Wynnefield Capital, Inc. v. Tile Shop Holdings, Inc.

This is a developing situation. Tile Shop (TTS) was trading for around $3 until the company announced plans to de-register with the SEC, suspend its dividend, and cancel its share buybacks. The share price crashed by 2/3rds as a result.

They have been sued by a shareholder who claims that this was a deliberate scheme to take over the company at a fire sale price:
The board of directors of a Delaware corporation has a fundamental duty and obligation to “protect the corporation enterprise,” and to defend stockholders “from harm reasonably perceived, irrespective of its source.” This case involves a board that is purposely letting half of its members – including the known repeat fraudster who founded the company – buy a controlling stake in the company through open market purchases at depressed prices, without paying a fair price, much less a control premium. Instead of adopting a poison pill or taking other defensive measures to protect public stockholders in the face of a change of control transaction executed in the open market, this board helped turn a slowly developing creeping takeover into a modern street sweep.
The company is temporarily enjoined from deregistering, and some think that the stock is interesting at the current price. The complaint filed in Delaware court is posted below.

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, 23, 24, 25, and 26. We just published Issue 27 to subscribers, but that will not be available without a subscription for a while.

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.

And also see this post for what's been going on in the Oddball Universe.

Just Published: Issue 27 of the Oddball Stocks Newsletter

Happy Thanksgiving to all Oddballs! We just published Issue 27 of the Newsletter. If you are a subscriber, it should be in your inbox right now. If not, you can sign up right here.

Also, a lot has been going on in the Oddball universe. Some blog posts to catch up on:

Enterprise Diversified, Inc. v. Woodmont Lexington, LLC

Previously regarding Sitestar (now known as Enterprise Diversified or ENDI but still trading as SYTE), we had a post in 2016 about the activist takeover as well as an interview in Oddball Stocks Newsletter with the new management.

The company put out an 8-K today regarding a dispute with (and lawsuit filed against) the manager that took control of Mt. Melrose, LLC (its divested real estate division in Lexington, Kentucky) in July:
This morning, Wednesday, November 20, 2019, Enterprise Diversified, Inc. (the “Company”) filed a verified complaint in the Court of Chancery of the State of Delaware commencing a civil action against Woodmont Lexington, LLC, a Delaware limited liability company (“Woodmont”).

As previously reported in the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on July 3, 2019, the Company had sold to Woodmont, on June 27, 2019, 65% of the Company’s membership interest in Mt Melrose, LLC, a Delaware limited liability company (“Mt Melrose”), which, as has been previously reported, owns and operates a portfolio of income-producing real estate in Lexington, Kentucky. Since the closing of the Mt Melrose transaction, Woodmont, by its representative, Tice Brown, has made repeated offers to buy out the Company’s remaining interest in Mt Melrose. Woodmont’s most recent offer was received by the Company, in writing, on November 11, 2019, with a deadline for acceptance of 9:00 a.m. Monday, November 18, 2019. All such offers have been rejected or not responded to by the Company, as being unfavorable, undesirable and not in the long-term best interests of the Company and its shareholders.

The present action was filed by the Company in response to repeated claims and demands and injurious conduct by Woodmont and its representative, Tice Brown. The Company is seeking, among other relief available, injunctive, declaratory and equitable relief against Woodmont, along with attorneys’ fees and expenses.
The LLC agreement between Woodmont Lexington, LLC and Enterprise Diversified, Inc. is available as an exhibit here. And here is the most recent investor presentation of ENDI, from November 14th.

The docket shows that Enterprise Diversified has filed a Verified Complaint for Injunctive Relief (Confidential Filing), a Motion for Temporary Restraining Order, and a Motion for Expedited Proceedings, as well as a Brief in Support of those Motions, plus various other documents like proposed Orders. Some of these documents were filed under seal, but the two motions can be seen below:

201911201503 by Nate Tobik on Scribd
The case is currently assigned to Delaware Court of Chancery Vice Chancellor J. Travis Laster. We read a lot of his decisions for the "Delaware Chancery Corner" section of the Oddball Stocks Newsletter - he is extremely sharp. 

Life Insurance Company of Alabama

Life Insurance Company of Alabama (LICOA) is a micro cap insurance company with two share classes, one of which (LINS, the fully voting shares) trades at a modest (~20%) discount to book value and the other of which (LINSA, with limited voting rights) trades at a gigantic (>50%) discount to book value. Note that in addition to the voting rights difference, the LINS shares have 5x the economic interest of the LINSA shares.

The company was written up on Value Investors Club and the story is broadly the same as it was then. Despite the big gap between the trading price and book value per share, management is not buying back any stock, and the valuation gap is not closing.

The State of Alabama Department of Insurance periodically examines the insurance companies that are licensed there and publishes a report about them. It is a report that is very helpful for gleaning more information about an insurance company, and helps fill in the gaps between what is in LICOA's bare-bones annual report or even in its annual and quarterly statements filed with the NAIC.

The old reports are not available on the Department of Insurance website, but they are available to anyone who writes in and asks for them. (And pays $1 per page.) The examination report on LICOA from May 2005 has some interesting revelations on the conduct of the family that controls and manages the company:

“It was noted that Rosalie F. Renfrow was hired as a management trainee in September 2002. Ms. Renfrow is the daughter of Raymond Rudolph Renfrom, Jr., a director, officer and stockholder of the Company and Anne Daugette Renfrow, a director of the Company. Ms. Renfrow's monthly salary for 2002, 2003 and 2004 was $1,900, $2,000 and $2,300, respectively, with her salary being increased in September of each year. Ms. Renfrow is also receiving a monthly automobile allowance. This allowance was $300 per month in January and February 2003 and increased to $550 per month for the remainder of the examination period. Ms. Renfrow did not keep regular business hours at the Company – it was noted by examiners that she was routinely not in the office.”

“Company management is not avoiding the appearance of impropriety. If Ms. Renfrow is being developed for a managerial position, she needs a defined job and training program. Due to nepotism within the Company, the Company's President should either actively supervise the training (before it happens, while it is happening, and after the fact) or delegate it where possible. Ms. Renfrow should report to the manager of each department in which she is training. The examiners find it highly unusual that a recent college graduate would be allowed to set their own schedule while receiving a full-time management salary. The preceding report of examination noted an issue with nepotism and this issue stands to harm the Company due to potential shareholder and/or policyholder lawsuits. It is imperative that the Company avoid the appearance of impropriety with the payment of salaries to family members. Ms. Renfrow should maintain working hours comparable to other employees of the Company and report to someone other than her father, Mr. Raymond Renfrow, in order to avoid internal control weaknesses and the appearances of improprieties.”

It is pretty amazing to see a report by a state regulator pointing out behavior by small company management that could cause "shareholder lawsuits". For one thing, only a certain subset of companies have their operations holistically assessed by a regulator: banks and insurance companies are two. And even then, the reports by bank regulators are not usually going to be seen by investors.

One wonders what was in the "preceding report of examination" as well? Meanwhile, here is the full report from 2003 as well as an excerpt with the section called "Other Compensation Issues".

The Problem With "Sum of the Parts"

A version of this essay appeared in Oddball Stocks Newsletter Issue 26. Stay tuned for the upcoming Issue 27 in about a month.

In a finance Twitter discussion about investment theses that revolve around sum-of-the-parts (SOTP) valuations, one astute person pointed out a big problem with these SOTP ideas: the “sum” rarely subtracts the net present value of the corporate overhead.

We have been seeing this problem with a lot of Oddballs recently. For example, Pardee Resources is focused on (mis)-allocating capital to new investments to justify their high SG&A expense, rather than selling timberland at once a millenium high cash flow multiples, cutting SG&A, and buying back stock. The result won't be pretty. Pardee's SG&A expense, meanwhile, is almost $7 million. Is this a perpetuity paid to headquarters staff? What is the appropriate discount rate to capitalize it? Whatever variables you plug into the calculation, the NPV is an unfortunately high fraction of Pardee's asset value.

Or take Avalon Holdings, which we have written about in the Newsletter before. The market capitalization of $7.8 million is only 21% of the book value of $37 million. Avalon is cheap relative to book value, but its assets don't produce much in the way of earnings. The balance sheet shows $73.1 million of assets (of which $46.8 million is property and equipment) financed with $13 million of debt, $21 million of current liabilities, and then the shareholders (and non-controlling interests') equity. These assets only produced $51,000 of operating income (EBIT) for the first six months of 2019!

The pattern at Avalon is that the company has been acquiring properties (like the Boardman Tennis Center last year for $1.3 million) and putting them in a vehicle whose equity trades at 21 cents on the dollar (of book value) and where the cash produced is eaten up by SG&A expense.

In general, these companies at discounts to sum-of-the-parts values (but not cheap based on dividends or cash flows) are suffering from an incentive alignment problem. Managements could stop buying assets, sell overpriced (i.e. low earnings relative to purported asset value) ones to third-parties, and return capital to shareholders. But managements need to own assets to justify being paid. And managers with bigger empires get paid more. (See our post, Small Companies (like Small Banks) As "Jobs Programs".)

With valuations at all-time highs and interest rates at all-time lows, there has never been a better time to sell assets and probably never a worse time to buy them. In Issue 26 of the Oddball Stocks Newsletter, one of our guest writers pointed out reason for the problems at diversified holding companies run by "capital allocators". We are at a cyclical extreme in what people are willing to pay for income generating assets, which explains the dearth of attractive “opcos” for capital allocators to buy. That is ultimately why the book value of Enterprise Diversified dropped to $10.7 million from $19.4 million a year ago.

We continue to see Oddballs – whether land-heavy companies, small banks, or other kinds – that trade for prices below liquidation value if managements sold and yet above the present value, at a reasonable interest rate, of the distributions that shareholders will likely receive over time.

Another problem we see is that investors have abdicated from supervision of their hired managements. Frankly, they are too cheap to engage in “activism” (as shareholder supervision is now known) because they had good results in the past without having to exert control over their investments.

This too shall pass. In the next bear market, micro-cap funds established post-crisis that take too much risk, older investors, and over-leveraged companies themselves will be forced sellers of Oddball shares at much lower prices. That is when it will pay to have studied and read about these companies.

Looking at the Hanover Foods Corporation Annual Results for 2019

Hanover Foods is a classic Oddball that has been written about on this blog a number of times over the years: the original posts (parts 1 and 2) back in 2012, and an update in 2013, among other mentions.

Over the past year and a half we've been writing about Hanover Foods Corporation (HNFSA/HNFSB) pretty frequently in the Oddball Stocks Newsletter. Will anything ever change there? Will value ever be realized? Both of its classes of stock have been in a slump and are back to where they were in 2011-2012. (Of course they have each been paying a small dividend of about $1.10 annually along the way.)

The annual report for the year ending June 2, 2019 just arrived in the mail. The market capitalization is now about $60 million, compared with net current assets of $127 million and common shareholders' equity of $229 million.

The common shareholders' equity is now $320 per share. This is up from the $250 per share when the idea was first written about on Oddball Stocks. Even ignoring goodwill and intangible assets the book value would be $309 per share - almost four times the price of the nonvoting A shares.

However one of our concerns has been that the Hanover business seems to be deteriorating. For this fiscal year, gross profit was $31.8 million, down from $40.8 million the prior year - a decrease of 22 percent. Operating profit dropped from $7 million to only $354,000.

Looking at the cash flow statement, the company had $17 million of depreciation and amortization over the two most recent fiscal years, but spent $25.3 million on purchases of property, plant, and equipment. That $8 million dollar difference was paid for essentially by liquidation of inventory over the most recent fiscal year.

Why was Hanover's profitability so poor? We know from the report that frozen and canned vegetable sales were up a little bit, but snack sales were down from $51.6 million to $44.6 million. Perhaps this segment was higher margin. It seems to consist of snacks like pretzels and cheese balls.

The annual report mentions that last June the company impaired the full amount of the goodwill associated with its snack foods reporting unit. Hanover also "ceased operating its direct store delivery business," resulting in an additional impairment of $2.1 million of intangible assets. These noncash charges drove up administrative expense and so are responsible for a fair bit of the year-over-year decline in profitability.

Hanover's business just seems to be in steady long-term decline. Between 2000 and 2004 sales were lower than today but gross margin was much higher, resulting in some decent profits. Hanover's market capitalization probably wouldn't be $60 million if it were still earning $10 million like it did in 2003 and 2004.

From 2000-2004, Hanover earned an average net income of almost $9 million: higher absolute profits on revenues that were only three-quarters of the current levels. One wonders how much of the declining profit margin is secular business decline and how much (if any) is coming from excessive insider compensation or expenses being run through the business.

On the plus side, since the market capitalization is only 26% of its shareholder equity, the low return on equity transforms into a shareholder earnings yield almost four times higher. (Of course there is the risk that the current, low profitability levels will deteriorate further or become losses...)

We have seen in the past that “one-day” good events can happen for shareholders of companies where the market price is too dislocated from asset values. And we have also seen low returns on equity turn into respectable IRRs for shareholders who buy in at very big discounts to book value. And one other thing worth mentioning – Hanover was probably the most hated Oddball at our Newsletter meetup this year. There was only one gentleman willing to raise his hand to say he had not given up on it!

We have written about Hanover in a number of recent Issues of the Newsletter (back Issues are here) and will continue to do so going forward.

Vulcan International Corp. Timberlands Listed for Sale!

A fellow Oddball sent in a new development for Vulcan International, the previously mentioned (in 2015 and 2018) Oddball that announced plans to liquidate last year but has not announced any progress with the liquidation or paid any distributions.

One of the company's assets is 14k acres of land and timber in the UP of Michigan. This has been placed on the market, with bids due on October 11th:
American Forest Management, Inc. (AFM) has been retained to solicit sealed bids for 14,306± gross GIS acres of land and timber located in Houghton and Ontonagon Counties, in Michigan’s Upper Peninsula. This high-quality property will be offered for sale in its entirety as a lump sum, single-phase, sealed bid event. Offers will not be considered for individual tracts.

Vulcan is located about 25 miles south of Houghton in the area of Twin Lakes. This property is known to be a well-managed, high quality Sugar Maple forest. The Upper Great Lakes Region has numerous markets for many forest products, and Vulcan is well-positioned to take advantage of these markets. The property has an improved road system throughout, allowing for both summer and winter harvesting with little immediate investment. The productive acres of the property are better than average with less than 1% being non-forested.

AFM has set up an electronic data room containing information for bidders to use as they evaluate the property. Access to the data room will be permitted only to prospective bidders who have executed a Non-Disclosure Agreement (NDA) as approved by AFM. The data room will be accessible to such prospective bidders starting on August 30, 2019.

Vulcan is being presented for sale in its entirety, as a single stage, lump sum sealed bid event, with no further option to subdivide. Prospective bidders are invited to participate in the process upon execution of the NDA. Final bids will be due October 11, 2019.
There is also a short video of the Vulcan land with drone footage.

Lately the share price of Vulcan has been declining. It peaked at $140 last October but has dropped to $120, possibly reflecting concern about the lack of updates on the liquidation.We know that shareholders have been contacting the company and at least one sent a formal Section 220 request for information about what is going on.

(P.S. The timber sale will also be interesting because the value it puts on northern Michigan timber will be helpful in thinking about what Keweenaw Land Association's timber is worth.)

Just Published: Issue 26 of the Oddball Stocks Newsletter

Happy Friday to all Oddballs!

Just a quick note that we have published Issue 26 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.

"What is an Oddball Stock?" with Nate Tobik on SNN Network

Nate had an appearance on SNN Network talking about our recent post, "What is an Oddball Stock?"

DuArt Film Laboratories, Inc. Annual Meeting on Tuesday

FYI: the DuArt Film Laboratories, Inc. annual meeting is being held in New York this Tuesday at 10:30 a.m. If you are attended and interested in meeting other Oddballs, get in touch with us.

DuArt sold its Western Broadcasting of Puerto Rico subsidiary in November. The sales proceeds were $3 million versus a book value of $391k of the assets sold.

Boston Sand & Gravel Company - 2018 Annual Report

See our earlier post that contains an excerpt from Issue 21 of the Newsletter (published last August) about Boston Sand & Gravel Company (BSND). The company announced that the annual meting was going to be held in Boston on July 25th, which was very short notice. Highlights from the annual report:
  • They sold a 12 acre intermodal site in Everett, MA for $14.3 million. That is 24% of the market capitalization of the company. The gain on sale was $14.16 million, so the book value had significantly understated the value.
  • "Capital additions for the year totaled $4.5 million as the Company focused on reinvestment in its ready mix plants and fleet, as well as continuing to improve the infrastructure for its short line railroad." Both this year and last year, capital expenditures exceeded depreciation.
  • "The first quarter of 2019 has gotten off to a slow start as several downtown projects have been stalled coming out of the ground. The much discussed federal infrastructure spending package has not come to fruition, so our Company continues to rely heavily on large downtown high rise projects funded primarily by strong foreign investment."
  • A dividend of $30 per share was declared and paid in January 2019. 
  • Gross profit was up slightly but SG&A was up more, resulting in a decline in operating profit from $5.6 million to $4.8 million (-14%). 
At a share price of $600 and 100,327 shares issued and outstanding, the company's market capitalization is $60.2 million, compared to a book value of $54.5 million. The company has $29.2 million of cash and short term investments and $22 million of total liabilities, so the balance sheet is strong. There is also $9.6 million of real estate under development.

We'll have more about this one in the upcoming August Issue of the Oddball Stocks Newsletter. Until then, make sure you see Issue 25 of the Newsletter, and if you are missing any back Issues, you can get them here.

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%
FCF % 14% 18% 6% 5% 10%

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

ROE 10% 23% 5% 3% 6%


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:
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.

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.