The SFB Bancorp activist battle

I could write a novel about SFB Bancorp.  It would include all the usual characters, the entrenched bank management that's missing in action, the activist shareholder, and the legions of silent shareholders hoping for a satisfactory return.  The story has become VERY interesting, mostly because a group of value investors have taken it upon themselves to unlock value at a cheap company.

I wrote about the company in December and linked to my initial Oddball Stocks Newsletter writeup and also included an interview with the managing director at Trondheim Capital.  You can read that here.

For those of you with a tight time budget let me summarize.  This could be the story of most small community banks.

A long time ago in a rural area no one has heard of a group of people started a bank.  The bank operated mostly untouched for decades.  At some point shares began to trade, either from an IPO or a mutual conversion.  The bank likes to proclaim their record of profitability, although it's worth noting they don't differentiate between merely profitable and earning a satisfactory return.  That's probably because management has no idea what "satisfactory return" or "cost of capital" means, to them earning $1 more than $0 is considered success.

SFB Bancorp IPO'ed in the late 1990s and shares traded at almost the exact same price for the next 13 years.  The only return anyone earned besides interest was the free toasters (I'm presuming, it's that caliber of bank) given away to depositors for opening accounts.  Shares traded for ~30% of book value in 2013.  This was when Trondheim Capital discovered the bank and began the process of unlocking shareholder value.

There is a paradox at this bank, management repurchased 40% of their outstanding shares, yet they claim they don't understand how to correctly compute book value.  The company would deliberately compute book value per share based on the number of issued shares, not their outstanding shares.  And when a company re-purchases as much stock as they did a significant difference in the value is created.  The company was re-purchasing shares from shareholders and claiming shareholders got a good deal compared to "book value", the erroneously calculated value.  Does that sound like a bait and switch? It was.  And it speaks volumes to the quality of the people running the bank.

I spoke with a banker recently who made the comment that "most bankers are playing bank." Management at SFB Bancorp is clearly "playing bank."

Many community bankers like the idea of being a stalwart in the community, belonging to a country club, knowing business leaders by name and having status in a small town.  This is desirable, and it's understandable, and perfectly acceptable if the bank is private.  The CEO of SFB Bancorp is also an attorney and for all intensive purposes is 100% focused on his law practice verses the day to day operations of the bank, or even the long term bank strategy.  I tried to call him twice a little over a year ago, the first time he was unavailable due to his attorney obligations, and the second time he said he didn't have time to chat because he had a case he was preparing for.  Is this the type of person who should be running a public bank?  It's like he's moonlighting as a bank CEO.  If it's a slow week at the law practice maybe he'll think about banking a little bit.

I don't want to get into character details too much because anyone can sling mud.  And what I might find disagreeable might be acceptable to others.  But I think any and all shareholders can agree that management who cares more about their law practice rather than the bank shouldn't be employed by the bank any longer.  And management that doesn't care about shareholders earning a satisfactory return need to be replaced.  I don't know of any investment strategy where earning 0% over 13 years is considered successful.

The question you're probably wondering is "where do things stand right now?"  This is where the story gets interesting.  Trondheim Capital, Meixler Investment Management, and outside investors have amassed a position that is equal to or greater than management's own stake.  And Trondheim is pushing for two Board seats, a request that isn't unusual given their ownership position.  Suddenly bank management has been woken up from their very deep slumber, they hired an expensive DC law firm and have been stone-walling shareholders.  No one knows when the annual meeting is, what the record date for voting, and any further questions are met with sham responses.  I submitted my own proposal that the bank convert to an S-Corp, buy shareholders out at book ($40 per share) and pay out 90% of net income as dividends post conversion.  The company could do a conversion like this with cash on hand.  Their response to me was a copy and paste letter stating that I failed to meet certain bylaw requirements in how I worded my request.  This is the same transaction that North State Bank undertook last year.  I wrote about it for Seeking Alpha.

A friend of mine decided to pursue his shareholder proposal further than I did, I gave up after receiving my form letter.  My friend has found that each iteration has been met with more phony rules and requirements that are seemingly created on the fly.

Predictably the bank is sending letters to shareholders about the "out of town" activists and how they want to take over the bank.  The implication is these activists are from evil big city hedge funds looking to pillage this helpless bank.  There are two ironies with this branding.  The first is one of the funds, Meixler Investment Management, is located in rural Arizona and the fund principle is involved in an organic farm co-op project.  A rural investment fund that is working on a project to help farmers probably has more in common with SFB depositors than SFB management itself does.  The second irony is that management is willing to sell the bank and they don't need hedge funds to force a sale.  Rumors have floated around that SFB Bancorp shopped itself a few years back but the price they wanted was too high.  Management is willing to dump the bank, but only if they get to set the rules.

I've really only scratched the surface on SFB Bancorp, but if I've whetted your appetite there is a lot more reading available.  Trondheim in a very rare and unusual move has published ALL of their correspondence with the bank and bank management.  They've also provided a number of other resources on the website http://sfbkshareholders.com .  The website is a case study on small company activism.  If you've ever thought of attempting this yourself Trondheim has paved the way by making all of this information public and free.

If you are a shareholder I'd ask that you vote for Trondheim and Meixler Investment Management on your proxy.

Disclosure: Long SFBK

13 comments:

  1. This is an interesting situation. Is a share repurchase the best thing? It makes sense looking at the financial statements alone -- but it would allow management to gain a stronger hold on the company. Under that scenario, the company would be less valuable. So there is a duality there -- by buying executing a share buyback, the company making a good financial investment. But at the same time, it is investing in keeping the same poor management -- which makes it a bad investment.

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    1. Right, it would probably be better to pay a big dividend so that the ownership ratios don't change.

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  2. I love how the activist website is a blatant homage to Berkshire:

    http://berkshirehathaway.com/

    These must be our type of guys.

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  3. What's the potential upside from where the stock is trading today? Taking a quick glance at the financials on SNL, it looks like shares have traded recently at a little under 87% of TBV. The bank seems to be overcapitalized with a 23% TCE ratio so if you could generate enough liquidity you could feasibly pay out a little more than half the equity account as a dividend and still be well capitalized. However I'm not sure the remaining equity is worth much more than book value - they generate a 1.1% ROAA today which is not bad for a tiny sub-scale bank in the current environment so even with new management I think it's tough to bank on much improvement in profitability. Assuming a dividend takes you to a 10% TCE ratio, the ROE would be a little north of 10%. Given the size and liquidity of the stock I don't see how you get to much of a premium to book valuation unless you sell the bank.

    What am I missing?

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    1. Exactly. And, I do not know that a win by the dissidents is a forgone conclusion. What if they lose?

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    2. Based on some rough numbers I have I believe they will win. But the wildcard is whether management acknowledges their own loss. I don't think they will, and my guess is the end result is a court battle.

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    3. In terms of value you're correct, they could pay out a significant dividend and still be well-capitalized.

      The end-game for these guys is a sale, and this is something they themselves know. They shopped themselves a few years ago but wanted too much. A sale at book is reasonable, maybe a slight premium, although I don't think it's deserved. There are other banks in town that would happily purchase them, they've inquired in the past and were rebuffed by SFB.

      My guess is from current prices you have a 20% gain or so. I'm trying to eek that out myself, I purchased much lower, and while I'm happy with my gains it's become a matter of principle at this point.

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    4. I doubt management is going to have an epiphany regarding how they run the bank because they lose an election. Rather, they may just start putting up additional barriers. Unless Peterson and Meixler arrive on the scene with a plan of action, rather than just "now we are on the Board", then they will be ineffective.

      I have no position -- but I do find it interesting to follow. I am generally on the side of these guys, and I hope they do win. Just trying to be a realistic about what happens post-election. Planning wise -- Peterson and Meixler should not be thinking that winning the election is the plan, but rather thinking that winning the election is the first step in the plan. Hopefully Peterson and Meixler are thinking of it that way.

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    5. academy,

      They are, and if you're curious I'd recommend giving Colin a call. He's more than willing to share his thoughts on this via the phone. But yes, this isn't a get-on-the-board-and-now-what type of a thing.

      What I find interesting in this is how much state law plays into an investment thesis. There are a number of Tennessee law items that are strongly in favor of shareholders, or minority shareholders. But one needs to be willing to flight for them, which is something Peterson and Meixler are willing (and capitalized) to do.

      This is a great story, especially because it shows what anyone can do with perseverance. Although what we're really running into is the American small town mentality. I've tried to talk to the local newspaper a few times, they won't give me the time of day, I'm an "outsider." That's not the real issue, the real issue is someone at the paper is involved in land deals with Bill Hampton, SFB's chairman. A paper that is supposed to sell eyeballs and ads has taken sides.

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    6. If they have a plan, then that is great - they should tell investors about it. It seems as if not that long ago the plan was to sell stock back to the company; at least that is what management says in its proxy.

      But if they are going to be elected then they also need to be prepared for a counteraction by the current Board. As for the locals, that's par for the course. Buffett and Icahn both had similar experiences.

      I'm pulling for these guys -- I really am. But they need to be prepared.

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  4. Election results? I believe it was supposed have occurred by now.

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  5. Hi Nate,

    how was the meeting, exept for the police call (why?). Any new informations about the company or management?

    greetings
    valuetradeblog

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  6. I too am curious as to how the annual meeting went, especially in light of your tweet about the police being called. Though it sounds like no real changes occurred (as the proposed people didn't become board members) and there was a small ($.30/share) special dividend, though it wasn't noted if this was a response to the shareholders' requests.

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