above.  The prices are the same through my link and when you go directly to Amazon.com.

Thursday, April 18, 2013

Anyone can invest in this above average hedge fund

Hedge funds, bastions of wealth, accessible to the rich and famous and well connected.  These purported money machines are so sophisticated that they're off limits to anyone who isn't an accredited investor, supposedly someone who's wealthy enough that they know how to not lose money.  The truth is much different from the myth, most hedge funds, like most mutual funds do poorly.  In aggregate hedge funds and mutual funds are the market, it's impossible for all of them to outperform.  The largest ones have managers who are constantly in the news promoting their views.  Who in finance doesn't know who David Einhorn, Bill Ackman, or Carl Icahn are?

I'm guessing all my readers are familiar with hedge funds, and most probably work at one, but not many can actually invest in one, let alone one with a record of outperformance.  Of course all my hedge fund readers work at outperforming funds, you're all headquartered in Lake Wobegon right?  There actually are many funds that outperform each year, and some outperform for decades.  Most of these funds fly under the radar and away from the news.  Most are not household names like the company in this post.

The selling point for a hedge fund is an investor is gaining access to a vehicle that has the ability to outperform the market through going long and short stocks with a judicious amount of leverage.  To gain access to such a dream machine investors pay steep fees upwards with the standard being a 2% management fee and 20% of profits going to the fund.  In theory the fund will do well enough after fees that the gross fee amount doesn't matter.  This is certainly true for some funds, but others don't do well enough to justify their fees.

Senvest Capital (SEC.TO, SVCTF) is an asset manager based in Montreal Quebec.  The company started off as a manufacturer of electronic theft systems, listing on the TSX in 1971.  Starting in the 1980s and into the 1990s the company morphed from being an electronics company to a holding company for various investments.  Management realized that they were better at understanding business and allocating capital than running an electronics company.

From the early 90s to 1997 the company primarily invested capital through their New York subsidiary.  In 1997 they launched their first limited partnership, Senvest Partners.  Again in 2003 the company seeded a partnership, Senvest Israel Partners.  The funds have done well, Barrons noted in 2011 that Senvest Partners was the best performing long-short fund over the 2008-2010 time period.  Bloomberg cited Senvest Israel as the best performing fund for the five year period ending February 28th 2011.  In a world with thousands of hedge funds remarks like this are significant.

Senvest Capital is a bit of an oddball stock.  Senvest Capital is the asset manager that owns Senvest Partners and Senvest Israel along with a grab bag of other assets.  If this company simply were an asset manager with some outside holdings they wouldn't be any more interesting than any of the dozens of other public asset managers.  The difference is that a large part of Senvest Capital's holdings are in their own funds, and that investors can buy these assets at a significant discount.

Here are the company's assets from their latest annual report:

The three biggest items on the balance sheet are their investments, their investments in their hedge funds (investments in associates), and some miscellaneous real estate investments.  The company has almost no liabilities, they amount to $95m and consist mostly of liabilities related to equities sold short.

The company isn't exactly transparent when it comes to explaining their own investments.  They make the following disclosure:

The company has $184m in listed securities and $32m in unlisted securities.  The notes explain that the unlisted securities are positions in private companies that have no public market.  Inquiring minds are probably dying to know what securities the company holds in their listed portfolio.  Unfortunately the notes in the annual report don't reveal anything, but there is a way to get a peek.  Senvest manages their money through a subsidiary in New York.  The subsidiary in New York is required to file their holdings with the SEC regularly.  While the filing doesn't disclose all of their holdings it does give a good picture as to what they hold.  The link to those filings is here.

Some of the unlisted holdings are non-traded REITs, and shares in non-public banks.

What makes this investment so interesting is how cheap the holding company is, and how well they've performed over the years.  The company is trading at a discount to NCAV, a significant discount.  Shares last traded at C$81.85 against a book value of C$117.50.  A friend who is very familiar with this stock estimates that book value is above $120 p/s currently.

It's almost strange that the management company of outstanding hedge funds would trade at 2/3 of BV.  What's even more incredible is that book value consists of mostly liquid investments, equity securities, stakes in hedge funds, and some illiquid real estate investments.  What I find even more incredible is that Senvest as a company has a history of providing solid returns, this isn't a one time undervalue of a mediocre money manager.  I have a table showing book value and earnings per share back to 2004 below:


From 2004 to 2012 the company grew book value from $22 to $117, that's a compound growth rate of 22.8%.  The company's funds have performed similarly over the same period of time.

Readers will note that earnings per share are very volatile.  The company earns a revenue stream from fees associated with the funds.  Unfortunately the fund fees don't cover all of the company's operating expenses meaning the difference ($10m) is made up from equity holding gains.  Given the company's investment performance over the past eight years making up this shortfall hasn't been an issue.  In years when their company's investments do poorly their earnings take a significant hit, like in 2011.  In years when their investments do well earnings do well too, like in 2012.  The company is trading for a P/E of 3x, although I'm not sure earnings are the best way to value the company.

I've explained the math in the past on investing in companies below book value that are consistently growing book value.  Using this math an investor today buying at 2/3 of BV with the company's 22.8% growth rate is actually earning a 34.5% return on their investment if the future looks somewhat close to the past.

Investing in Senvest Capital isn't a normal value investment, it's more of a mutual fund, value stock, and hedge fund hybrid investment.  An investor gets the chance to own pieces of Senvest's mutual funds, along with some of their private investments, all at a 2/3 discount.  Along with this the common equity investor pays no fees, rather they are a beneficiary of the fees that the company's fund investors pay.  Even with all these things investors are still provided a margin of safety, they're buying at 2/3 of a very tangible and liquid book value.


Disclosure: Long Senvest


Saturday, April 13, 2013

A liquidation with a huge hidden asset

Liquidation..that elusive thing all net-net investors hope for but never expect to happen.  A friend sent me a note a few weeks ago suggesting I take a look at Alpine Group (APNI), he said they were cheap at 44% of NCAV and profitable.  We traded a few notes after I looked at the company and then he sent an email last week saying they announced they were liquidating.

Alpine Group is nothing more than a collection of four companies, Exeon, Wolverine Tube, Synergy Cables, and Posterloid.  Posterloid makes signboards like the ones you'd see at the McDonalds drive-thru.  Wolverine Tube manufactures copper tube used in HVAC, refrigeration, and power generation applications.  Synergy Cables is an Israeli traded company that manufactures power cabling, and Exeon manufactures copper wire.

The company has had a turbulent history of profitability, but in a liquidation that doesn't matter much anymore.  The company recently released their 2012 annual report which contained an adverse opinion from their accountants.  It appears that Alpine Group refused to consolidate Synergy Cables even though they owned 50.4% of the company.  Instead they chose to record their Synergy Cables holding using the equity method.  The accountants point out this isn't allowed under GAAP,  management responded that they intended to sell down their stake so they shouldn't be required to adhere to the letter of the law.  What management doesn't seem to understand is that financial statements are not meant to reflect management's intentions but rather take a snapshot of the company on a particular date.  Management did stay true to their word reducing their stake below 50%.

The company invested in Wolverine Tube at the top of the housing market, the exact wrong time to invest in a housing related stock.  Wolverine eventually went bankrupt, Alpine ended up with a pile of options on Wolverine in exchange for their worthless equity investment.  Additionally the company purchased 4.5% of the company on the open market after it re-emerged from bankruptcy.  Alpine wrote off their initial Wolverine investment, and subsequent options as well.  Wolverine is held at zero on the balance sheet, but the holding is worth something.  The company has been profitable since emerging from bankruptcy.  It's hard to know what the company might receive for their 4.5% stake in the company.

Alpine has had a long history of continued capital commitments to Synergy Cables.  This is most likely because the CEO of Alpine is also the CEO of Synergy Cables.  To make a long story short Alpine loaned a lot of money to Synergy over the years all of it which was subsequently lost.  This resulted in the write down of their Synergy investment to zero.  From the financial statement perspective there is no value to the Synergy investment, but this isn't accurate from an economic perspective.  Alpine owns 40% of Synergy Cables, and since Synergy Cables (SNCB.Tel Aviv) is actively traded on the Israeli stock exchange it's fairly easy to determine how much their stake is worth, it's close to $5m.  This is considerable for a company with a market cap of $8m.

Valuing Alpine is very straightforward, determine the value of the assets and subtract the liabilities.  Most liquidations take longer than expected, Alpine expects theirs to be mostly complete by mid-2014.  Many liquidating companies are burning cash which needs to be taken into account when doing a valuation.  Alpine is cash flow positive, although barely.  Looking through the cash flow statement it's entirely possible that the company won't burn cash as they liquidate.  After all Alpine is simply a holding company, their holdings will continue to operate and conduct business next year as they are today.  The only thing being dissolved is the holding company.

The first valuation is the most aggressive, I took Alpine's equity value and added the value of their Synergy Cables holding.


If this valuation holds there is clearly a lot of value here, liquidation value is $1.24 a share and the company is trading for $.73.  Both of these valuations don't include Wolverine which could be worth something.

The problem with book value is it's opaque, the company has close to $1m in PP&E, but investors have no idea what it is.  They own $27k worth of land somewhere, maybe a few acres, a $232k building and then $1.7m worth of machines.  Are these components part of a consolidated subsidiary or the holding company?  What will happen to them?  We don't really know, so I created a conservative scenario based off of NCAV and a discounted NCAV:


The company is trading right around unadjusted NCAV, and well above a discounted NCAV.

To determine if this is a good investment at the current price an investor needs to assess whether the company's long term assets have value, and whether the company will realize their full current asset value.  If they do both and their holdings continue to generate profits up to the end of the liquidation this is an extremely attractive investment at the current price.  If neither of these assumptions pan out then someone buying today could end up with a loss.


Disclosure: No position

Wednesday, April 10, 2013

Cash boxes

I prefer three types of investments, net-nets, cash boxes, and two pillar stocks.  My reasoning behind investing in net-nets is pretty well covered throughout the blog.  I've covered two pillar stocks through a few examples, such as Nexeya, Gevelot, Hanover etc.  While I've covered a number of cash boxes I have never expressly discussed why I like them and why they're worth considering as investments.

This post came about as I looked over my portfolio and realized that I own 20 holdings in my portfolio that are cash boxes and they all fit a similar investment profile.  Some of these cash boxes are net-nets as well, but not all are.

It might help to define what I'm talking about when I mention a cash box company.  Most investors when they hear the term think of the stereotypical cashbox: an old obsolete company barely making a return that has hoards of cash at their disposal.  The company is of secondary concern to the pile of money in the company's possession. I prefer to define a cash box as a business where a significant, if not majority of the company's market cap consists of cash.  For example if a company were to have a market cap of $50m and held $30m in cash in addition to their operating business this would be a cash box.  Additionally my sort of cash box has a decent business attached which I'll cover below.

To me there's a fine line between a cash box, and a pile of cash.  A pile of cash in the investing world is usually a bio-tech or some startup company peddling promise.  The company starts with a pile of cash that they slowly and methodically work down to zero as they develop the next greatest thing.  Very few piles of cash work out, but the ones that do work out spectacularly so.  The successes are supposed to counteract the failures, in theory.  My experience has been a few lucky people invest in the success and most everyone else chasing success ends up in the failures.  I have invested in a few piles of cash before, I have never met success, but I know failure well.  A pile of cash is often a very efficient transfer mechanism to take cash from equity investors and turn it into salaries for professional executives.

The biggest question when it comes to cash boxes is why doesn't management reinvest the cash profitably somewhere else?  The answer to this question leads to my favorite type of investment, the profitable niche business bolted onto a pile of cash.

Floating out there in the market are companies that have tiny moats in small niches of the marketplace.  These are companies like Conrad Industries, a barge builder in Louisiana.  Conrad exhibits a competitive advantage, but there is a limit to how many barges can be made in a year, and a lot of that depends on external demand.  The company is extremely profitable and earns excellent returns on their invested capital, the problem is they have nowhere to reinvest that excess cash.  With management worrying about running the company and not managing an investment portfolio the excess cash builds.  Sometimes management will try to justify the cash saying they're on the lookout for an acquisition, or it helps them to be flexible.  When managers repeat that they're on the hunt for an acquisition, but one never happens it's a pretty good sign one will never happen.  I liken this to the person who only wants to golf on a day when it's 75 and sunny without a breeze and not a weekend.  If the golfer is lucky they might find that day once a year at most.

The best cash box companies are actually good businesses.  If excess cash is removed from the balance sheet these companies make reasonable returns on equity.  Management is prudent and invests in the business wisely.  There is often some growth in both revenue and earnings.  The problem is the business isn't able to support the amount of cash that's being generated.

For many investors excess cash is a worrying sign, it's read as a signal that management doesn't know how to reinvest.  I see excess cash differently, to me the excess cash in many cases is a sign of prudence on the part of management.  Instead of wasting money on dubious investments they prefer to let it sit idle for some point in the future.  For many of these companies if the cash were paid out as a dividend the companies would suddenly become extremely attractive.

I like to look at a company, back out the cash and then evaluate the company on the reduced basis.  Suddenly a company with a 5% ROE can have a 18% ROE once the excess cash is taken into account.

So what are the things to look for in finding the ideal cash box?

1.) A business that's stable and possibly growing, not in decline.
2.) Management that isn't hasty to spend the excess cash and is conservative in operation.
3.) Management that is invested in the business.
4.) Management that is aware of shareholder value.
5.) A low valuation, I prefer cash boxes selling for less than book value, or less than cash (gross not net, but I'll take net if it's available)
6.) Consistent earnings, but more importantly consistent cash flow.
7.) A business model that can survive the test of time.
8.) A debt free, or very low debt amount on the balance sheet.
9.) A cash balance that's growing and has grown over time, not the result of a one time sale or other event.

When all of these factors come together it is usually the type of company I will invest in.

The second biggest question with a cash box is what happens next?  What's the point of investing in a business even if it's decent if it continues to accumulate excess cash and go no where?

Many of these companies do eventually do something good with the cash.  A cash box I own, Goodheart-Willcox repurchased a significant amount of their shares at less than book value.  They trade at $72 and are on track to earn about $6 this year.  That doesn't seem that impressive until you back out the $60 or so in excess cash, suddenly the company is selling at a P/E of 2x.  And their cash is piling back up, they have shown a willingness to repurchase shares, they might do it again.

Some cash boxes eventually pay out large dividends.  A number of them paid special dividends around December of last year before proposed dividend tax increases were supposed to go into effect.  A company barely cash flowing their debt isn't able to pay out a large special dividend, a cash box has that flexibility.

I believe value is it's own catalyst.  When I buy a company for less than book value, of which 70% is excess cash, and the company's operations are profitable, earn reasonable returns, and management is honest and shareholder friendly, I don't see how an investor can go wrong.  These are boring companies that might languish in a portfolio for years.  But if an investor's goal is to buy safe companies cheaply cash boxes surely play a role in the portfolio.

Talk to Nate

Disclosure: Long Conrad, Goodheart-Willcox, and 18 other cash boxes!

Saturday, April 6, 2013

LAACO, store this company for the future

Given the name of this blog it's unusual that I don't actually cover that many esoteric investments.  I'm not writing about strange derivative trades or unveiling hidden resource companies; mostly I write about small cheap stocks.  Most of the companies are boring and forgettable, but they all share a characteristic, they're cheap.  Unfortunately in today's market a tiny obsolete manufacturing company selling for less than book value is considered an oddball stock.  The stock in this post is actually worthy of being called an oddball, it's a mess of assets wrapped in a partnership structure with a very high price per share.  The company is LAACO (LAACZ).

LAACO is a California limited partnership with ownership interests in a variety of assets in the West.  The partnership mainly owns storage unit facilities, as well as the Los Angeles Athletic Club and the California Yacht Club.  Part of the Los Angeles Athletic Club is a 72 room hotel.  Additionally the company owns two buildings in downtown LA, and some surface parking lots.  Measuring by revenue the storage units deliver 65% of the partnership's revenue, and the club, hotel, buildings, parking lots and boat club provide the rest.

The company has been in the storage unit business since the 1970s and has slowly grown to 47 locations.  The majority of the facilities are located in California, some in Nevada, Arizona and now Texas.  The company has identified Houston as an area where they are targeting growth.  They purchased a facility there in 2012 for $6.3m and are looking for further acquisitions.

Storage units qualify as a boring business, that is unless you factor in the crazy TV show focused on them, Storage Wars.  I would wager that at least one of LAACO's facilities has been the host of loud antique collectors bidding high prices for units full of junk at least once given the location of the show, and the location of the partnership's units.  Where else but in America can someone make a TV show out of people standing around a storage unit bidding like crazy for items they can't even see?  When I've watched the show I've been struck by the parallel, that everywhere there is value in cheap junk.  It might be cheap companies for some, and old lamps and bed frames for others.  Anything purchased cheap gives the possibility of a reasonable return.

When I first found LAACO I had two thoughts, the first was hidden assets, the second inflation play.  As far as I can tell neither of these impressions were true.  Let's tackle the asset angle first.  Using the $6.3m paid for the Houston facility as a metric, and then extrapolating it to the other 46 locations results in a value of $296m, higher than what the balance sheet shows.  But further in the annual report there is a comment that two facilities together are only worth $5m, or $2.5 each.  Of course the $296m is only the storage units, the company also owns the athletic club and yacht clubs, both worth something, and possibly a lot.  Just going back of the napkin I'm not seeing a fat enough pitch on the real estate.  If the storage facilities are worth $4.4m each (average of $6.3m and $2.5m) the value of the storage units would be $206m.  Book value for PP&E is $267m, leaving $61m for the assortment of other assets.  This seems like a fair estimation.

There is some shareholder out there reading this that is going to email me a spreadsheet with the detailed value of each asset proclaiming this is the investment of a lifetime.  The caveat will be that shareholder purchased at a much lower price.

Because the company is a collection of assets it makes sense to value them as such and piece their values together.  Currently the company is trading for $1074 a share, and book value is $915 per share. And based on my assumptions that book value is mostly correct buying these assets above book value doesn't seem like that great of an investment.  If the price of shares suddenly dropped to $600 I would be a very interested buyer.

So to that shareholder, I appreciate the spreadsheet, and I probably don't disagree on your valuation, but at this price I don't have enough wiggle room.

What's impressive about LAACO is that the company is earning a respectable return, they had a 8% ROE in 2012.  The company is very generous about paying out a portion of earnings as a dividend, this past year they paid $47 a share in dividends.  When evaluating their earnings remember to compare them to real estate rentals, a hotel, and athletic/boat clubs.  In that context 8% is reasonable, although some of that return is due to the company's leveraged balance sheet.  The company included a five year results table in their annual report reproduced below:



I mentioned earlier my second thought about the company was that they could be a possible inflation hedge.  My thought was this company owns real estate, something tangible, and they could possibly raise rates each year at or above inflation.  The company is a way to hold Los Angeles real estate, but unfortunately the collection of companies they run haven't been successful at continually raising rates.  Part of this is a capacity problem, the storage units are 79% filled.  Presumably most other storage locations in the area with similar prices would have similar occupancy rates.  This means if LAACO suddenly raised their rates significantly a tenant could easily move their stuff a few miles and save a lot of money.  Over the past few years the company has been able to raise rates at roughly 1% a year, far below the rate of inflation.

The company noted in the CEO letter that they had trouble raising rates in the poor economy.  The company's athletic club membership grew last year, but a decline in yacht club membership balanced out the gain resulting in no net change.

Usually companies like this are structurally cheap for a few reasons.  The first is the company is a partnership meaning shareholders receive a K-1 each year which complicates taxes.  The second is the share price is high.  At $1k per share prospective buyers are locked into buying in $1k increments.  Lastly as a collection of assets the company doesn't fit into a mold.  They're not a hospitality company because they have storage units.  They aren't a pure storage unit company either because they own a boat club, hotel and athletic club.

For now shares of the company aren't cheap, but this is the type of company I want to keep on my radar, and if shares do drop I'd consider picking them up and tucking them away into a corner of my portfolio.

Talk to Nate about LAACO

Disclosure: No Position.

Tuesday, April 2, 2013

A misguided activist at DT Interpreting

This would be an appropriate April Fools post, but unfortunately this post isn't a joke, it's real.  Usually the appearance of a catalyst is good for a stock, unfortunately in this case it's just confusing.  There are so many strange things about this investment that I'm not even sure where to begin, I'll start with a little background.

The company is named Deaf Talk, but does business as DT Interpreting.  They're located in Carnegie, Pennsylvania, which is about eight miles from where I'm typing this.  I've driven past their location a number of times.  For me there's an added intangible element to knowing about the physical location of a company.  In DT Interpreting's case I know they are in a sketchy part of town that was hard hit by steel mill closures and a flood in 2004.  This is all to say the company isn't soaking shareholders by renting out glamorous digs in a ritzy part of town, management appears somewhat frugal, at least in their choice of location.

The company went public in 2010 after being privately held for 12 years.  They became a public company utilizing a reverse merger wherein the company merged with an empty shell company that had a ticker symbol.  The company doesn't file statements with the SEC, they trade on the pink sheets and volume is light.

The company itself is interesting, they started out as an interpretive service for individuals with hearing problems.  The company would have calls sent to them where an interpreter listens and signs into a camera.  The deaf individual watches a video of the DT Interpretive interpreter to understand what was discussed.  I couldn't figure out from their website if there is two way interaction via video camera.  The company has 400 installations of their technology and has branched into other interpretive ventures.  They provide translation services for documents as well as general translation for a number of languages.

The company is small, earning just $2.5m in revenue last year and $2.3m in revenue the year before.  Their earnings have grown dramatically, they earned $65,000 in 2011 and $141,000 in 2012.  The increase in earnings were due to a decrease in ASL and interpretive service expenses.  The financial statements can be found on their website, or at this link, they will be uploaded to unlistedstocks.net soon too.  I have never seen such detailed statements for a public company; this level of detail is common for a private company, but never a public company.  For instance they note that they spent $141.67 for subscriptions and dues, the magazines in the lobby perhaps.  They also spent $38.47 on repairs, it doesn't mention the type, but whatever was fixed came cheap.  The company even reports the penny they earned in interest on their bank account.

The company isn't trading at a jaw dropping valuation, they trade at 5.85x book value and 13x net income.  Granted for their growth this might be cheap, but it isn't the typical low P/E, or low P/B multiple seen with many unlisted stocks.

Enough with the background, let's get straight to the interesting part of this story.  A reader sent me an email mentioning that he saw that a 13-D was filed for the company last week.  The 13-D is extremely strange, first the filer mentions that his purpose is to buy the company outright.  He then details that he plans on increasing revenue by entering into partnerships with "symbiotic companies of equal or greater gravitas."

The filing then goes onto state that the investor intends to announce a buyback of all of the company's shares at substantially higher prices.  To top things off the filer owns 450,000 shares, which is a $10,000 position that he claims is 5% of the company's shares.  The problem is he made a small mistake, the 8m shares he lists is only the company's public float, the company actually has 42,552,700 shares outstanding, meaning this guy only owns 1.06% of the company.

I did some Googling on the filer and he appears to be an 86 year old who lives in a nice apartment east of the city.  The reader who alerted me to this situation tried to contact him, but his phone number is disconnected.  The filing has a name and address to receive notices which is different from the filing person.  The notice name and address is associated with someone who according to LinkedIn owns a small investment banking partnership that I couldn't find any information on (outside of his LinkedIn page).

It doesn't make sense to me why this person is filing a 13D for an unlisted company in the first place.  If a company isn't SEC filing my understanding was they were viewed no differently than a private company.  In a private company if ownership changes the exact changes aren't announced to the world, that's they the company is private.  Often management likes to take companies dark so they can have the same level of secrecy.  In this case it's nice that the aspiring acquirer announced their intentions to the world.  My concern is will they follow through?  I can imagine a number of scenarios here.  The first is I can imagine an older gentleman looking at these overly detailed financials and ranting "They paid $205,000 on phones last year, my phone from Verizon is $45 a month, those idiot managers…"  The second scenario is one where this is an older man who's investments and affairs are being taken care of by a broker or a family member, and the family member is orchestrating this whole thing.  It's impossible to know given that the investor's phone number is disconnected, if he is being scammed there's no way to contact him.

Even if the investor isn't getting scammed this is pretty poor strategy to announce to any and all investors that he intends to purchase shares at a significantly higher price very soon.  My guess is if he entered in his significantly higher order with a broker he would probably get a fill from all the investors who are tired of owning this stock.

For the brave souls that think this thing might be real this is an opportunity to front run a massive tender.  After some digging I'm questioning what's actually going on here, and I doubt there will be a massive tender or a buyout.  I'm actually concerned enough that this is an older man getting scammed that I'm thinking about writing a letter and mailing it across town asking about this whole situation.

Talk to Nate

Disclosure: No position