Oddball Update: "Pardee Authorizes Share Repurchases"

Just announced by the company:
PHILADELPHIA, July 10, 2019
Pardee Resources Company (OTC: PDER) (the "Company") announced today that its Board of Directors has authorized the repurchase by the Company of up to $3.5 million of its outstanding common shares in 2019. This stock repurchase program may be carried out through up to $1.5 million in privately negotiated transactions and through up to $2 million in open market purchases. This program provides the Company with the flexibility to repurchase shares opportunistically from time to time based on market and business conditions, stock price and other factors. The Company is not obliged to repurchase any of its common shares and there can be no assurance as to when, or whether, any shares will be repurchased under this program.
Share repurchases were a big topic at the recent annual meeting in May. The most recent Issue (#25) of the Oddball Stocks Newsletter has a detailed account of that meeting as well as thoughts about the valuation and management's incentives to maintain the size of the company rather than sell assets at good prices and return capital.

The non-stop machine

I find failure utter fascinating.  Why did a particular thing fail? Why was it that thing and not something else?  Failure is especially important in investing, but also in other aspects of life.  While there are a ton of article (and a number on here) about failure in the personal or professional sense I want to talk about failure in the mechanical sense.

It's fun to think about really hard problems and try to back of the napkin a solution.  Things like "how would you stretch a single piece of string around the world?"  Or "could you design a machine that never fails?"

The second question is realistic, and one that I had a discussion about with a friend that spurred this post.  She helped invent the ATM system and was describing the challenge of building a robust system that never lost a transaction.  And that set me on a journey thinking about mechanical failure.

In a physical system failure can usually be reduced to the weakest link.  The weakest part will break down first.  But the ultimate failure might not be that part, in some systems it's possible for a weak part to fail and the machine to continue, but the failure increases stress on another part that ultimately fails.

Think of an engine, a simple $30 head gasket kit is the difference between a functioning engine, and sitting on the side of the road.  You rarely hear of a piston failing, it's a head gasket that cracks, a simple seal that goes bad.  But that failure creates a cascading effect.  A cracked gasket allows coolant into the oil, and a coolant oil mixture gunks up the pistons and ultimately the engine seizes.  That $30 part can create a multi-thousand dollar repair.

So what about critical systems?  This is where things get exciting.  If a non-critical system fails the system is down until a replacement part can be procured.  We see this all the time in life.  A gas pump will have an out of order sign, or we'll be told "that machine isn't working today."  But what happens when it's a ventilator that goes bad? Or a core banking system? Or the guidance system for aircraft?

The usual solution is to build in redundancy.  This is what Boeing is facing with their 737 MAX.  The aircraft had a critical sensor, a single critical sensor that if it had a bad reading could result in an error situation.  The obvious fix is to add a second or third sensor and correlate data between them to ensure no errors.  In aircraft redundancy is key.  Planes have multiple engines multiple pilots, multiple electrical systems etc.

In an aircraft you can make most things redundant because it is a completely isolated system.  An airplane has everything it needs itself when in the sky.

This redundancy concept is also used in computers.  Instead of a single hard drive put in multiple drives that mirror themselves.  Or put in multiple computers that mirror themselves.  All the way up to double everything, power, cooling, machines, everything into a massive distributed system.

The concept of massively distributed systems are what dominate our computing now.  The Google idea of having millions of generic computers that when they fail can be replaced without disruption is popular.

But this concept of massive distribution, or clustering hasn't always been the only way.  My friend who built the ATM network worked at a financial service provider along with some banks.  Their concept of "no failures" was quite different, and something I find utterly fascinating.

In the 1970s a company named Tandem was formed.  Tandem built computers that ran non-stop.  Once booted they never stopped.  In the late 90s Tandem was purchased by Compaq, which in turn was purchased by HP.  And like the computer systems this division has continued non-stop as well.  Now HP has non-stop computers.

The concept behind a non-stop computer is simple.  The entire system is designed for resiliency.  Everything is engineered to last as long as possible and built in a modular fashion.  This means when anything fails it can be removed and replaced without having to shut the machine off.  You can remove ram, or a processor all while the computer is running.  You can even swap out the motherboard of the machine while it's running all without losing a single transaction.

And just like anything can be swapped for failure it can be swapped for an upgrade too.  I was told it isn't uncommon for these machines to be in continuous operation for 35+ years.  To me that's astounding.  Someone turned on a machine 35 years ago and it hasn't turned off or had any downtime since.

The reason these machines work so well is because they share nothing.  Each component is like the airplane, completely self contained.  Components talk to each other, but if a single one fails it brings down nothing else.

What I've noticed is in a lot of newer clustered or fault resistant systems there are a lot of shared components.  And this shared-ness is usually the cause of a cascading failure.  Truly fault tolerant or resistant systems have hard barriers between all aspects and failure is isolated and don't cause issues anywhere else.

It's interesting to think about this at a higher level.  Obviously almost everything in life is interconnected.  And everything is going to fail as well.  But I wonder how often we consider both of those things together and make sure whatever systems (or processes are built) handle and isolate failure to the smallest and most replaceable component?

I think the reason we don't do this is because it's expensive.  It's expensive to design for failure in mind and expensive to build out redundancy.  But there is a cost to failure, and we are ignorant if we don't think things are going to fail.

The best systems are the ones where the designer sat down and said "how can this break?" before designing the final solution.

The same failure design thinking that goes into computers or machines can be extrapolated to systems, processes, businesses, or really anything.  You need to consider what can go wrong first, then build out redundancy and ways to isolate the failure before you can have a robust system.

There are too many things in life that work until they don't.  And the "they don't" is a result of short term thinking or expecting things to always just work.  If you can't envision failure it's impossible to ensure long term success.

Goodheart-Willcox Company ($GWOX) 2019 Annual Report

Earlier this month we published an update on the Goodheart-Willcox Company tender offer (also, previously). With 52k shares being taken off the market, the stock is even less liquid now, and is bid $120 and offered $199 (but the stock hasn't traded since April 30th).

The bad thing about the GWOX tender offers, from an outside shareholder perspective, is that they have been done by the ESOP and not by the company itself. Even worse, the company has loaned the ESOP money at low interest rates to do the buybacks.

These buybacks by the ESOP also make the outstanding share calculations a little wonky. The company had 446,542 shares outstanding as of April 30, 2019, but it likes to use a lower number (410,542) which excludes shares that are in the ESOP but unreleased and held in a suspense account. We think that it makes more economic sense to use the higher share number, especially since dividends on the unreleased ESOP shares go to paying back the loan from the ESOP to the company.

The result is that the market capitalization, based on 446,542 shares, is $53.6 million at the bid and $88.9 million at the offer. The company had $43.75 million of cash and securities at April 30, 2019 against $27.6 million of total liabilities. However, $23.3 million of the liabilities are deferred revenue.

At the recent tender offer price of $150, the market capitalization is $67 million. Using that figure, the enterprise value is therefore somewhere between $27.5 million and $50 million depending on how you treat the deferred revenue in the enterprise value calculation. According to Note C of the financials, the deferred revenue is coming (as you would expect) from the sale of digital online content, which revenue is then recognized over the subscription periods. Given that this revenue should have very high incremental profit margins it seems reasonable to haircut it substantially and derive an enterprise value figure at the low end of the range.

By the way, it is notable that so much of the balance sheet is funded by deferred revenue. This is a company that is actually very capital light and all of its $27.6 million of liabilities seem to be trade liabilities; i.e. non-interest-bearing.

So what do we get for a ballpark of $30 million enterprise value? Here is a snapshot of the relevant metrics:

Fiscal 2019 2018 2017 2016 2015
Total Average
Net Income 3,564 8,287 1,637 866 1,928
16,282 3,256
D&A 998 941 789 809 822
4,359 872
CapEx -506 -1,645 -1,035 -722 -557
-4,465 -893
FCF 4,056 7,583 1,391 953 2,193
16,176 3,235









Sales 29,257 41,162 24,151 20,684 22,032
137,286 27,457
NI % 12% 20% 7% 4% 9%
12%
FCF % 14% 18% 6% 5% 10%
12%









Book Equity 36,532 36,328 32,202 31,199 31,095

33,471
ROE 10% 23% 5% 3% 6%

10%

Some things to notice over the past five years: the net income reliably translates into cash flow at an earnings margin of about 12 percent on sales. If you figure that the business has $3 million of annual earnings power, then the stock is not exactly cheap or expensive either. (However: management's projections in the tender offer document have net income growing from $3.2 million in 2020 to $8.4 million in 2024, a total of $30 million over the five year period, which would earn back the entire estimated enterprise value.)

The return on book equity understates the quality of the business because there is so much excess cash on the balance sheet. It actually looks as though an owner could dividend out cash greater the book equity, which would mean the business could operate entirely with free external financing. (It would then have negative book value, and profitable companies with negative book value outperform.)

This is all somewhat academic because (a) the shares are so illiquid now and (b) management is allocating capital more to its benefit than to shareholders'; but it is also instructive. These return on capital and asset figures could hardly be more different than the other business we looked at this week - Scheid Vineyards. There are some quality businesses in the Oddball space; they just rarely come paired with quality managements and good prices.

We believe it is important to study and monitor Oddballs over the market cycle so that you are already familiar with them when big market dislocations happen.

We will have more about this (GWOX and educational publishing) in upcoming Issues of Oddball Stocks Newsletter. Our next Issue (#26) will be out in August. Until then, make sure you see Issue 25 of the Newsletter, and if you are missing any back Issues, you can get them here.

Do the Disappointing Scheid Vineyards Results Show a Bad Business in Decline?

Scheid Vineyards is an idea that was posted on the blog exactly six years ago (July 2013) when shares were trading for about $25. Here was the simple thesis at the time:
Earning $9.13 a share is significant given their most recent share price of $24.23.  Not all of the company's recent earnings can be attributed to continuing operations, the company reported a $5.7m gain on a $7.5m sale of a 238 acre vineyard. Backing out the one time gain lowers operating income to $4.5m or $5.17 per share.  The company's operating cash flow was $4.08m which tracks nicely with their adjusted income, meaning this company is trading with a P/E of 4.68.
The stock hovered around $30 a share for several years after that before exploding higher during the summer of 2017. So it has been a good investment when purchased at opportune times. David Tepper owned it in certificate form in the late 90s when he was posting on The Motley Fool.

Scheid stock reached a peak of $108 in March 2018, but has lately collapsed and after announcing results on June 26th it is down to the $60 range. (The summer of 2017 was when a fund called Maran Capital Management published a short write-up of the idea. In January 2018 they published a much longer and more detailed presentation.)

Opening the shareholder letter last week, our eyes jumped to the sentence, "it was not for the faint of heart to take this leap" which appeared in a section discussing Scheid's efforts to become "a fully vertically integrated company and [producing] our own estate branded wines for the national and international marketplace". Uh oh. Here was the upshot:
The wine grape harvest of 2018 was larger than average throughout the state of California. This contributed to depressed grape and bulk wine prices which represent about half of our sales. It also reduced the value of our unsold bulk wine inventories. We decided to write down of those inventories by $2 million in order to reflect more accurately its true market value. These events contributed to our loss for fiscal 2019.
Was it a warning sign that Pardee Resources, a hard commodity producer, had gotten into agricultural investments including grapes? We decided to do a reality check on the quality of the business, taking into account the past fifteen years from the end of 2003 until present.

The shareholders' equity was $38 million at the end of 2003 and it's $43 million now. They haven't paid any dividends. In 2003 they had 449,751 outstanding A shares and 645,223 outstanding B shares (reverse split-adjusted; a total of 1.09 million) and now they have 735,617 of the A and 147,469 of the B (total of 883k). So, no dividends but they have shrunk the float by 19% - about 1.27% per year. Certainly some capital has been returned.

But here is what seems crazy to us. In 2003, they had sales of $26 million, gross profit of $12 million, and pre-tax income of $5 million on an asset base of $68 million. Most recent fiscal year, they had sales of $58 million, gross profit of $12 million, and an $11 million pretax loss - on an asset base of $159 million.

Sales/assets has remained somewhat steady (but low), but gross margin has fallen from 46% to 20% over 15 years. And it is not clear why their asset turns are so low when they are selling low (and falling) margin bulk wine. Bulk wine and grapes were 44% of revenue last fiscal year versus all of revenue fifteen years ago - some how gross margins are lower despite deploying significant capital into the cased wine business.

So because of the lower gross profit, higher SG&A, and lower incomes, return on equity has fallen even as leverage has gone up! In 2003, equity/assets was 56% and now it's only 27%. In fiscal years 2018 and 2017 (since the company had a loss for FY 2019) the annual net incomes were less than $3 million, which was less than the 2003 level.

Look at the Scheid Vineyard writeups by other investors and they seem to focus on the sum-of-the-parts asset valuation. And we do not doubt that Scheid could be liquidated or sold at a profit. But they aren't going to sell or liquidate, just as Pardee is not going to sell or liquidate its overpriced timber. That leaves investors with just the earnings power, not asset value.

Nobody who has done an asset valuation writeup of this has commented on the deteriorating profitability and margins, or the fact that management has responded to it by taking on more leverage to make much bigger investments in the business.

At December 31, 2003, they had $67 million of gross investment in PP&E. At February 28, 2019 (most recent), they had $174 million of gross investment. Inventories have increased from $7 million to $50 million. But the gross profit is lower and net income is lower!

Let's look at the inventory. At the end of 2003 they had $1.9 million of bulk and bottled wine inventory followed by $5.7 million of bulk wine sales the following year. At the end of fiscal 2018, they had $40 million of bulk and cased wine inventory versus $47 million of sales the following year. And that understates the slowing inventory turns because in 2003 and 2004 more of the sales were of raw grapes, which are sold when harvested.

Here is the acid test of whether this is a good business or not: how did they fund that massive asset expansion from $68 million to $159 million? (Those are the figures net of depreciation; which required over $150 million of gross investment.) Did they bootstrap with cash flows, denying shareholders dividends but building the business with retained earnings?

The answer is that total liabilities grew from $28 million in 2003 to the present level of $116 million. And in case you think that this was low cost float from vendors or something (almost none of their liabilities are this type) the truth is that long term debt went from $13 million to over $100 million. That is why book value is flat; that is why retained earnings plus treasury stock repurchased was $27 million at the end of 2003 and is $44 million today.

So what happened here, really? Is this a nine-figure malinvestment, and if so why did it happen? One of our astute correspondents writes in,
Most of these firms [like Pardee and Scheid] exist because of institutional loyalty and for no other reason. If they were rational, they would have sold to better, larger, more scaled operators long ago. Managements here lack vision and ambition, but get to work with their friends and they value that highly.

Also there is much more stature in owning the local "big business" than just being a local rich guy. There is much more power in owning the local business with employees who depend on your firm for their livelihoods. Chances to sponsor local sporting events and attend various "power broker" meetings. Rich people are not respected. Business people are.
We will be writing about this theme in much more detail for subscribers of the Oddball Stocks Newsletter. Also see our June post, Small Companies (like Small Banks) As "Jobs Programs".

Just Published: Issue 25 of the Oddball Stocks Newsletter

Happy Friday to all Oddballs!

Just a quick note that we have published Issue 25 of the Newsletter this afternoon. If you are a subscriber, it should be in your inbox right now.

If not, you can sign up right here.

Small Companies (like Small Banks) As "Jobs Programs"

In Part I of this series, "What is an Oddball Stock?", we mentioned that the pattern of Oddball opportunity over the market cycle goes from just cheap to cheap assuming activism or a "one day" type of liquidity event. Recently there have been quite a few of the one-days happening: Paradise, Inc., Vulcan International Corp, Stonecutter Mills Corp, Randall Bearings, and so forth.

Unfortunately, a lot of the remaining Oddballs that have not had their "one day" are continuing along earning low returns on equity, cheap relative to the liquidation value of their assets - but that asset value has to be discounted because they function as jobs programs for insiders.

What do we mean by "jobs program"? Well, we would describe those as companies that are earning low returns on equity for shareholders but paying quite a high percentage of assets or shareholder equity as salaries.

In a recent Issue of the Newsletter we wrote about a small rural bank: Southern Community Bancshares, Inc. (OTC: SCBS), the holding company of First Community Bank of Cullman. That is a small town of about 15,000 people located 50 miles north of Birmingham, Alabama that was ranked among Businessweek's "50 Best Places to Raise Your Kids" in 2012. This is one of the dwindling number of small banks still trading at substantial discounts to tangible book value. The current offer for the stock is $8.55 (bid is $8.30), and with the 505,592 shares outstanding that makes for a market capitalization of $4.3 million. Meanwhile, the stockholders' equity is $10 million, up from $9.7 million the previous year, for a price-to-book ratio of 0.43x.

There are no intangible assets on the balance sheet, nor is there goodwill. There are a surprisingly small amount of investment securities (U.S. government agency, municipal, corporate, and mortgage backed): only $6.3 million of which $5 million is maturing within five years. The bank had huge loan growth over the past year, from $58 million to $90 million (a 55% increase!). This was funded by a $20 million increase in interest bearing deposits and a $7.5 million increase in borrowings from the FHLB.

Interest income grew 52% and interest expense almost tripled, so net interest income after providing for loan losses only increased by 34%. But the amazing thing is that net income was actually down year over year, falling from $398k to $374k – a sub-4% ROE both years. The reason was a big increase in non-interest expense, primarily salaries and employee benefits. Possibly, someone made (and perhaps deserved) a big commission on the $22 million in new loans (which if so would be a one-time expense).

However, the other gotcha if an investor is looking at this from a P/B perspective (and since ROE is so low how else is there to look at it?) is that there is over $5 million of property and equipment on the balance sheet, which feels like quite a bit for a bank with only $10 million of equity. Looking at the footnotes, this is mostly land and buildings/improvements, so we are guessing that we must be seeing the balance sheet effect of the building depicted below:

Another cupola! Perhaps we need to start a Bank of Utica Small-Town Bank Headquarters Hall of Fame? Having half of the bank's equity tied up in premises makes the 57% discount to book value feel much less generous.

According to the Form FR Y-6 filed by the holding company in 2017, there is an employee stock ownership plan that owned 25% of SCBS. Other insiders are reported owning significant stakes as well (the company does not provide ownership figures in the notice of annual meeting). So the insiders have significant skin in the game. They must be really bullish on rural northern Alabama real estate to have spent half their equity on this building. We will have to stop and see the town next time we are in the area. (One other odd thing is that they still have $326k of "occupancy expenses" despite owning $5 million of real estate and apparently having only one branch.)

But it underlines the absurd business model of small banks, which we have been harping on for the past year. Imagine if you were going to take $10 million in equity to start a fixed income closed end fund – or maybe a business development company. What if someone foolishly offered to guarantee your liabilities so you could borrow really cheaply and lever up ten times. Wouldn't you hope to earn more than four percent on the equity after all that? And would you spend half the equity on a headquarters?

Like many small banks, maintaining this as a going concern seems to be of dubious value to shareholders, compared to the immediate return (and opportunity to redeploy capital) that they would get if the bank were sold. Instead, its purpose as a company might perhaps be better understood either as a jobs program ($1.65 million of salaries) or as civic monument with a copper cupola.

One could look at the non-interest expenses is as percentage of assets or as a percentage of equity (which is obviously multiplied by the leverage of the bank). So, the $3.1 million of total non-interest expense for 2018 was 2.7% of the year-end total assets.

If the bank can maintain its net interest margin (which may be tricky with short term rates higher than what they paid on deposits last year), this situation might continue indefinitely, even though it may not be the most efficient use of shareholders' capital or the most efficient way for society to provide deposit and lending services to rural northern Alabamans.

Oddball Stocks Newsletter - Also Available à La Carte

Just a quick note that there are two different ways to become a true Oddball: subscribe to the Oddball Stocks Newsletter, or purchase one of the limited number of back Issues that we have published à la carte.

You can see a full list of à la carte Issues, but they are Issues 19, 20, 21, 22, and 23.

The June 2019 Issue (#25) of Oddball Stocks Newsletter covering the 2019 annual report season will be published shortly, and the only way to get it is to be a subscriber.

Some comments from happy subscribers:
  • "You need to raise the price!"
  • " I think you guys are selling yourself short on your company visits. Saying that you are visiting or reporting from a company in your marketing, doesn’t give justice to the insight and analysis you are providing."
  • "The quality of the writing (even including your new contributors) is really top-drawer."
  • "Great newsletter! - you guys are either providing too much info or not charging enough..."
We also posted some excerpts to give a taste of the Oddball writing and coverage style - but just remember that the most interesting content is for subscribers only. The excerpts were on Tower Properties, Bank of Utica, small banks, Avalon Holdings, Boston Sand and Gravel, Conrad Industries, and Sitestar / Enterprise Diversified.

“What is an Oddball Stock?”

The philosophical subject of “What is an Oddball Stock?” frequently comes up and we thought that we should share our thoughts on the question.

Oddballs are small companies. From time to time we talk about companies with larger market capitalizations or balance sheets (most always dark, OTC-listed ones) but an Oddball is much more likely to be a $1 million company than a $1 billion one.

Oddballs are opaque. We are always disappointed if we find a company's financial statements readily available because that means the company is much less likely to be inefficiently priced. So the opacity comes from being OTC traded and therefore not SEC-reporting. Oddballs have all different letters of shareholder friendliness and communication, from the detailed presentations of Pardee all the way down to a company like Vulcan International. Besides the paucity of information provided to shareholders by management, the Oddballs do not generate news. Time goes by with not a peep heard from them or about them.

Of course, that paucity of information is why the Oddball Stocks Newsletter serves such a valuable function for subscribers. Even though we make no "recommendations," we help investors in this space figure out what is going on. By the way, the dearth of information that the owners of Oddball companies have about them reminds us of something in the book Panic by Andy Redleaf:
What modern capital markets do very well is raise large amounts of capital from a broad base of investors who are persuaded to give their money to perfect strangers with precious little idea of what these fortunate recipients are going to do with it. In order to keep the money coming in under such admittedly odd circumstances, liquidity and the universal, instantaneous "price discovery" that financial markets offer with a glance at a computer screen are essential. The public investor, knowing so little about what he is buying, must be able to tell himself he can get that money back (or what's left of it) pretty much whenever he likes. [...] Public securities markets, and especially equity and derivative markets, are bad markets because their knowledge base is thin (at least compared to the sum of what could be known about the underlying companies if shareholders were allowed to know it, or inclined to learn it). 
Compared to bigger public companies, most Oddballs are illiquid. This comes from being small and also from having a small float. Many of the most interesting Oddballs are heavily insider-owned or at least owned by investors with a long time horizon who do not “trade” their stock. So, as small as the market capitalizations are, this makes the effective investible size of the companies even smaller.

Oddballs are older companies. You have probably noticed a number of companies that we have written about that are in the “Century Club,” having been around for a hundred years. And related to this, the Oddball companies are in simple and prosaic businesses. We hear a lot these days about “disruption,” but we think there is something interesting about companies that have been around for a century; especially if they are trading for less than 10x earnings. Also, because the Oddball businesses are older, they tend to be asset intensive. That is, they employ tangible assets that show up on the balance sheet, not intangibles or human capital. And because of this we are often discussing their valuations in terms of book value metrics.

The factors above tend to lead to inefficiency and underpricing of Oddballs because many investors systematically avoid these factors in their investing. Meanwhile, we have noticed that Oddball investors tend to prefer different subsets of investment theses. For example, some like the “cashbox” or negative enterprise value. Some like a very low EV/FCF ratio along with buybacks, so that the company can take itself private quickly if price stays the same. Most Oddball investors seem to prefer overcapitalization and shun debt. Also, Oddball managements seem to want their companies to be overcapitalized, which drives return on equity lower and therefore price-to-book lower.

The pattern of Oddball opportunity over the market cycle goes from just cheap to cheap assuming activism or a "one day" type of liquidity event. Recently there have been quite a few of the one days happening: Paradise, Inc., Vulcan International Corp, Stonecutter Mills Corp, Randall Bearings, and so forth.

Unfortunately, a lot of the remaining Oddballs that have not had their "one day" and continue along earning low returns on equity, cheap relative to the liquidation value of their assets, but which asset value has to be reasonably discounted because they function as jobs programs for insiders. More about that principal-agent problem in Part Two...

Another Oddball Stock Retrospective

We did a retrospective the other day on PC Connection, finding that it compounded at 24% (counting dividends) from the time it was mentioned in September 2010.

Another early Oddball Stocks post was Ingram Micro in September 2011. (In addition to the Oddball blog writeup, it was also presented at the Value Investing Congress in 2011.)

This is another boring business - not consumer facing and not a "compounder" - but let's see how it did over time. First, here was Nate's thesis on the blog back in 2011:
Valuation
Here are a few quick valuation stats:
-P/E of 9.69
-EV/EBIT 3.08
-EV/FCF 5.52

So on a few simple metrics the company is coming up cheap. What might be an appropriate valuation for Ingram Micro? The industry average P/E is 10.5, which if IM traded at that level they would be at $19.11, not much upside.

A P/E of 10.5 plus cash results in a price of $27.75 per share.

If the company traded at an EV/EBIT of 8 the price would be $32.34 which is quite a bit higher than $17.66.

Conclusion
Ingram Micro is trading at a very cheap discount to net assets, and the business is trading cheaply as well. Even with both of those factors I don't have a good feeling about Ingram Micro. The company has a decent amount of debt and operating leases, and earnings are extremely lumpy. I also don't know how much valuation expansion exists. Clearly the company is cheap, but how much cheaper than peers. And for an industry that has bad margins maybe a P/E of 10 is warranted. If the market values based on P/E they are already close to full value. This is going into my consider further, and re-consider if it drops bin.
What ended up happening is that in February 2016, Ingram Micro announced that it would be acquired by a Chinese company for $38.90 per share, cash. The deal ultimately closed in December of that year. Counting a couple of small dividends that were received in 2015, that was a compounded IRR of 16.3%.

It is often hard to find charts of stocks that have stopped trading, but Barchart.com has one for IM up until it was acquired.

Paradise, Inc. Is Liquidating! ($PARF)

Well, it looks like another "one-day" stock has had its day:
Dear Fellow Shareholders:

We are pleased to inform you that on April 15, 2019, Paradise, Inc. (“Paradise” or the “Company”) entered into an Asset Purchase Agreement (the “Purchase Agreement”), with Gray & Company (the “Buyer”) and Seneca Foods Corporation (the “Parent”). Subject to the closing conditions included in the Purchase Agreement, including most importantly approval by you as our shareholders, the Company will sell to the Buyer the assets of its glacé fruit product business (the “Fruit Business”). If approved and closed in accordance with its terms, the sale of the Fruit Business (the “Asset Sale”) would be for an aggregate purchase price of approximately $10.9 million, consisting of cash consideration of approximately $9.4 million and assumed liabilities of approximately $1.5 million. Approximately $0.9 million of the purchase price would be held in escrow for six months after the sale to satisfy indemnification obligations of the Company. We ask for your approval of the Asset Sale as described in further detail in the accompanying proxy statement.

In addition, our Board of Directors has determined that the best course of action following the Asset Sale is the orderly sale of our remaining assets, including our molded and thermoformed plastics business (the “Plastics Business”) and the real property on which we operate our businesses (the “Real Estate”), as part of a Plan of Complete Liquidation and Dissolution (the “Liquidation Plan”). As a result, we are also asking in the proxy statement for the approval by our shareholders of the Liquidation Plan.
That is from a proxy statement that was filed with the SEC. It goes on to give an estimate of the liquidation value:
Assuming shareholder approval and closing of the Asset Sale, the Board estimates that the aggregate amount of distributions to shareholders as a result of the Asset Sale and Liquidation Plan will be between approximately $18.0 million and $25.0 million, or approximately $35 to $48 per share based on 519,600 shares outstanding...
Paradise was a net-net idea that Nate posted way back in July 2012 - so seven years ago. At that point, shares were trading at about $18. Commenters actually gave the idea a bit of a hard time, for example:
Your investment in a business like PARF has costs -- the returns that you could have earned in treasuries, bonds, ETFs, or some other stock.

If one invests $100 in PARF's assets, one can expect 6% back per year; if one invests the same amount in the S&P or some other index, one can expect ~9% back a year. Every year one holds PARF, one loses 3% of the value of one's investment via opportunity cost.

That's why the business has negative economic value for the investor. Everyone else, -- employees, suppliers, customers, tax authorities -- are quite happy with PARF.As for the private investor,given that PARF's under-performance is built into the business (tremendous amount of working capital required to generate very little in terms of profit), why would a rational person -- private buyer or Mr. Market -- want to pay full price?

I don't think they would: the'd pay 2/3 of the price of the assets, just in order to break even.

And that missing 1/3, the proxy for value destruction, has a value of ~$5-$6 million, which, not coincidentally, is the value of the excess cash.
Over the years the company paid a paltry $0.92 of dividends, but with the liquidation announcement there is now a $38.52 bid for the shares. That represents an IRR of a little over 12%. If the liquidation were to result in $45 in proceeds a year from now, the IRR might end up being 13% compounded for eight years. (It should be noted that this is about the same as the total return of the S&P 500 over the same seven year time period.)

Regarding the acquisition, one Tweeter commented, "Seneca Foods is buying Paradise inc. candied fruits business for $9.4 mln, ~0.6x last year's sales and somewhat over 3x operating earnings. That's a nice buy for Seneca and a shitty sale for Paradise investors, a perennial OTC asset play."

In fairness, the proxy statement describes a very long lasting marketing process by Paradise's bankers, and apparently this was the highest offer. It would be interesting to know the real reason that nobody stepped up willing to pay more for this segment.

Another Tweeter observed that Paradise "announced in Feb18 it was exploring strategic alternatives. Didn't disclose until 12/7/18 that it had entered into a retention agreement effective 10/31/17 with CFO with $75K bonus paid when company sold."

The proxy statement is well worth reading. The negotiations with the eventual buyer lasted from March 2018 until April 2019. One thing that is a little ominous is that the buyer wanted the fruit business but not the plastics and especially not the real estate. See this little tidbit:
On January 3, 2019, the Parent terminated negotiations with the Company regarding a merger but communicated its willingness to purchase only the Fruit Business of the Company under an asset purchase. The Parent did not give any reason for this termination at this time, but later told the Company that it did not want to acquire the stock of the Company based on the preliminary results of the Phase 2 study. 
Apparently the buyer was emphatic that they did not want "to be in the 'chain of ownership' for the Company’s real estate property"! The way that this was resolved is that Paradise is doing an asset sale of just the fruit business; not a merger or sale of the whole company.

Here is the detail from the proxy statement on the estimated proceeds after the asset sale of the fruit business:
After execution of the Purchase Agreement, the Company will have an estimated remaining asset value net of liabilities of approximately $14.0 million (with the Plastics Business and Real Estate being valued at net book value). Given that, estimated future proceeds to shareholders are calculated as (1) the cash consideration from the Asset Sale; plus (2) the net tangible value of remaining assets less liabilities; less (3) transaction-related fees/expenses and severance ($4.2 million); plus/minus (4) operating profits/losses between the date of closing of the Asset Sale and the date of full liquidation of the Company (assumed to be break-even) — totaling $19.2 million of estimated proceeds.
Payments of severance and a special bonus are going to be an eye-popping $3.2 million -that is over $6 per share.

One wonders what the real estate is going to bring... It seems like management should have elaborated a bit on the problems revealed by the Phase 2 environmental study. Is it a Superfund site or what?

Activism Story: Texas Pacific Land Trust ($TPL)

An Oddball correspondent wrote in about the ongoing proxy fight at Texas Pacific Land Trust (TPL), which, while too big to be a true "Oddball" is certainly Odd, unique, very old, and interesting:
Here's a 55 minute video that allows you to experience the drama (from the special shareholders meeting on May 22). The man in front speaking is Eric Oliver, a "dissident" candidate who handily won the open trustee spot, although this is hotly contested in federal court. He is frequently interrupted by the attorney for the two existing sitting trustees. There's also a blog that has frequent updates.
Texas Pacific Land Trust has been around since 1888 and is a favorite of the Horizon Kinetics fund managers. From the Wikipedia history of the trust:
TPL was created in February 1888 in the wake of the Texas and Pacific Railway bankruptcy, as a means to dispose of the T&P's vast land holdings. TPL received over 3.5 million acres, and certain T&P bondholders were allowed to exchange their (now worthless) bonds for trust certificates. The certificates were later divided into "sub-share" certificates (3,000 sub-share certificates is the equivalent of one trust certificate), and the sub-share certificates have been traded on the NYSE since January 1927.

Over 100 years later, even having sold 75 percent of its original landholdings, TPL is still among the largest private landowners in the State of Texas. As of December 31, 2008, TPL owned 963,248.33 acres of land in 20 West Texas counties, of which around 70 percent is located in Culberson (315,640.09 acres), Reeves (194,750.28 acres), and Hudspeth (160,467.44 acres) counties. In addition, TPL owns a 1/128 nonparticipating perpetual royalty interest in 85,413.60 acres (over half of which is in Ector and Midland counties), and a 1/16 nonparticipating perpetual royalty interest in 386,987.70 acres (over 60 percent of which is in Culberson and Reeves counties).
See the map of TPL's west Texas acreage. One of the things that investors have liked about TPL is that it is a "cannibal" - allocating income to significant share repurchases:
TPL has a long-standing policy to repurchase sub-shares with excess cash. As noted in the 2015 annual report, "As provided in Article Seventh of the Declaration of Trust, dated February 1, 1888, establishing the Trust, it will continue to be the practice of the Trustees to purchase and cancel outstanding certificates and sub-shares. These purchases are generally made in the open market and there is no arrangement, contractual or otherwise, with any person for any such purchase."

In 2015, the Trust purchased and retired 204,335 sub-shares at a cost of $28,771,073, representing an average cost of $140.80 per sub-share. The number of sub-shares purchased and retired in 2015 amounted to 2.5% of the total number of sub-shares outstanding as of December 31, 2014.

The policy of buy backs has reduced the sub-share count by 26% between 2004 and 2015 (from 10,971,375 at the end of 2004 to 8,118,064 at the end of 2015.)
Of course, it helps that TPL's land was on top of the Permian oil bounty! Yet, historically, TPL's almost "autopilot" policy of self-repurchasing has proven to be a great capital allocation strategy, avoiding the all-too-common resource producer patterns of buying overpriced land (often at cyclical commodity peaks) just to grow production, or boondoggles from straying afield (something that Pardee investors are currently grappling with).

While we are not involved in the TPL flight, we believe that good corporate governance consists of real owners (not professional board members) sitting in the board room making decisions (with skin in the game) about their property. (See this example of an older Oddball post on activism.)

There is litigation between the Trust and the activist investors, and the countersuit by the dissident nominee is very interesting:
On information and belief, the incumbent trustees have caused TPL to spend upwards of $5 million of shareholder capital on this proxy contest to date. But nowhere in the Declaration of Trust are trustees vested with the authority to wage proxy contests against shareholders, or in any way utilize trust property to impose on shareholders the nominee of the incumbent trustees. The trustees do not enjoy the same broad set of powers and wide field of discretion as the directors of a modern corporation. Nothing gives the incumbent trustees the power to take actions outside of managing the trust's property as strictly outlined in the trust documents. Because the incumbent trustees have exceeded their authority under the Declaration of Trust, they are personally liable to the trust for all the expenses they have incurred without proper authority.
Check out how many copies of their proxy card the incumbents sent - all with the Trust beneficiaries' money!

The Eric Oliver dissident nominee is the Chairman of AMEN Properties which is a micro cap and kind of an Oddball. He and his fund have a $31 million stake in TPL! Oliver was also involved in a company that maps oil and gas activity in the Permian.

We'll have more on these topics - activism, share cannibalization, capital allocation, resource investments like Pardee Resources - in the upcoming June Issue of the Oddball Stocks Newsletter. If you've read this far into this post, you should really think about subscribing. Maybe try an à la carte back Issue, like Issue 19 or Issue 20 from last year.

Goodheart-Willcox Company (GWOX) Tender Offer Results Are In!

Back in March we posted about the tender offer by the Goodheart-Willcox Company Employees' Profit Sharing and Stock Ownership Plan and Trust of $150 per share for up to 124,000 shares (which is 27.8% of the outstanding stock) of GWOX.

The company has announced the results of the tender offer:
52,557 shares of The Goodheart-Willcox Company, Inc. common stock were tendered by shareholders at the price of $150.00 per share, for a total transaction amounting to $7,883,550 and representing 11.7834% of the total outstanding shares of the Company’s outstanding stock.

The shares were redeemed by The Goodheart-Willcox Company, Inc. Employees’ Profit Sharing and Stock Ownership Plan and Trust. By having the benefit plan acquire the shares, it allowed tendering shareholders to take advantage of certain provisions of the tax code called Section 1042 which allowed them to reinvest in U.S. qualified securities without incurring capital gains taxes.

The President of Goodheart-Willcox stated the optional tender offer provided two advantages to the shareholders ---liquidity for their shares as well as tax advantages for reinvesting the proceeds.

The shares added to the Employees’ Profit Sharing and Stock Ownership Plan and Trust will be used to attract and retain talent in order to grow the Company into the future.
So the tender offer was "undersubscribed" - they did not receive as many tenders as they had been willing to buy. The last trade of GWOX was for $150 per share at the end of April. This has always been pretty illiquid and now will probably be even more so.

We will have a discussion of this - and many, many other developments from Oddball annual report season - in the upcoming June Issue of the Oddball Stocks Newsletter, due to drop later this month.

Also, make sure you see Nate's post on the failure of Enloe State Bank in Texas. Watch how he uses CompleteBankData tools to delve into what was going on at that bank.

Why did Enloe State Bank fail?

It's been a few years since a bank failed.  Which has been excellent for industry observers, at one point during the crisis it seemed like a half dozen failed each weekend.  In typical fashion the FDIC drops a press release late on Friday when they close a bank.

Banks fail for a myriad of reasons from bad loans to being caught in a liquidity crisis.  Usually it's a combination of both.  A portion of the bank's loan book turns south requiring additional capital at the same time that the bank doesn't have access to capital, or capital is walking out the door.  These confluence of events eventually lead to FDIC receivership.

When a bank fails the FDIC negotiates an agreement with another local bank.  The local bank acquires some or all of the failed bank's deposits along with the choice loans.  Any "bad" loans are either handed over as part of the sale and guaranteed by the FDIC, or handled by the FDIC themselves.

As long time readers know this isn't a bank tracker blog, and I rarely write about failures.  So why this one?

The failure of Enloe State Bank is fascinating, and after a little digging I'm convinced there's a lot more here than meets the eye.

First off in the FDIC's press release they note that the bank had assets of $36m and deposits of $31m.  So then why did Legend Bank (the acquiring bank) only take $5.2m in assets and why did this little bank incur a $27m hit to the FDIC's insurance fund?  Secondly if you Googled the bank news articles from two weeks ago appeared saying that the ATF was investigating a suspicious fire at the bank.  Someone was seen burning papers inside.  Suddenly this is starting to sound like a movie plot and merited further investigation.

I did what any curious person would do, I started to dig into the numbers and wow... something is very off here.

First let me provide a little background.  At CompleteBankData we are building one of the most advanced market analysis, full-stack bank marketing and bank prospecting tools.  We collect data from a variety of sources daily and build out a mosaic showing the current lending market place and opportunity set.  We pull things like deeds, property assessments, mortgage originations, UCC filings, agricultural subsidies and farm information along with credit details and business profiles (revenue, fleet size, number of employees etc).

While the previous paragraph might just seem like a plug for my business, and in a small way it is, I provided it as background for what I found.  Because without knowing what we do you'll be scratching your head wondering how I researched this post.

In general if we pull up a bank with $285m in loans we will be able to find a number very close to that in our database.  There are usually differences due to rounding or other factors, but it's usually very close.  So image my surprise when I started to dig into Enloe State bank and only found a shadow of the number of loans they report.

The bank had $36m in assets, but in the last five years only originated $5.8m in loans.  Prior to that they'd only originated another $3m or so in loans in the prior ten years.

This was head turning at first, but it could make sense.  In Q1 they noted about $5.9m in first lien mortgages, that's right near our $5.8m number.  They also have $3.2m secured by farmland and another $10m in loans to finance agricultural production.  It's the ag loans where things start to get a little fishy.

The bank is classified as an agriculturally focused bank, yet the majority of their loans are for an acre or less.  I found a few on properties that were over 10 acres, which would be considered a very small farm.  A second aspect was that these "farmer" loans were small.  For example one couple on 50 acres borrowed $96k.  Digging into the loan details it appears that the $96k was to finance a residence on the property, not the farm land itself.

Which means I just can't find their $3.2m in farm loans.  Our property data only dates back to 2003, so it's possible the $3.2m in land loans all pre-date this century.  But let me let that hang for a second and let's talk about ag production lending.

If a bank is lending against production there are usually a few ways to identify the activity, primarily though UCC filings.  For example, a bank that is lending for seeds and operating costs they will also secure equipment such as tractors and spreaders.

When I looked at Enloe State Bank's secured financing history back to the 1980s they had a pattern of lending to farmers at least a dozen times a year if not more.  This persisted right up to 2011 and then just dropped off.  There were a few random loans since, but not much of note.

The weird UCC financing pattern might have an explanation, or it might not.  A second factor that turns my head a little is $2.3m in in unsecured loans to individuals.

Let me see if I can piece this together for you.  Legend Bank decided to acquire $5.7m in assets, so loans and possibly Enloe's $2m in held to maturity securities.  Meaning that the only "good" loans were potentially their $5.8m in residential loans that I found, although the number could be potentially less.

So what about all of the farm loans?  This is pure speculation, but I think this might be why someone was burning papers in the bank.  I think it's possible that the bank was lending on "production" that either didn't exist, or was highly inflated.  I know this is speculation, but it's somewhat founded speculation.  I took a list of their borrowers that I knew about with the largest land holding and attempted to cross correlate with farm subsidies or farm income.  It turns out that their largest farmers don't have any identifiable farm income to note.  They've never requested a federal subsidy, and they don't appear in any other sources of farmer income.

And then there's that $2.3m loan.  Was it for a farmer who fell behind? Maybe they had a few bad years? Or was it something else?

The malicious explanation is that the $2.3m in unsecured and production lending were fraudulent and a way to extract money from the bank.  The innocent explanation is that they were lending to a poor quality set of farmers who couldn't farm well.  Except if it was a bunch of lousy farmers I would have thought they would have requested a little something from Ol' Uncle Sam.  Maybe they were so lousy that never even crossed their mind!

 A few years ago or former bank examiner mentioned a story that is worth mentioning here.  He said he was assigned a sleepy little bank in a small town.  During his initial research he discovered the entire board consisted of the owner and employees all related to the same family and same car dealership.  Unsurprisingly the bank was only making loans to the dealership and family related to it.  Consider it a little captive nepotistic financing arm that flaunted a number of regulations.  This former examiner said he immediately called his boss and within a week the bank had been shut down.  Their credit quality wasn't quality, and a number of loans were questionable.

As I read about Enloe State Bank discovered some of the oddities posted above this same story came to mind.  If an innocent explanation doesn't exist here then I think it's possible something like this former examiner story could be plausible.  Someone from a regulatory agency started to dig deep and realized that a few things didn't quite add up.  Suddenly the bank is caught on their heels and by the time the FDIC realizes how bad things are it is easiest to just shut things down.

I want to end with this caveat.  I don't know any of this for sure, but there are a number of red flags here, the biggest being the FDIC's $27m expected loss, and a $27m hole in loan data.

I will be watching this one with interest for a detailed FDIC post mortem.


Announcing CompleteBankData: The ultimate growth tool for bankers

One of the most important things in business is identifying your customer, determining their needs, and evaluating whether your product fits their needs.  In most industries this is a well defined process.
If you are hired to sell software to accountants what do you do?  You pull a list of all accounting firms in your territory and begin to market and prospect to that set of potential customers.

But what do you do if you’re a bank? Who are your customers?  Is it everyone who might need money?  Does a bank that is interested in growing simply load every resident in their given footprint into their CRM and march through it?

The traditional way a bank conquered this problem was by trying to cross sell to depositors.  A bank’s depositors are their current customers, the ones who have money, enough money that they need a place to store it.  The problem is a bank’s customer is someone who needs money, not someone who already has it.  Because of this there’s a mismatch between who they are marketing to and who their ultimate customer is.

To solve this problem lending officers have relied on “centers of influence.”  A center of influence is a person in a related industry, an accountant, a lawyer, a consultant, who has industry connections and can refer prospects that need money to a banker who has money.

The problem is relying on centers of influence is reactive, a bank is waiting for demand to appear before they can react and provide prospective financing details.  The second issue is that banks end up marketing to centers of influence instead of directly to potential customers.  It becomes the job of the center of influence to pitch the positives of a bank verse the bank itself.  And lastly the relationships are between individual lenders and these centers, not the bank itself.  When a lender leaves to work for a competitor, they take those relationships with them along with subsequent referrals and their book of loans.



CompleteBankData has taken a different approach.  We believe that banks should be able to identify their ideal customers, market, prospect and own that relationship themselves.

We do this by taking data from a number of different sources including deed filings, mortgage originations, assessor data, real estate listings, commercial financing transactions, and demographic data and then creating links and relationships between these entities.

By having this large connected store of information, we can proactively define a bank’s ideal customer, and then put customized details about all prospective customers in front of them in real time.  But that isn’t all, we can predictively unearth leads based on the profile of a bank’s ideal customer that a bank might not know about.

For example, if a bank specializes in owner occupied commercial real estate to businesses with more than $1m in revenue we can alert them when a business that fits their profile purchases a new property for cash.

Another example of actionable and targeted information is the ability to show a bank loans in their market that fit their ideal customer profile that are set to mature or balloon within a given time period.


Let’s take another example, a banker who specializes in financing landlords and their property profiles.  It’s very difficult to discover non-corporate landlords, but in many cases these “hidden” landlords own substantial portfolios.  In Allegheny County, Pennsylvania there are over 1,000 individuals who own 12 properties or more, with one individual owning more than 600 properties.  The majority of these landlords have no website and no information outside of a few “For Rent” signs on their properties.

What our system can do is alert a banker when one of these landlords purchases a house for cash in an area they desire to lend into.  The banker can then discuss with the landlord the potential for providing liquidity by financing the most recent purchase, or potentially refinance their entire portfolio.  The icing on the cake is that a lender can use CompleteBankData to evaluate the real estate property profile of a prospective landlord all without ever having to speak to them.  Through the system they can see what properties they own, the property on a map and details on the liens associated with the properties.

Of course, these are just two examples of many possibilities.

The real key is that we enable a bank to discover, contact and interact with their prospects directly instead of having to rely on a center of influence relationship to sell for them.

What this means for a bank is they can control their own destiny.  A bank can decide to chart its own course, build a prospective sales pipeline and then follow those leads through the pipeline from discovery to loan origination while measuring and reporting on their progress the entire time.  These relationships we help banks discover are their own, not owned by the centers of influence, or a star banker, they are the bank’s.

By enabling banks to proactively discover their customers we also help banks reduce risk.  Typically, when a bank enters a market, or attempts to grow aggressively they end up taking somewhat marginal business because all of the good customers are already financed.  With CompleteBankData customers can “shop” for new relationships by looking at customer lists, loan terms and contact details for competitor banks.  The risk is that competitors with good underwriting might find their clients walking out the door, whereas for our customers they can grow their portfolio with quality loans without taking undue risks.

Let’s consider what this means for branch expansion.  In the current world a bank will hire a set of loan officers, build a building (or purchase one) and hang their sign on the roof.  They now have a shiney new branch, and little to no business at that new branch.  The bank spends an outsized amount of their marketing dollars attempting to attract retail deposits at their new branch.  In turn the bank then markets to their depositors hoping to drum up new loans.  At the same time their commercial bankers are hitting the business networking circuit attempting to build new relationships around this branch outpost.



What we offer is a more efficient approach.  CompleteBankData can be used to pre-emptively evaluate the lending market even before opening a branch.  A bank can evaluate the number of borrowers, size of existing loans, and look at who they are competing against.  After they’ve settled on a soft spot in the market then they can establish a physical branch.  But what’s different is instead of opening with a few relationships on day one the bank can proactively work to build excitement even before the branch opens.  They can do this by building marketing lists of prospects from CompleteBankData and marketing to them digitally and traditionally via the mail months before the branch opens in their location.  Commercial loan officers can be proactively working on building relationships ahead of the launch with target customers.  With marketing and direct relationships ahead of a branch launch a bank can ensure that when the doors open they will have a sizable customer presence ready to bank with them.

Is this for you?

If you are a banker, primarily in a community bank sized $1b-$50b in assets we want to speak with you.  You can schedule a demo here, or give us a call at 1-866-591-8315.  We are familiar with the challenges you face and believe that we an tip the scales in your favor.  Email Nate Now

If you are an investor in banks and have an investment in a bank that might be able to use this.  Would you be able to introduce us to the CEO or CLO (Chief Lending Officer)?

We are always looking for introductions and connections with others in the industry.  If you know someone who might be worth talking to please drop me an email at: Email Nate

Recent Press

We were recently profiled in the Pittsburgh Business Times about what we're doing.





New to banking? Check out The Bank Investors Handbook

And of course if you're new to banking or would like to understand how banks work better I'd suggest you check out my book, The Bank Investors Handbook.  The book is available on Amazon in both paperback and Kindle format.

Oddball Stocks Newsletter: Boston Sand and Gravel Co. (BSND)

Here is another sample piece from the Oddball Stocks Newsletter. This is another excerpt from Issue 21, published last August, about Boston Sand and Gravel (BSND).

Last summer BSND was trading in the mid $400s. It is up pretty substantially since then, to $546 bid and $573 offer. The 2018 annual report is not out yet, but we'll be writing an update in the Newsletter when it is. Last year, BSND's annual meeting was held in Boston on July 26th.

You can subscribe here to the Oddball Stocks Newsletter, and we also have some a la carte samples of back issues available.




Also, be sure to watch Bob Vila take a tour of the Boston Sand and Gravel Plant!

Oddball Stocks Newsletter: Conrad Industries Inc. (CNRD)

Here is another sample piece from the Oddball Stocks Newsletter. This one is from Issue 22, published in November 2018. This one is about Conrad Industries, which has been posted on the Oddball Stocks blog multiple times in the past (like here and here back in 2012).

In addition to a pretty good track record of interesting ideas that worked well, the Newsletter has also sounded some cautionary notes about names, which have turned out to be prescient. For example, back in August we wrote some cautionary thoughts about Conrad when its shares were trading in the high teens. The shares collapsed down to $13 at the end of the year and have only now recovered to $15.

Conrad is a rare Oddball with friendly management, but their business is really challenged by the lack of oil and gas activity in the Gulf of Mexico. We will continue to monitor and report on developments in the Newsletter. (You can subscribe here to the Newsletter, and we also have some a la carte samples of back issues available.)

Tender Offer for Goodheart-Willcox Company (GWOX)

Textbook publisher Goodheart-Willcox is an Oddball that was written up on Oddball Stocks way back in October 2012 when shares were trading for about $72.
I ran across Goodheart-Willcox in the Walkers Manual, the numbers in the manual intrigued me, from 1998-2001 the company had earned anywhere between a 24% and 32% return on equity, and EPS had grown at 25% annually. I was even more impressed with the ROE when I noticed the company was debt free. I was curious about how they were doing now, so I picked up some shares and contacted the company for an annual report. I received a few years worth of reports and liked what I saw. In the years between 2001 and 2011 the company had continued to throw off excess cash, but with reinvestment opportunities limited cash just piled up on the balance sheet. The company had become what value investors affectionately call a "cash box". A cash heavy company with a business bolted on.

So what is the business of G-W you ask? They're a textbook publisher. Most readers will see the last line and think "no wonder they're a cash box, dying business, dying industry, and relies on government funding." That's the bear case in a nutshell, a bit more information might change some perceptions, but my guess is for 99% of my readers this stock is untouchable because of some preconceived negative bias. I understand that, I've wrote about this stock to a number of investor friends, and all of them came back with some variation of my above sentence. I've heard it said that courage of conviction, and patience are two skills investors need to succeed. Both of these traits are required in double doses for G-W.
The Oddball Stocks Newsletter also did an update on Goodheart-Willcox in November 2014 when it was trading for $81, which was right around book value at the time.

Along the way from 2012 until now, GWOX paid some healthy dividends - a total of $23 per share since the post back in October 2012. The last trade of the stock was in December 2018 for $107 per share. That made for an IRR of 10%... until today.

We received a notice today that the GWOX Employees' Profit Sharing and Stock Ownership Plan and Trust is offering $150 per share for up to 124,000 shares (which is 27.8% of the outstanding stock). That boosts the IRR to 15%... but it happened in "One Day".

At $150, the market capitalization of the company (with 445,725 shares outstanding) is $66.9 million.

The P&L for GWOX is "cyclical" because of the school book adoption cycle. To some, the business looked like it was in secular decline. If you look at the financials from back in 2012, it earned $5.6 million in 2006 (on $31 million of sales) but only $563,000 in 2012 (on $17 million of sales). Even from 2013 through 2017 it never earned more than $1.6 million, with two of those years being below $1 million. But then for the year ended April 30, 2018, it earned $8.3 million!

Is the tender offer worth taking? There's some juicy nuggets that bear on that in the tender offer document - we will be discussing in the upcoming Issue of Oddball Stocks Newsletter in June. Stay tuned!

On outsourcing and vertical integration

There is an interesting pattern happening in the business world at the moment.  It's the outsourcing of everything.  And it's interesting because there are leaders, followers, and my conclusion from watching what's happening is that this outsourcing shift is more than an outsourcing movement, it's actually a shift in intellectual capital from one sector to another.

I'm not sure when this started, but in my mind the current batch of outsourcing picked up steam in the 1990s with IT outsourcing.  As technology was a newer thing to companies they thought it might be easier to hire experts rather than develop their own in-house capabilities.

Of course outsourcing isn't new, companies have always relied on vendors to help them in their business.  Not every company that delivers parts owns a trucking or rail fleet.  Completely vertical integration isn't possible, and isn't necessary, but that's not what I want to talk about.

What's happening is a technical outsourcing on steroids.  Because companies were comfortable outsourcing initial IT support, or systems there has always been a comfort level to other types of technical outsourcing.

Executives have an idea that it's much easier to outsource an accounting system, rather than host their own customized accounting system.  Or to outsource sales verses building an in-house staff.  The rallying cry is "we don't want to be involved in things that aren't our core competency."

Of course that makes sense.  If a business is the best in the world at manufacturing widgets why would they want to get bogged down in the logistics of distributing those widgets to the world?  Or why would they want to waste time hiring people to manage facilities, or run a phone system?  Instead they should focus all of their energy on manufacturing widgets and let others do the rest.

The problem is most companies don't really have a core competency.  If you take a deep dive into a businesses' operations you'll find there really isn't much of a secret sauce.  It's just a group of people working together in a unique way to provide a solution.  And if you begin to abstract the pieces away like lego blocks you start to realize there isn't anything at the center that can't be replicated elsewhere.  The exception to a generalization like this would be companies that own infrastructure, or prized real estate that is truly one of a kind.

What's happened is these outsourced vendors begin to understand their client's business better than themselves.  And the vendor starts to think "why don't we just bolt on a few front office features too?"  Then suddenly the back office vendor becomes a vertically integrated company that is competing with their clients and doing it better than they could do it themselves.

In effect many companies have leadership teams that have bought into this outsourcing mentality so deeply that they're slowly disassembling their own companies and transferring their knowledge and skills to their vendors.  And those vendors are realizing that with their knowledge and expertise that they can replicate what their clients are doing better.

It's fascinating that the competitive advantage Carnegie had with his steel was that he fully integrated operations.  He owned coal mines, owned the path to the coaling and coking plants and eventually steel.  The great innovation was the fully assembly line from coal to steel was physically located in close proximity eliminating the distributed logistics gap that existed at the time.  It was an enormous factory made up of many smaller operations all lining the same river.

The end result of this outsourcing transformation is this "new economy" that we're experiencing.  Old main-line companies are willingly disassembling their businesses and re-incarnating as portions of multiple tech companies.

The implications of this are far ranging and wide, and I'm not sure this process can be stopped.  It's the pattern of the Innovators Dilemma on a much larger macro scale.

-Nate

What's going on in the Oddball world?

I wanted to put together a quick update post of what's been going on for me (Nate) in the Oddball Stocks world.

As you've noticed my posting frequency has slowed to a crawl.  This has coincided with the acceleration of my software business, CompleteBankData.  As that's taken off I just haven't had as much time to write and muse on investment topics.

Our company was accepted early in 2019 into the AlphaLab start-up accelerator here in Pittsburgh and that's taken up even more time.  But I'm not lamenting the loss of time, the benefits far outweigh how crammed things are.  Here's an article about the current cohort of companies, ours included.

While being a part of an accelerator I've had the opportunity to greatly widen my network and meet a ton of entrepreneurs and successful executives.  As readers know I'm a value investor through and through.  Which is sort of a paradox in that I'm running a growth company, and the maxim of our company is that we help banks grow.  So how is it that I'm a value and growth person?  I think it all breaks down to the level of involvement.

A lot of investors and activists struggle to push a stagnant company to grow.  That's because growth isn't in their DNA, and for a lot of people growth means change, and it's hard to change.  When someone else is buying the dollar for $.30 and liquidating it I'm happy to take a ride.  But I'm not sure I'd want to be doing that liquidating myself.

On the other hand I really enjoy running a company.  I love talking to clients, love networking with prospects, and getting involved in client operations and helping them accelerate their growth.  But you can't do this if a company doesn't want to grow.

In the meantime my partner in crime at the Oddball Stocks Newsletter (and you really should subscribe if you haven't already) will be starting to post from time on this blog.

The posts I author have my name attached at the bottom, whereas the posts Colin authors have "Oddball Stocks Newsletter" attached.

I want to take a quick turn and talk about the newsletter for a minute.  Over the past year I brought Colin on board and he's taken the letter to a place that I didn't have the ability to take it.  We've dramatically increased our coverage universe of oddball stocks, while at the same time expanding the depth of coverage on each name.  If you're in the oddball investment space I'd highly recommend you take a look and consider a subscription.  There is a lot of content we put together that is simply not available anywhere else.

A parting word.  Lest you think I've lost the value gene, I'm still out hunting for bargains, although not always stocks.  I've been out in the real world finding bargains on hard goods and reselling them on eBay.  It helps me scratch the itch until the market is littered with similar bargains.

-Nate

The first post ever on Oddball Stocks...

...was PC Connection back in September 2010 when it was trading at $6.85 a share.

The thesis was pretty simple. There was $6.70 per share in working capital (current assets - all liabilities).

Assuming a 10x multiple for the business at a $0.45 earnings level for the year would have valued the business at $4.50, so that ($4.50+$6.70) suggested a valuation of $11.20. Or, being more conservative and placing a 10x multiple on the then-current earnings (and assuming no growth for the year) resulted in a $2.70 value for the business and thus $9.40 for everything. So, back then the "conservative" estimate was a 40% upside from the trading price.

So what happened along the way? Well, note that in 2016, the company changed its name to "Connection" and the ticker symbol to CNXN. Names are trendy and subject to fads, so one thing that we find is that doing a retrospective can be more complicated than just typing in the ticker symbol.

But here is the stunner: the share price is now $36!

Starting in November 2011, the company paid a dividend of $0.40 and then has paid an annual end of year dividend of similar amounts since then, for a total of $2.98 of dividends. The dividends plus the share price appreciation have resulted in an IRR of 24% compounded for eight and a half years!

Let's look at what happened here. Revenue grew from $1.9 billion for the year ending at the time of the blog post to $2.7 billion for the year 2018. Gross margin grew from 11.6% to 15.2%. The result is that gross profit almost doubled (+88%). Meanwhile, SG&A only grew 70%, so operating income more than doubled.

The result is that earnings per share have grown and in 2018 they were $2.41 a share. (They were 85 cents a share for the full year of 2010.)

So, coming out of the recession you could buy this business for 15 cents a share because current assets covered almost the entire purchase price - and it ended up being a growth stock that had nice operating leverage.

We've been talking about this lately... price rules. Whenever a business sells for a really low price (e.g. for no price once you subtract current assets minus all liabilities, or for zero or negative enterprise value), the market is already acknowledging the problems people are worried about: a recession, a business that seems to be highly competitive and lacking a moat; or in other cases, bad management, bad capital allocation, unfriendly insiders.

Sometimes bad factors win out and a company goes to zero. Or a stock purchase can do really poorly even if they company survives when too high a price is paid. But when companies don't have much debt (and that's what a low or negative enterprise value is telling you), there is a lot more runway to try to improve things. So much more runway, in fact, that most shortsellers are not very interested in situations where there are not financial debts or other fixed liabilities to act as catalysts.