Saturday, November 30, 2013

Valuation thoughts: Terminal Value

An oft repeated mantra is that something is worth more than it's selling for now, but it's exact full value is unknown.  It's as Benjamin Graham said, you don't need to know a man's exact weight to know that he's fat.  Along these lines I've been thinking a lot about a concept I will call terminal value.  I believe each company has a maximum, or terminal value that is the most it could be worth.

A company's terminal value is what they would be worth if their assets could be put to their highest and most productive use.  Another way to define terminal value is what a company might be worth if the world's best capital allocator with expertise in a company's given sector were in control of the company and made perfect decisions.

I came to think about the concept of terminal value after thinking about valuing companies at a micro level.  As an example think about a bank branch.  Bank branches are everywhere, on some street corners all four corners are inhabited by branches of different banks.  The location of all four branches is the same yet each might have different levels of profitability, why?  Why can one branch across the street from another one differ so much in profitability?  Why is it that an underperforming branch can suddenly become profitable when the bank is acquired, a new logo hung outside, and new processes and procedures implemented?

At a micro level it should be possible to model the perfect bank branch.  We could take the best processes and procedures from any bank in the US and apply those theoretically to our example branch.  Then we could take into account location and geographic details.  All of these inputs would give us the maximum a perfect branch could produce given a certain level of deposits.  If this exercise were extended to all of a bank's branches in theory we could create the maximum value of a bank.

The sum of these maximum branch values, plus an ideal lending program could be considered a bank's terminal value.  Our model creates the most this bank could possibly be worth in an ideal environment.  If an investor is expecting a bank to be worth more than a terminal value their expectations are too lofty.  Conversely if a non-perfect management team, or non-ideal environment exist then the bank's intrinsic value should be much less than its terminal value.

I used the example of a bank and bank branches because branches are easy to understand, and somewhat fungible.  But the concept of terminal value isn't limited to banks, I would say in many ways it's more applicable to other business types.

Take an example of a real estate company that owns an apartment building.  If the company were to attempt to rent their apartments for double the rent of any nearby building they'd have a vacant building.  So it's reasonable to assume that there is some value of rent that minimizes vacancies and maximizes revenue at the building.  If the company were to keep the building in this ideal state forever that cash flow might represent terminal value.  For this real estate company they can't be worth more than this value unless something unusual happens.

It seems like many investors build investment thesis on the premise that something unusual needs to happen for an investment to work out.  A company with an entrenched management team needs a change of heart.  A previously unsalable asset suddenly becomes liquid, an underperforming division suddenly wildly profitable.  Something unusual is different than a reversion to the mean.  A company can't underperform, or outperform forever, eventually competitive dynamics will either hurt or help the company and push them towards the middle (the mean).  The something unusual thesis is expecting that something external to the company, which is unpredictable, and unknowable will unlock value for investors.

Unusual things to happen to companies, they are nice surprises that everyone can celebrate.  Maybe the real estate company owns a property in a depressed area that suddenly experiences revitalization.  While it's nice to experience an external event that unlocks value, it is speculative to base an investment thesis on something unknown and unknowable.

What's the practical application of the terminal value concept?  I don't expect any investor to build a giant model of the highest and best use for each property a company owns.  I think terminal value is a great framework that provides a double check on investment assumptions.  If a thesis assumes Warren Buffett's expertise, but instead has Barney Fife as management it's time to scale back expectations of intrinsic value.  This framework can also help clarify where we think ultimate value will be derived from.  Will it be better utilization of current assets, or something external to the company?

Sunday, November 24, 2013

West View Savings..a sleepy bank ripe for an activist

I have a confession to make, when I see a cheap bank I have a hard time not purchasing shares, when the bank is local the shares become irresistible, which is how I ended up owning a position in WVS Financial (WVFC), the holding company of West View Savings Bank.

There's something to be said about investing in local companies.  It's easier to conduct research beyond filings.  I used to live behind West View Bank's headquarters, my evening run used to take me past their building and parking lot.  One might argue this is meaningless to an investment, but I'd argue otherwise.  After running past their branch daily I had a sense for how busy the bank became on certain days, and could see how well the company maintained their facilities.  The biggest advantage though is that their annual meetings are local, in West View's case they hold them at a church about 15m away from where I live.

The annual meeting was a great opportunity to meet other like minded investors in Pittsburgh, it also gave me a chance to talk to senior management at WVS Financial and question the board.  Unlike my experience at Solitron, the WVS Financial team was open to questions and glad to have shareholders interested in the company.

West View Savings Bank was a Pennsylvania chartered mutual savings bank up until the early 1990s.  A mutual savings bank is owned by their depositors.  When a mutual bank IPO's the depositors are given the option of subscribing to the IPO, in effect they're doubling down on their stake in the company.  The bank raises capital in the IPO and shareholders receive the cash they put in, along with the existing equity they had previously owned.  It became apparent to me at the meeting that many of the shareholders in attendance were original participants in the IPO.  One even going as far as asking the CEO if it was even possible to dispose of shares, to which the CEO told him that he could go down the street to the local Fidelity office and open an account to sell them for $8.

The bank is listed on the NASDAQ, but their listing hasn't attracted much investor attention, shares trade infrequently and were selling at 50% of BV in the past year and a half.

The investment case for WVS Financial is fairly simple and can be summarized in a few bullet points:

  • The bank is selling for 72% of tangible common equity.
  • They are profitable, and remained so during the financial crisis.
  • The CEO is fanatical about managing risk, NPA's are almost nonexistent, charge-offs are low, lending is extremely conservative.
  • The bank's balance sheet is conservative, most of their assets are in cash and securities, lending is very low.
  • Due to the balance sheet mix if the bank were to grow their lending, or rates were to rise earnings would rise significantly.
Here is a snapshot of the holding company's statistics from CompleteBankData.com :


Two numbers from the above stats are probably sticking out to anyone who invests in banks, the 5.87% ROE, and the 1.63% NIM.  You're inclined to stop reading, please bear with me, those figures are low, but there is hope.

The reason for the bank's below average net interest margin can be easily spotted by looking at their balance sheet:



The bank's loan book has been in decline over the past decade from $61m down to $33m.  Couple the lending decline with a decline in interest rates over the same period and it's not a surprise that their NIM has been trending downward.  The bank has never been a strong earner due to their conservatism, but even if lending had stayed flat at 2011 levels earnings would be much higher than now.

At the annual meeting the company was questioned regarding their lending and their conservatism.  Management says they're waiting until rates jump 100bps before they increase lending.  Unfortunately there's no telling when this might be, in the next year, or in five years or more.  The conclusion I took away from the meeting is that the company has a lackluster lending operation.  In a low rate environment they should have been originating loans and earning the servicing revenue where possible.

Compared to the lackluster lending operations the company's deposit base is strong:

Most of their deposits are interest bearing, but from what management explained at the annual meeting the majority of the interest bearing deposits are in 1-year or shorter CD's paying a nominal amount of interest.

If I could summarize my post to this point it would be: West View Savings is a very conservative bank with a poor lending program, solid deposits, and a great branch network selling at a cheap price.

The issue all investors ask is whether the price is justified, and what might happen to unlock value.  If West View were to never change, then it's possible that 72% of book value is a reasonable valuation.  I don't believe it's reasonable because I believe cheap sleepy banks eventually catch the eye of an activist or acquirer.  One bank activist who has a small toehold position in the stock is Joseph Stilwell, he owns about 1.5% of the common, not much more than a book mark position.

While a stock activist might not be waiting in the wings I think West View is extremely attractive to a potential acquirer.  I've spoken to some knowledgable individuals in the bank industry and there are rumors floating that a few regional banks are looking to buy into Pittsburgh.  Wesbanco did this recently with Fidelity Bancorp.  Fidelity had a similar profile as West View, a great deposit network, but poor lending.  Wesbanco purchased their deposits and placed their own lending program in the branches, the formerly poorly producing branches should be churning out profits for Wesbanco soon. It's possible Wesbanco would be interested in acquiring West View to further expand their presence, or another bank looking to enter the market.

An acquiring bank would see a valuable branch network, valuable deposits, a clean loan book, and inefficient assets.  Turning West View's mortgage backed securities portfolio into a valuable loan portfolio is a much easier task than turning around failed assets, or trying to build a brand in a new market.

I'm hoping that either West View's current management will be prompted to develop their lending, an activist will get involved, or an acquirer will see value in the bank.  I believe in the maxim, but something cheap and maybe something good will happen.  I'm also not opposed to working to unlock value myself through discussions with other investors/funds/potential banks/management.

Disclosure: Long WVS Financial, open to acquiring more.

All screenshots are from CompleteBankData.com, stop hunting down call reports, FFEIC reports and building massive spreadsheets, let us do the work for you.


Tuesday, November 19, 2013

Costar, a missed opportunity in review

Back in January I wrote a small post about a company named Costar (CSTI), the post was fairly concise and to the point.  I researched the company and found some things that made me uneasy, the sum of the uneasy items led me to pass on investing.  That was when the stock was at $2.02 a share, it trades today at $8.25, and hit $10 two days ago.

I wanted to review the investment with the benefit of hindsight, the most cruel type of review possible.  Decisions that look sound at the time appear foolish in hindsight, and decisions that were foolish and reckless can appear to be genius in hindsight.  The purpose of looking at Costar again is a examine my initial reasoning.  If my initial conclusions were made on a sound basis, and because I can't know the future I will be satisfied that even with a missed investment gain that I made the right decision.

The reasons I passed on the company were fairly simple, I was worried their profits weren't sustainable, I didn't like that it took them five years to turn the business around, and I didn't like their debt and cash situation.  All of those items combined led me to pass on investing in the company at 46% of NCAV.

When I wrote Costar up they had a book value of $8m, $203k in cash and $1.4m on their credit line, trailing earnings (9mo) were $.45 p/s.  Fast forward to today, they have $2.5m in cash, $10m in equity, no debt, and trailing 9mo earnings are $1.43 p/s.

I made a bold claim at the end of my previous post on Costar, I believed they were fairly valued at $2, because I felt their inventory might be overstated, and I was concerned their profitability was a mirage.  I had good reason to believe that as well, the company had earned $.45 in the first three quarters of 2012, but in Q3 they were essentially break-even earning $2,000.

With the benefit of hindsight I look like a moron, I was worried about earnings disappearing, and instead they more than tripled.  There was no way to know earnings would suddenly explode, when I looked at the company they had their first reported profit in years, and then suddenly a quarter later they were operating at break-even again.  It appeared at the time that their earnings were temporary, and were back onto a normal declining trajectory.  On the earnings front I feel like my decision at the time was the right one.

When reviewing my decisions regarding the balance sheet I'm much more mixed on whether I made the right decision.  The company reported in 2012 that they had trouble securing a credit line, they were able to secure one from a lender with a high rate, and low underwriting standards.  This was a concern, I felt that going to a lender like this was an indicator of the quality of the company.

I've had a number of conversations with bankers and small business owners recently that casts doubt on my conclusion over Costar's debt.  I've come to find that financing for a small company with the income history of Costar is almost nonexistent at a traditional bank right now.  Banks are only interested in loaning a million dollars to a guy with two million in his account.  Large banks are lending to large companies, and large companies have no problems issuing debt, but the financing market is still difficult for small companies, especially ones that aren't pristine.

My myopia on their lender prevented me from seeing that the company had aggressively paid down debt.  Management was serious about eliminating debt and finally did so in the past few months.  The cash the company was using to pay off their debt has now started to pile up on the balance sheet.

Overall I'm mixed on Costar, if I were to look at them again today as they were in January it's possible I'd make the same decision.  If I had known more about the small business financing market I might have cut them more slack.  With a net-net the balance sheet is the starting point for an investment, if confidence in the balance sheet is lost the investment is lost.  I didn't have confidence in Costar's balance sheet, and while earnings recovered nicely there was simply no way of knowing it would happen.

What does the future hold for Costar?  I don't know, they earned $.72 p/s this past quarter, annualized that's $2.80 in earnings for the year, for a whopping 40% ROE.  Unfortunately one of my key questions remain, are these earnings sustainable?  If so then Costar is probably a bargain at these prices, if not then look out below.

Disclosure: None


Saturday, November 16, 2013

Why go Buffett?

There seems to be an unspoken (but often implied) mantra in value investing that beginner investors start with asset investments and then once they learn the ropes and grow they graduate to real investment, buying great companies based on earnings or free cash flow.  A special few graduate to the highest honors of value investing, special situations, catalysts and bankruptcies.

I was attracted to the idea of value investing because it appeared so simple, purchase something for less than it's worth.  When I first encountered this it was so obvious, I couldn't believe that everyone in the market wasn't investing like this.  Purchasing something tangible for less than it's appraised value is something most of the population can grasp.  People will brag about the great deal they got on a pair of pants, or how they purchased a house out of foreclosure and saved a lot of money.  Buying an item at a discount to salable value is not a foreign concept to anyone, except participants in the public markets.  Market participants will bend over backwards to explain all the reasons a company should sell for less than book, or NCAV.  

Fortunes are made and lost in the market on a whim.  To make a fortune outside of the market you need to either marry the right person, be born in the right family, or most often work hard for sweat equity.  I've never heard of a young intelligent person starting a business, and within months turning the little local Carpet Barn into a billion dollar fortune through their raw intelligence, yet these sorts of stories percolate around Wall Street often.  A young fund manager can become famous from a single year of outperformance, or a single great trade.

For many it appears easy to make money in the market, do some reading, invest and profit.  The market's greatest spokesman, and one of the world's richest men doesn't help, Warren Buffett's folksy explanations of value investing are simple, but I feel miss the point.  I don't talk much about Buffett on this blog because I'm not sure if there's much to learn from him.  This might sound strange to say, but I put Buffett in a class of his own.  Buffett is a superstar investor, he is the Ussain Bolt, or Michael Jordan of investing.  Are Ussain Bolt's tips on running going to help me run any faster for my Thanksgiving race?  Probably not, no matter how simple they are, Ussain Bolt is naturally more gifted than I am.  I enjoyed reading The Snowball and Buffett's annual letters, but I don't believe he can be replicated, he's naturally a great investor, I don't have that same gift.

Given Buffett's success it's no surprise that there are legions of investors attempting to follow in his footsteps.  The problem is his footsteps are unclear, is it cheap stocks like he did in the 1950s, is it his concentration, is it his ability to discern great management teams, or his ability to take advantage of opportunity?  Everyone seems to have a slightly different take on what made him successful, and there is no consistent pattern to follow.

Buffett most recently has been preaching that investors should be buying great companies at good prices and let them compound.  Math is in his favor with a statement like this, it's impossible to argue against buying a company that continually compounds at 15-20% forever at a good or cheap price.  The issue is these companies don't sell at low prices often, and when they're priced low it's usually due to an issue or problem they're facing.  In my view claiming that the company will come out unscathed and continue on their unrelenting compounding journey is hubris that's often reinforced with hindsight bias.  No one knows the future, at best one is making an educated gamble that the future will resemble the past, with the twist that an investor is hoping any issue is resolved without incident.  We've lived in an unprecedented age of prosperity in America since the 1940s which has provided a nice tailwind for this style of investing, momentum is hard to change.

The mere fact that the world's most successful investor preaches a particular philosophy is reason enough for most investors follow after him prowling around for great businesses at good prices.  My view is that just because Buffett does something doesn't mean that everyone else can do the same as him no matter how easy he makes it seem.

What I don't understand is the general disdain for asset investing compared to Buffett's growth value investing.  The research bears out that simple value strategies like net-nets, or low P/B stocks outperform the market significantly.  In the book Quantitative Value the authors make note of a study that showed that if one were to take all stocks at less than 1x book value, short the ones with a low F_Score and purchase the ones with a high F_Score they would outperform the market by a whopping 20% a year.  The problem is doing something like this is too simple for most investors.  They want a challenge and buying and churning through cheap stocks isn't enough for them.

I like to think of value investors who follow in the footsteps of Graham are the antique collectors of the market.  We are digging through flea markets looking at old baseball cards hoping to luck on a mint condition Mickey Mantle rookie card.  We never quite find that Mickey Mantle card, but we do find a lot of Wade Boggs and Jose Canseco cards which if purchased cheap enough can be flipped for a nice profit.  The Buffett school of investing continually visits flea markets until the Mickey Mantle is found.  The problem is if one might not know exactly what mint condition constitutes, or how to tell the difference between an authentic and fraud card, and eventually overpay for their Mickey Mantle rookie card.

For me investing is a means to an end, it's a way to prudently manage extra savings and grow it at a rate above inflation.  When I need the money at some future date I hope to have more, I don't think I'll care much about how I got there, either by net-nets, low P/B stocks, or growing a business.

I'm not sure if this post has much of a point, maybe it's really a rant against an attitude I see a lot.  My question to you is: "Why so much disdain against a proven investment methodology, that while simple has historically consistently high results?"


Monday, November 11, 2013

Who are you talking to?

There is this stereotype image of a value investor being a lone wolf figure, holed up in some library poring over annual reports feverishly looking for investments.  Said investor simply reads and generates profits for themselves or their fund.  If all it took was a quiet location and lots of reading to be a successful investor the world would be overrun by rich librarians.  Fortunately, or unfortunately if you're a librarian, that's not the case.

I went to a local company's annual meeting recently, and the number of connections I made coming out of that meeting have had me thinking about the role networking plays in investing.

There's an interesting evolution in life, the young think they have everything figured out and have no need to listen to experience of the older generation.  They then repeat the same mistakes, learn the same lessons and then try to pass them down to the next generation with the same results.  It seems futile, but it's the course of life.  I remember being in college and receiving advice from mentors and bosses saying that networking and building connections is what mattered, not necessarily book knowledge.  I of course ignored the advice until I learned it on my own.  Now I'm sharing the same advice with younger people who ask, and I would imagine they're ignoring it much like I did.

Think about any given topic in investing, there are probably thousands of investors with experience investing in that space, maybe a few dozen will write blog posts about it, and maybe one will write a book.  Of the thousands of varied experiences the only remembered in a decade will be the ones in the book, or potentially a few blog posts.  Yet the experiences not recorded didn't vanish, and in many cases they might be better examples, and better explain the pitfalls and potential than what is recorded.  The verbal history isn't visible while the literary history is, what is visible is what's remembered.

I feel like there are certain foundational books to creating an investment style, the books explain important foundational concepts, but beyond that for an investor to grow they need to start talking to other investors.  It isn't enough to just read a few books, sit in a room reading 10-Ks and invest.  The investor who does this repeats the mistakes of earlier generations.

When an author writes a book they write it for a wide audience, they write generically.  When I talk to someone on the phone (or email) and ask for advice I can share my situation and the person giving advice can give specific advice tailored to my exact situation.  Additionally a conversation takes much less time than reading a book or a blog post, and can yield much more information.

So how does networking with other investors help?  First and foremost you get to meet interesting people.  If you put yourself out there as someone who wants to learn and meet new people you will start to make a number of connections quickly.  Secondly you might learn a lot about something that you can't learn anywhere else, especially online.  There is so much history that's stored up within people and will never be published to the world.  If you can make the connections with these people these stories can be unlocked.  Don't discount verbal history simply because it's unseen.

Another value investor stereotype that needs to be shattered is that all management is promotional and slimy.  If you're investing in junior miners in Canada, or Nevada development stage companies this might be true, but I've found otherwise.  Of course management is going to talk their book, I'm sure you'd talk your book about your portfolio if given the chance as well.  But most likely you're not an expert in the field that the CEO works in.  I've had short conversations with executives where I've quickly learned the important drivers and a number of considerations from a management perspective that I'd never seen anywhere else.

In the more than three years I've been writing this blog I've probably made about $150 in consideration directly from the blog.  What I have made is a great network of friends and investors I can talk to about potential investments, business opportunities, and general career and life advice.  If it weren't for reaching out and being willing to talk I would never have the network I have today.

The bottom line is that to grow as an investor you need to be talking to other investors, other business people, and people who work at companies you research and invest in.  These people will teach you, encourage you, and challenge you in a way that you can't get yourself.  In turn you might teach them, challenge them, and encourage them.  In the spirit of this post I leave you with a small excerpt of prose:

"No man is an island,
Entire of itself,
Every man is a piece of the continent,
A part of the main."

-John Donne

Thursday, November 7, 2013

Announcing CompleteBankData.com



After months of hard work, I'm excited to announce the launch of CompleteBankData.com!

As many readers know, I'm an avid bank investor, the number of banks I own rivals the number of net-nets I own.  The problem with banks is it can be hard to find comprehensive information quickly.  There are SEC filings, FDIC call reports, and FFEIC filings, each needed to be examined separately and manually put into a spreadsheet.  There was nothing that brought all these sources together in a simple, powerful, yet easy to use tool.  We set out to change that.

We designed CompleteBankData.com differently from the start, instead of building a platform for regulators we took regulatory information and put it at the finger tips of investors and bankers in a familiar format.  The site allows users to quickly sift through all US banks, both public and private, compare banks against each other on over 1,000 different industry specific metrics, and view a bank from the highest level, to the lowest granular view possible.

I believe we have created the best platform for both bankers and bank investors.  An investor can screen for new ideas, research regulatory and holding company financials, compare potential investments, and review SEC filings all without leaving the site.  Our goal is to be your complete banking research solution.

If you're interested in a free trial, I'd encourage you to register here.

I want to walk through a few features that I feel set the site apart from any tool currently available.

Incredibly powerful search

Screen using relative metrics and market data, find holding companies and banks below or above specific thresholds easily.


Customize bank searches on over 1,000+ industry specific criteria.  Are you looking for banks in Illinois that do $320-875k in auto lending, have less than $1m in commercial lending and more than 29 employees?  We can do that, eight banks match..



Details: Big Picture to Granular

Find everything from summary financials to the number of deposit accounts with a balance less than $100k.  Detailed performance ratios and statistics for both banks and holding companies.  We have all the data to help you make better decisions.


Extensive

View up to ten years of annual data:



Compare

Quickly compare an unlimited number of banks on more than 1,000 industry specific criteria.  Save off interesting banks to the My Banks page for further research later.



Monitor

Keep track of the latest SEC filings for ALL banks in the US


Save banks to the My Banks page for later viewing.  Organize and categorize banks simplifying your workflow.


Flexible

We didn't just build a website, we built a platform for bank investing.  By focusing on building an extensible and re-usable platform we have built flexibility in from the start.  From data feeds via an API, to completely customized screens the sky is the limit.

I believe we've built a tool that will change how investors research banks.  Powerful, detailed, yet accessible.

If you're interested and would like more information register for a free trial, or contact me here (info @ completebankdata.com).

Monday, November 4, 2013

Sunlink: liquidating their way to profits

A common term associated with net-net investing is liquidation value.  In theory a company's current assets minus their liabilities approximates liquidation value, what the company might receive if it were to decide to close down and distribute the proceeds to shareholders.  Often a company's accounting liquidation value is not accurate except in cases where a company's assets are mostly cash, they have no liabilities, and management is determined to return the proceeds with as little friction as possible (read: lawyer/advisor fees).  A liquidation is where accounting value meets real world value, and a company's balance sheet gets a gut check.  Are the values on the balance sheet accurate?

In the public markets companies don't liquidate often, principally due to an incentive mis-alignment.  In many public companies management does not own a majority stake, and the company's ownership interest is divided among many diverse parties, that have never had, or will ever have contact.  A company's management is incented to keep their job, after all that's usually their only source of income. The company's owners usually don't have enough power individually to force a liquidation, and when they do have enough power management can often work against them eroding value.

Sunlink Health Systems (SSY) is in a unique position not unlike many companies on the brink of failure.  The company's management needs to work hard to liquidate balance sheet assets to stave off potential failure.  As management fights to keep their jobs shareholders are rewarded as potentially undervalued assets are sold for market value.

I was first introduced to Sunklink Health Systems through Whopper Investments, he wrote them up as a potential odd-lot tender opportunity.  I received their annual report in the mail, and even though I only own a tiny position for a tender I was compelled to browse their financials.  Browsing their financials led me to read most of the report as I became hooked on their story.

Sunlink Health Systems purchased five hospitals in 2001 with leasehold rights to a sixth hospital.  The company subsequently purchased another two hospitals and three home health businesses.  The company also operates nursing homes and a pharmacy business.  The company currently operates 232 hospital beds and 166 nursing home beds throughout their facilities.  The company's hospitals are primarily in rural locations.

The health care industry landscape has changed dramatically since the company acquired their facilities in 2001.  They went from earning operating profits from their hospitals to sustained losses most recently.  Compounding their losses is the fact that the company took on debt to finance their acquisitions, and it's coming due quickly.  The company doesn't have the means to raise capital, and with their operating subsidiaries generating losses management has been placed in a tough spot.  As a result the company has started to sell off hospitals.

Most recently the company sold two hospitals.  The first was a 50 bed facility in Southeast Missouri for net proceeds of $7.4m.  The company used $5.2m of the sale proceeds to pay down their debt.  The company also sold the Memorial Hospital of Adel, located in Georgia for $8.35m last year.  They used the net proceeds of $7.5m to pay down debt further.

In 2011 the company sold the lease to the Chilton Medical Center to Carraway Medical Systems for a monthly rent of $37,000, and the option to purchase the facility for $3.7m.  Carraway Medical Systems operating license for the hospital was revoked by the Alabama Department of Public Health due to their inability to meet financial obligations.  Carraway defaulted on their lease to Sunlink.  Sunlink tried to re-lease the facility but failed, their lease reverted to the original owner.  This property will be a total loss for Sunlink.

In 2004 the company sold a medical center in Georgia for $40m in consideration.

As of the most recent annual report, the company owned and operated three hospitals, one nursing home, and one joint hospital/nursing home, as well as their pharmacy business.

As mentioned above the company is facing two issues forcing them to monetize their assets, they are losing incentive payments for electronic health record conversion, and they are facing a debt maturity date in the next year.  As such the company expects to sell three of their hospitals within the next year if possible, and apply those funds to their debt, and use the remainder as working capital.  In theory the facilities they are keeping are expected to be profitable in the near future.

It's significant that I haven't mentioned anything related to the company's valuation yet, understanding the background is important to Sunlink.  The company trades with a market cap of $7.5m, but a better measure of value would be enterprise value, which is $23.3m.  The company's book value is $33m, of which $30m is their physical plant, which has an original cost of $64m.  The company has $9.5m of debt due in the next year, with $8.7m due shortly thereafter.

An investment thesis for Sunlink is fairly simple to construct after building out this story.  Are the three hospitals the company plans on selling worth more than $18m?  The two hospitals sold in the past few years sold for about $7.5m apiece (net).  If that figure holds true for the three latest hospitals the company would be able to pay back their debt and have cash left over to finance working capital.  The company is attempting to hold onto their best assets, the profitable pharmacy operations, nursing homes with profit potential, and land that is being redeveloped into a multi-use office park.

A simple scenario for what might happen is as follows: the company sells the three hospitals for $7.5m each net of taxes and fees for a total of $22.5m.  They pay back $18m in debt and then have $6m available as cash and a greatly reduced liability structure.  The company retains their pharmacy segment which is currently profitable, although barely, and the nursing home/hospital that they believe has the best profit potential.

An investment in Sunlink works out if the company is able to sell their hospitals for $7.5m or more each.  If they can do that then this is a much slimmer company, with no interest payments, and a remaining collection of assets that are profitable, or will be soon.  If the company can't sell their hospitals for $7.5m it's possible they will enter receivership.  A bankruptcy receiver might sell the company's hospitals, but it's likely shareholder recovery would be much smaller.

Investors seem to love lottery ticket investments, and Sunlink qualifies as such.  Investors have an additional factor on their side, the company's management is highly incentivized to sell the three hospitals, if they don't they will likely lose their jobs.  If they do they will keep their jobs, but also reap the benefits as the share price rises, and their stock options vest.

Disclosure: Long an odd-lot.