When is enough enough? Research and the curious case of Bozzutos

In many ways I'm both party to and perplexed by the desire to research to death consumer purchases. Looking for a new set of wrenches?  There is someone out there who's written an exhaustive online review of popular wrench sets.  The review might contain things like "the handle wasn't as solid as I would have liked." or "the jaws didn't slide as easily as xyz brand's did."  And it's at this point that suddenly as a consumer you have doubts about a product.  Did you know jaws on wrenches slide differently, or the metal forging process different between brands and that someday, somehow that might be important?  If you didn't you know now, and you're now paranoid you'll purchase a dud when you finally decide to "invest in a wrench", because everything you spend money on these days is an "investment."

I almost can't help myself from reading online reviews.  The detail and descriptions of everyday products by everyday people is fascinating.  Who knew a pair of jeans could change someone's life, or that someone searched for years for just the right backpack?  Prior to the Internet everyone went to a local store (or used a catalog) and purchased what was available.  If there were three wrenches they fell into a general pattern.  There would be a cheap one, a middle grade one and an expensive one.  My dad taught me that the middle quality level product was always the one to buy.  Why? I don't know, but I've heeded his advice since.

The review/research explosion was perfectly timed with the explosion of super computers in people's pockets, or shall we call them smartphones.  In the past if I wanted a rare craft beer I'd have to read about them, write down the names and then see if they were in stock at the local store.  Sometimes I'd drive to a number of stores, or make a series of phone calls and give up.  Now I can go without any prior knowledge of what I want and look up reviews on the spot determining the best of what's available.  This isn't just craft beer, it's vacuum cleaners, pots and pans, cars, anything and everything.  We've become a nation of critics on the finer points of meaninglessness.

This same phenomenon has carried through to stocks.  Investors have become so unsure of themselves that they now reference the 'reviewers.'  "Oh my stock has abc guru invested in it." or "I heard this was pitched at some conference." All of these are shortcuts are ways to reaffirm to ourselves that we've made a good pick.  Maybe some of this stems from the lack of defined processes for individuals, but I think a lot of it is due to the review culture.  If people are blogging about gold toe socks and reading sock reviews in a store it would only make sense that the'd hesitate before purchasing something bigger, such as shares in a company.

Information is just that, a set of numbers or facts or details that describe something.  Information by itself is mostly meaningless.  I can tell you the dimensions of the shed in my backyard, the material it was made out of and variety of precise details.  But it doesn't matter.  You don't care about my shed, I don't really even care about my shed.  It serves a purpose, to hold kid toys, a lawnmower and garden equipment.  The shed's purpose gives meaning to the information about it.  If the purpose is to hold a lawnmower and the shed is too small it won't be able to fulfill it's purpose.

More information about something isn't always better, sometimes it's worse.  Sometimes the minutia of information blinds us from seeing what's really important.  A key skill for an investor is to research a company up to the point of diminishing returns, but not any further.  Anything past the point of diminishing returns is wasted time.  Although I should point out, investors do seem to like wasting time, because there is a feeling of doing something.

I love to invest in stocks that report financials once a year, or maybe twice a year.  For someone who's addicted to the minute by minute ticks of the market this must seem like insanity.  But I don't care about daily ticks, or weekly ticks, or even monthly ticks.  My first rule of investing is to look for a margin of safety, downside protection and the confidence that a company I own isn't going to disappear between my yearly statements.  If I'm comfortable that the business will continue as usual why do I need to check in hourly/daily/monthly how things are going?  Imagine being the part owner of an burger joint and hiring someone to run the place.  Then calling up your partner hourly and asking "how's business right now?"  "Is it slow, is it fast?"  You'd go insane.  In the morning you'd be worried about how slow it is, and at lunch and dinner you'd be patting yourself on the back for how successful your restaurant is.  This seems like a silly analogy, but if you look online people are starved for information, even a steady drip of meaningless information is like water to a thirsty soul.

The successful investor is one who can identify the steady drip of information as meaningless and focus on what's truly important.

When a company doesn't report financials often it's easy to keep the forest in mind rather than focusing on the trees.  Even focusing on the trees would be progress for some investors. There are investors who are looking at branches and tiny pieces of bark wondering what their greater meaning is, but I digress.

That brings us to Buzzutos, a grocery store distributor and grocery store operator in New England.  The company has the potential to trade, and I say that loosely.  Shares are by appointment, although I was able to snag a few when there was a seller a few years ago.  I purchased the shares based on a tip, and by tip I mean someone sent me their annual report.  I realized that the gap between the market value and what they were worth was fairly sizable.  I also like to lock my money up for years with no return and this seemed opportune, of course on that point I kid, but only slightly.

The company is mainly a distributor, and distributors make the smallest margin in the world.  In 2013 the company reported $1.8b in revenue and $420k in net income.  This is down dramatically from the $5.8m they earned on $1.7b in revenue in 2012.  It's worth noting that if the CEO didn't pay himself $5m that shareholders would be looking at a lot more net income.  This is nothing more than a private company disguised as something public with a tiny float.

The CEO and a relative own 70% of the stock.  There is a company ESOP that controls another 16% of the company's stock.  The company has a 14% free float, not much at all.  This is also why shares never trade.

The attraction for the company is they have a $20m market cap with a book value of $37m or so (as of 2013).  They trade for a significant discount to book, and when they were earning $5m a year they were trading for 4x earnings.  A company at 4x earnings and 54% of book value is my type of investment, even if I have to sit and wait for years for something to happen.  It's also worth pointing out that in 2012 the company generated $15m in operating cash flow, that's almost their market cap thrown off in cash in a single year.  There are a few other items that combined made this potentially attractive.  The company uses LIFO accounting and if they used FIFO like the rest of the world their assets and corresponding book value would be $28m higher.  Suddenly this is a $65m stock trading for $20m, or 30% of book value. The last item of note is that the company owns 50% of the Better Val-U grocery store chain that's held on the books at $900k, it's original cost.  Better Val-U earned $15m in revenue in 2013, if there was profit it was probably washed away into management's coffers.

I'm a sucker for these dead end stocks.  I picked up a few shares and had forgotten about them in the corner of my portfolio.  There is a lot of hair on this stock, and I mean a lot, we're talking Chewbacca levels of hair.  The CEO is basically picking shareholder pockets with a ton of related party transactions, and one-sided agreements to enrich management.  If there's something egregious that management can do to take advantage of shareholders it's probably in their annual report.  I'm not going to even add up all of the related party stuff, it's sickening.  From a quick glance management is pulling $20-30m out of the company a year.  This could be a profitable company, but management has decided against it, it is personally profitable for themselves.

At this point in this post you're probably confused.  How did I start talking about research and end up talking about management's highway robbery of Bozzutos?  The missing link is a piece of mail I received yesterday.  A fund sent a tender offer circular  to me via my broker to buy my shares in an offer for 40,000 total shares.  The offer is at a very slight premium, but not worth trying to take advantage of.

This is where my research antenna went up.  Why is a fund trying to buy almost all of the available float of a tightly held company?  What's the motive here?  Activism is most successful when management owns a minority of a company's shares, not almost every last one.

The first instinct of most shareholders who receive the circular will be to sell their shares to the fund, and I think that's probably a good idea.  The activist fund is providing liquidity, they're offering a fair price, and they can afford to buy out almost everyone.  But I'm not everyone, I'm thinking about this differently.  Once the shareholder base is management, a hedge fund and a few stubborn souls like myself what will happen?  Will this fund petition the company to buy out everyone else?  Will they sue management and arrange a settlement?  Whatever it is it would have to be at a premium to the offer price.  And my cost basis is right around there.  So in a sense I have almost nothing to lose by holding.

This is also where my points about the minimum threshold of research apply as well.  One doesn't need to drive around New England checking out grocery stores and distribution centers.  One also doesn't need to spend much time looking at the annual report.  This is a company with a lot of revenue where much of the revenue is siphoned off to management.  But if management were forced to cut their pay 10% that would be an enormous payout for shareholders in the form of increased net income.

At current prices (if you can get shares, and it's doubtful you can) Bozzutos offers investors a lot of optionality.  At worst shares continue to do what they've done for years, absolutely nothing.  But with someone stirring the pot there's no hope that maybe something else might happen.  Maybe we'll be bought out at book value.  I wouldn't mind a 2.5-3x return on this.  And a return like that annualized even over a long time is still attractive.  That's one of the reasons I get into stocks like this.  Flat for years then a 3x return is significant.

So what now?  Nothing really.  I'm not doing anything, I'm just going to continue to wait and see what happens.  I think shareholders who want liquidity should get out, and everyone else should sit around and see what happens.