CIBL is undervalued again, is the valuation gap enough?

Getting to know a company is much like getting to know a person.  At first two people are acquaintances, knowing surface level facts about each other.  As the relationship develops those small facts and experiences add up and join with the person's character until each person knows each other, not just knows about each other.  And just like when two old friends get back together and get up to speed quickly getting back up to speed on an old investment is similar.

A reader mentioned in the comments somewhere that I should take a look at CIBL (CIBY) again.  I posted about CIBL a year ago here.  You're welcome to read the old post, but I'll do a Reader's Digest summary for those with limited time.  CIBL was a spin-off from LICT, a Mario Gabelli controlled telecom company.  Gabelli is on the Board of CIBL, and signaled to shareholders he was serious about realizing value for them.  The company owned two TV stations in Iowa, and cell towers inside of a joint venture in New Mexico.  The company's annual report repeatedly mentioned they had received an offer to purchase their cellular interests for a price greater than the company's market cap.  Even with this explicit signal the efficient market failed to adjust CIBL's price upwards.  The company did end up selling the wireless interests for a price that far exceeded the market cap, and the shares finally ran up.

I ended up selling my shares when I received the proxy for the sale in the mail, I ended up making 50% on my purchase in a few months.  I wish all my investments worked out that well and that fast, but if they did I wouldn't be writing this, I'd be sipping a drink by a pool somewhere tropical.  Instead I'm sitting in my basement office at night scouring markets for opportunities, and writing about it.  I enjoy this, but if someone is willing to offer me the tropical gig I'm all ears.

A lot has happened since I sold my shares.  The company decided to return cash to shareholders in the form of a dutch auction.  The company offered to buy 7,000 shares of their stock at a price of up to $860 per share.  Only 2,460 shares were tendered, so while shareholders were happy the company sold the cellular interests, they are also happy to let Gabelli make capital allocation decisions instead of themselves.

After the dutch auction CIBL then went on a buying binge, they purchased 40% of ICTC Group (ITCG) which is another Gabelli spin-off from LICT.  ICTC Group is a rural telephone carrier in North Dakota with 2300 lines and 600 DSL customers.  The company also runs an ISP which services 1000 customers.  The 40% interest was purchased in two parts, 20% was purchased as a private placement, and the second 20% was purchased through a tender the company offered to ICTC Group shareholders.  Of all the things CIBL has done in the last year this is the one that fails the sniff test for me.  Gabelli's company LICT spun-off both CIBL and ICTC Group, and now CIBL purchased part of ICTC Group back in a private placement.  My suspicion is that CIBL was used to cash out Gabelli's position in ICTC Group.  If this is true there might be a note in the annual report in a few months.

The company also increased the authorization to buy back their own shares, and acted on that authorization.  There are still a few shares available to buyback, but not enough to move the needle at this point.

I created a small spreadsheet showing the changes to CIBL's balance sheet since Sept 30th with all the cash movement:

At the end of the year the company had $17.41m in cash available to use.  Because the company is essentially a holding company they don't have any liabilities except for taxes.  I reduced the cash balance by taxes the company is expected to pay out in periodic payments over the next year.

Valuing CIBL

Valuing the company is relatively easy considering they're not much more than a pile of assets.  The company does have earnings from equity interests but only the relevant subsidiary should be valued on an earnings basis, not the entire holding company.  The best way to value CIBL is a sum of the parts.  The only piece of their holding that's difficult to value is their TV station interests.  In my prior post I took a stab at valuing them based on the information in the annual report.  After that post and upon further research I think my valuation of the TV stations was on the high side.  The two stations earned $185k in the last quarter, but the company noted this was higher than normal due to political ad spending.  The TV station interest is held on the balance sheet for $519k which is on the low side considering that $519k generated $185k in earnings.  Based on the earnings the stations generated last year, and the low salability I took them at 4x of last year's earnings.  This value might seem low, but there is some debt attached to the stations, and for indebted marginally profitable local TV stations I think a low multiple is appropriate.

Here is how the valuation breaks down:

Based on this estimate CIBL is selling for 25% less than the sum of the parts.  Most readers will spot that this valuation is extremely sensitive to the value of the TV stations.  Purchasing at the current price gives the investor $965 p/s in cash and investments, plus the TV stations for free.

While a valuation is sensitive to the value of the TV stations the biggest wildcard for me is what comes next.  If CIBL was simply returning cash to shareholders and planning to sell the TV stations it would be very attractive at this price.  Instead the company coffers are full of cash and management has indicated they are looking to make substantial acquisitions.  If the company is a savvy acquirer with a competent manager CIBL could work out well for shareholders.  My concern is that this isn't the case, they have acquired 40% of a marginal rural telco that isn't creating a lot of economic value for CIBL shareholders.  The shares of ICTC Group were purchased below book value, but the company isn't contributing all that much in terms of earnings or cash flow.  In other words CIBL took liquid cash, and tied it up into something that ultimately needs to be sold to generate value, the holding pays no dividends, and doesn't have much free cash flow.

While the valuation gap is compelling, I've decided to wait this out for now.  If CIBL drops significantly I would be a buyer once again, but for now this will have to wait.

Talk to Nate about CIBL

Disclosure: No position

How I passed on Costar

I apologize for the delay in blogging, I had some urgent family matters to attend to, and investing hasn't crossed my mind for a number of days.  Things have stabilized and I wanted to get back into researching and writing.  For anyone wondering I didn't abandon the blog, I have no intention of joining the long list of value bloggers who've disappeared.

I realize a fundamental flaw of this blog, and many stock blogs is they mostly highlights companies that are worth researching.  If I look at a company and decide to stop further research readers will never know that I looked at the company, or why I decided to pass.  Because of this an important part of my investment process is kept out of view.  From time to time I'll come across a company that I wouldn't invest in for a variety of reasons, and the company is easy to write about, Costar is one such company.  As a result I want to take readers through a journey as to why Costar was worth researching, and why I won't be investing with them.

I found Costar (CSTI) through a very dubious screen of OTC net-net stocks.  I say dubious because a number of unlisted companies I'm very familiar with appeared on the screen as net-nets, none are net-nets.  And as the operator of Unlistedstocks.net I know there are a number of net-nets on my site that didn't appear on this screen.  Even with the junky data it was a starting point.

Costar manufacturers and distributes video surveillance systems for retail and industrial uses.  The company buys parts from Asian suppliers, assembles them and then sells the video systems as a complete package to customers.  The videos and systems the company sells are familiar to most readers, ceiling mounted black cameras, standard CCTV cameras, and recording systems.  The market is large, and the company is small, I really have no idea who their target customer is.  If I had to venture a guess it'd be local retailers and industrial users who are too small to move the needle of Honeywell or a similar competitor.

The biggest draw to Costar is that they're a net-net trading at a significant discount.  At the most recent price of $2.02 they're trading at a 42% discount to NCAV, which is less than the magical 2/3 of NCAV that Graham advocated purchasing below.  Here is their net-net worksheet:

Most of the company's assets are receivables and inventory, which isn't surprising given the line of business they're in.  The company's website had a PowerPoint deck showing some pictures of their offices, assembly areas, and warehouse.  The amount of inventory is staggering, $4.7m of hard drives, wires, cameras, and electronic components.  Electronics inventory is hard to value, to Costar the parts have a value, and if parted out individually on eBay each component could probably fetch close to cost.  While the company isn't planning on liquidating, the liquidity, and resale value of inventory are important to keep in mind.  Costar has high liquidity, and high resale value, but due to the high volume of pieces some sort of discount needs to be applied.

My first concern before I left the balance sheet was that the company is running very light on cash.  The balance sheet at the last snapshot had $203,000 held in cash, but previous periods had the amount as low as $90,000.  I wondered what business dynamics put them in a position where they had large working capital requirements, but no cash to speak of.  The answer is located in the liabilities section the heading: line of credit.  The company has been aggressive at paying this item down, but at various times in the past it's clearly been used to fund working capital needs.

Debt alone isn't usually a concern, for a net-net with a shaky business I'd prefer no debt, but it's not an ultimate rule.  But Costar is the exception, in the CEO's letter to shareholders he mentioned the difficulty the company had in obtaining a new credit line for 2012/2013.  We don't have any statements since the company opened the new line of credit to know how punishing the interest rate is, the company ultimately went with Briar Capital to fund the line of credit.  

When I'm looking at a potential investment, I want things to fall into place for the good or bad like puzzle pieces.  One item of data leads to another which leads to another, etc.  I don't generally read statements in a top to bottom fashion, I follow a story through them, either looking at the balance sheet and what it says about the company, or what the cash flow is saying.  In Costar's case the comment about Briar Capital led me to the income statement.

Briar Capital is an asset based lender, they talk at great lengths on their website about how cash flow isn't needed to obtain a load, good collateral is enough.  Banks are asset lenders for real estate, but for businesses they are usually income lenders.  If a company can show a consistent income pattern over months or years a bank will extend capital.  Costar had trouble with banks because they haven't had a history of profit.  The company has been chronically unprofitable for years before deciding in 2009 to execute a turnaround.

The company sold off a large division, and re-focused on the camera market.  The company has worked to increase productivity, and margins.  The company reported $688k in revenue per employee in 2011 verses revenue per employee figures for competitors ranging from $160k to $560k.  The numbers are impressive, but you can only squeeze so much juice from a lemon.  At some point the company is going to want to grow their volume, and that'll require extra personnel to build the systems, sell the systems, and manage the implementations.  My gut feeling is at this point the company is operating with the absolute fewest workers possible, and the addition of new employees to support growth could sink income into the red again.

In a PowerPoint on the company's website management lays out their turnaround strategy for the company which extends to 2014.  Clearly things are changing because the company finally reported a profit, I'm just weary of a turnaround that takes five years to execute.  At the five year mark it's unclear whether management actions had an effect, or if the market just recovered on its own.  I'm inclined to say that the market is recovering, and Costar is a beneficiary at this point.

I've talked around the income statement and cash flow statement.  The company has reported alternating periods of strong cash flow, then strong negative cash flow roughly equaling what they had brought in during strong periods.  All free cash flow is consumed by repaying the line of credit when possible.  For all the management talk about investing for growth not much cash has been needed, in the latest quarter the company spent $14,000 on capex.  The company isn't resource intensive, but it's not resource light either, they are a light-manufacturing company.

The company reported their first profit this past year, before that they broke even, or reported losses.  

If you've made it this far in the post you're probably wondering what the nail in the coffin was for this company, the problem is there wasn't one nail, it was a combination of all of the things mentioned above.  The company has an average balance sheet loaded down with receivables and inventory, and a sprinkling of debt.  They don't earn enough cash to fund their working capital needs, and alternate between drawing down the line, and paying it back.  The company is working on turning around operations, but it seems like they just cut their workforce to the bone and are experiencing some sales growth as the economy recovers.

None of the above items alone was enough for me to walk away, but the combination of all of the above was it for me.  Some readers will ask the question "Since this is a net-net, aren't those problems expected, and shouldn't you just invest by the numbers anyways?"  My answer to this is bold, I think that Costar is probably fairly valued at this point.  If I were privy to the books I'd guess that inventory is overstated some, and receivables aren't going to be collected completely.  The company isn't making any money either, so with an overstated balance sheet, and no earnings, trading at a discounted NCAV is probably appropriate.

Talk to Nate about Costar

Disclosure: None

Is Guinness Peat Group still a buy? The Coats story..

The holy grail of a deep value investment is a company that's in the process of liquidating and selling on the market for less than the amount to be realized in the liquidation.  Situations like this don't come along too often, but one did recently, Guinness Peat Group (GPG.LSE/ASX/NSX).  The difference between the Guinness Peat Group liquidation, and a usual liquidation is what happens at the end of the process.  In a normal liquidation shareholders end up with cash, for GPG shareholders they will end up with a exposure to a company called Coats.

I wrote previously about GPG with the thesis being that it was selling at too low of a price considering their assets and what Coats could potentially be worth.  In the intervening months a lot has happened for GPG and shareholders have been provided with the official liquidation plan.  The company plans on selling all of their non-Coats investments and using the cash to buy back shares.  Eventually GPG shareholders will have a pure exposure to Coats through GPG.  When I wrote about GPG in the past shares were trading below the book value of the investments, but since then they've converged, with book value decreasing and the share price increasing.  The quick gain in a few months, and the fundamental business change for GPG has led me to re-examine the situation.

Coats background

Coats is the world's largest thread manufacturer for industrial and craft uses.  They are three times the size of their next nearest competitor.  The company's threads are used in everything from shoes, to clothes, to coats, to knitting yarn.  According to the company's website 20% of all thread originates from Coats.  The company is also an industry pioneer for thread innovations.  Operations are spread out across the world, and clients are large brand name apparel manufacturers.

The company was publicly traded up until 2003 when Guinness Peat Group took them over and took the company private.  GPG paid £414m for Coats, over the ensuing decade the value of Coats has fallen with GPG internally valuing them at £320m.

The investment case

The market is valuing GPG at book value, which means Coats is being valued at £80m by the market.  GPG has an internal value for Coats of £320m which is four times more than what the market is saying they're worth.  In addition the per share value of Coats should increase as GPG sells off their investments and buys back shares.  An investment in GPG at current prices means an investor has the ability to buy Coats for £80m, the question I had was, is this a good price for Coats, and would I want to own them?

Here is a spreadsheet I put together with some historical data for Coats:

Before diving into the details of Coats I want to mention one thing regarding currency.  GPG is a New Zealand company listed in New Zealand, Australia, and the United Kingdom, they use the Pound as their functional currency, but provide figures in NZD as convenient.  Coats uses the US Dollar as their functional currency, but is a UK company, headquartered and taxed in the UK in Pounds.  Guinness Peat Group is listed in the UK, New Zealand, and Australia.  The currencies are confusing to say the least.  I take everything in the company's functional currency and convert to something else where appropriate.

The bull case has already been well established, but the results bolster it further.  The company earned $61m in 2011, and have average earnings of $20m.  Coats is trading for an effective P/E of 6x on average earnings, or a P/E of 2.2x based on last year's earnings.  The company has £77m in cash on the books too.  Coats is also attractive on an EV/EBIT basis, trading with a ratio of 2.74x.

Here are averages for the last eight years:

My concerns about Coats doesn't have anything to do with their valuation, it has to do with their debt, and their ability to earn a satisfactory return.

Coats is highly levered, at the middle of the year they had $350m in short and long term debt.  It's concerning to me that they continue to carry, and rely on short term debt as much as they do.  Short term debt is riskier than longer term debt.  If the company fails to roll over the short term debt within a year they could be in default and bankers would be deciding the fate of my investment.  In general I'm adverse to debt, but if a company prudently borrows long term I don't have as much of a concern.  I get concerned when a company continually needs to go back to their bankers, rolling forward their debt to operate, that's the position Coats is in.

Another concern I have with Coats regarding their debt is that their interest coverage isn't that high.  In their best years Coats had their interest covered 5x, but the coverage ratio isn't consistent.  At worst interest was covered less than 2x in 2009.  This year is trending to be slightly less than 3x.

My second concern is about the financial return that Coats is making on their invested capital.  I purposely didn't include ROE on my spreadsheet because it would be artificially high.  In 2011 the company earned $61m on equity of $114m for a ROE of 54%, unrealistically high.  The company was able to achieve a high ROE because they have almost no equity.  A better measure of performance is return on invested capital.  I calculate it using free cash flow dividend by the total invested capital.  If you're confused as to why I do it this way I wrote a post a while ago explaining my reasoning.  The ROIC metric tells a much different story about Coats.  Rather than having incredible earning power Coats is barely generating a return on all of the capital they have invested.

The company achieved their highest ROIC in 2009, most likely because they were working off excess inventory, and didn't re-invest as needed, generating higher than normal free cash flow.  Outside of 2009 the company earned anywhere from nothing to 8% in 2004.  Last year came in above 6%, but the company doesn't think that historic performance will be repeated.

It's confusing to consider GPG and Coats within the context of the investment liquidations and share buybacks.  I decided to consider Coats and GPG different.  I looked at Coats in isolation and asked the question, "Would I buy Coats for £80m?"  On first glance the investment is appealing, the company is clearly cheap, and they hold a leading market position.  My problem is there doesn't appear to be much of a margin of safety at these levels.  There are plenty of highly levered companies selling at low multiples, the risk is that business stays steady or grows and we avoid a downturn.  Coats issued a press release stating they believe the 2012 levels of business will be below 2011 levels.

When I initially purchased GPG there was a strong margin of safety, the company was selling below the value of their investments.  But as the price has run up, and results have come in for Coats the investment has changed.  I still think Coats is cheap, but it's more of a speculative return from here, not a safe return.  I will most likely be selling out of my Guinness Peat Group shares to buy something much safer.

Before I wrap up I do want to mention that if Coats traded for £320m, the internal value that would be a 67% gain from these levels.

Talk to Nate about Coats/GPG

Disclosure: Long GPG shares for now.

Argo, an undervalued asset manager with a potential catalyst

Some of the best investment opportunities are the hardest to write about, the stocks are plain cheap and there isn't much to say.  I've heard it said in the past that there are stocks that make good stories and there are stocks that make good investments.  My goal on this blog has always been to find stocks that could potentially be good investments, and if they have a great story attached all the better.  Argo has a mixture of both.

I first came across Argo and wrote about them a year and a half ago.  They came up on a net-net screen I ran for profitable net-nets trading in the UK.  I spend a few hours reading their annual reports and ended up purchasing shares.  At some point between then and now I doubled my investment, the date or reason doesn't matter because the thesis (and price!) has stayed the same since then.

The Argo Group Limited (ARGO.London) is an alternative asset manager.  The company manages a number of emerging market fixed income hedge funds.  In their admission document to the AIM they make they claim that they seek to be fundamental value investors in the emerging fixed income space.  The funds invest in fixed income, special situations, local currencies, interest rate strategies, private equity, real estate, and quoted equities.  The only things I didn't seen mentioned in that list were gold and farmland.  As most investors know asset management is a great business model, fixed costs are low and the business is scalable.  

The company came into being publicly traded through a strange set of circumstances.  Initially Argo was founded by the Rialas brothers, Andreas and Kyriakos.  The company was privately held and was fairly successful.  Assets under management grew significantly, and their funds won a number of awards.  The success didn't go unnoticed as they were acquired by Absolute Capital Management Holdings in 2007.  Absolute Capital Management Holdings Limited was a Swiss hedge fund firm that traded in London.  Absolute Capital Management hit a rocky patch as the founder left in 2007 and it was revealed that he put more than half of their biggest funds' assets into highly illiquid pink sheets.  Not only did they invest in illiquid stocks they also worked with another party to manipulate the price of the pink sheet stocks to inflate the NAV of their flagship fund.

While Absolute Capital Management hemorrhaged assets the Rialas brothers wanted a clean break from the troubled parent.  They engineered a spin-off of the Argo assets before Absolute Capital Management folded.  

There are some other aspects of the company's history that are fascinating, but ultimately they aren't relevant to the main reason why Argo is worth considering.  The biggest attraction to Argo is that they're a net-net, and not only a net-net, but a net-net with a decent asset management business along for the ride.

The company has a NCAV of £15.98 against a marketcap of £8.34, the company's NCAV is almost double the last trade.  The company had an operating profit of £411 in the first semester this year.  They reported a loss due to a goodwill write down.  The company's balance sheet has almost no liabilities and assets consist of cash, receivables, and an investment in their flagship fund.  

The company has significant earning power even at their lower asset levels, last year they earned £1.36m on close to $400m in assets.  The first semester this year they paid out £870,000 in dividends. 

Before moving on I want to highlight that Argo is trading at half of their net current asset value.  In addition they have reasonable earning power for a fund their size, and pay out most of their profits as dividends.  While shareholders sit and wait for Argo to appreciate towards its true value they're paid close to a 10% yield, the dividend yield alone is satisfactory for most investors.

I'm not going to sugarcoat Argo, the only reason the company is attractive is because they're selling at such a low valuation.  If someone presented me this company selling for £35m I wouldn't be interested, but at £8m I am.  The company has considerable headwinds, the biggest are the slide in assets and problems with their real estate fund.  The asset outflows stem from below average performance in some newer funds right after the lockup expired.  The Argo Fund (TAF) has performed acceptably well.  The Special Situations Fund, and the real estate fund both have done poorly.  The Real Estate Opportunities Fund (AREOF) invests in entire real estate projects in Eastern Europe.  

The AREOF purchased two shopping centers in Romania in the past year stating that they believed the malls were bargains.  The only problem is the fund was short on cash and was having trouble obtaining credit.  At one point they were in default on some of their loans.  The fund was able to secure lending with Argo backstopping the fund.  Even working through the numbers with the backstop factored in Argo is still cheap.

Another issue is that Argo operates out of Cyprus while being listed in London.  Cyprus has been in the news recently as a potential trouble spot in Europe.  At one point the company had offices throughout the world.  Before any reader is impressed my initial impression when seeing eight or so world offices for a company of 30 was that regional offices such as Buenos Aires were nothing more than an analyst working out of their apartment.  The company's address is on the Isle of Man, and I have a suspicion one would be very hard pressed to find a physical office for Argo.  A distributed company doesn't concern me, but some might believe management is up to no good.

With all the problems the company is facing a valid question to ask is whether they are actually worth any more than NCAV?  The valuation gap between the current price and NCAV is enough for an acceptable return, but some investors aren't satisfied playing for doubles, they want triples and home runs.  

The standard way to value an asset management firm is a percentage of AUM.  A great asset manager might be worth 7% of AUM, a poor one 1-3% of AUM.  I would expect Argo to be worth at least the low end of the valuation scale, so $3-9m for just the asset management business alone.  Add in the cash and securities and they're worth a bit more than double.  A side note, the company's functional currency is the US Dollar, all trading stats are in Pounds.  

If the valuation gap between NCAV and the current price isn't enough there's a potential catalyst for Argo.  A fellow blogger Wexboy has been in communication with the Rialas brothers about ways to unlock value for shareholders.  He's written two letters to the Board.  Guy Thomas, the author of Free Capital has also become a significant shareholder and has signed onto Wexboy's campaign.  The first signs are encouraging, management has been receptive to communication. 

When considering Argo and their valuation gap, plus a potential catalyst I'm reminded of a Walter Schloss quote "something good will happen."

Talk to Nate about Argo

Disclosure: Long Argo

Margin of safety

So many things wrong, cyprus, aum, real estate fund

Not many need to go right, activist (wexboy link)

13 stocks for 2013

The popular thing to do this time of the year seems to be generating lists of stocks that will do the best over the next year.  I thought I'd get in the game with a twist, I won't claim any of these stocks will do well in the next year, but I think over the next three to five you'd be happy to own them.  Most of the stocks are companies I have written up in the past, some aren't, but I own shares in all of them.  I put my money where my mouth is, I have adding to, or been trying to add to some of these positions recently.  All of the following stocks are just as attractive as when I wrote about them, or first purchased them.

I thought about naming this post "13 stocks to make you rich", or "The HOTTEST 13 stocks", but I don't have glossy ads I need to sell, so I'll leave those to the magazines.  I would challenge any magazine to pit their stocks against mine over a five year period.  I'd much rather own this motley group over any set of blue chips English majors from an Ivy picked.

The stocks are ordered alphabetically.


Argo (ARGO.UK) - I first wrote about Argo about a year and a half ago, and they're even more attractive now then they were then.  The company is an emerging markets asset manager listed in London but based out of Cyprus.  They are trading far below NCAV, and even below net cash.  There are some value bloggers who've started to raise the undervaluation issue with management, and management has been very receptive.  I plan on posting about them again soon.

Bank of the James (BOTJ) - I don't write about banks, but that doesn't mean I don't invest in them, I actually own quite a few community banks.  Bank of the James is a classic community bank, they own a number of branches in Lynchburg Virginia, and are exposed to the local market.  Losses are rolling off and branches that were opened in 2008 are becoming profitable.  The bank could do more to improve their efficiency ratio, but I don't think cuts are in the future.  A community bank trading far below book with a low earnings multiple, and recovering earnings, I'm a buyer.

Carlo Gavazzi (GAV.Swiss) - Carlo Gavazzi is a Swiss manufacturing company, but they're more than Swiss, they're global.  The company manufacturers automation components, whole bus assemblies and sensors such as the ones that keep elevator doors open.  The company is cheap on an EV/EBIT basis and earns an outsized return on invested capital.  They're family owned and controlled through a dual share structure which is a turn off for a lot of investors.  The family is conservative and eschews debt, they're focusing on growth outside of Europe.

Conduril (CDU.Portugal) - A Portuguese construction company that could be one of the cheaper equities on the continent.  They have a P/E of 2x and are a net-net, they're also family owned and controlled.  The family tried to take the company private a few years ago but the regulator wouldn't let them.  The company is heavily exposed to African construction, the writeup on them is here.

Conrad Industries (CNRD) - A stock I researched then dilly-dalled on buying, much to my dismay.  An American boat builder based in Louisiana.  Another family controlled company with outsized metrics, high returns on equity, an extremely low P/E and some potential catalysts.  The family has engaged a banker to examine strategic alternatives, they've also declared a $2/sh special dividend.  In addition to all of this they're using their copious free cash flow to buy back shares.

FRMO (FRMO) - A strange unlisted public company that generated a lot of interest.  This is Murray Stahl and Steven Bregman's personal investment vehicle.  The company owns close to a 1% stake in Horizon Kinetics along with a slew of owner operated equities.  It's like owning a fund managed by Stahl and Bregman without the expenses.

Goodheart-Willcox (GWOX) - An text book publisher that hit hard times over the past few years.  The company's market appears to be bottoming with sales finally increasing over the last quarter.  The company was a cash box but put most of the cash to use buying back shares.  Because of the buyback earnings only need to recover to a mere shadow of what they once were before this is a P/E 4x stock.

Hanover (HNFSB) - This is a great story stock that's incredibly cheap, I wrote a two part series here, and here.  Even though shares are up since my initial post the company has continued to grow and the valuation gap remains.  If you can get past the self-interested CEO you'll find a food company growing at close to 8% a year selling for 30% of book value with a P/E of 5x.

Installux (STAL.France) - This is a classic French owner-operator company.  The company manufacturers aluminum panels and decorative pieces for the sides of buildings.  They're a cash box, and if you back out cash ROE is 14%.  They earned €17.97 in 2011, €21.78 in 2010, and €15.57 for the first six months of 2011 (they trade at €140).  Sales have increased year over year, and cash increased €5.1m this past quarter.  Of course they're mostly exposed to domestic French policies, but that's also why they're so cheap.

Japanese net-nets (Japan) - Not a specific company per-se, but a general investing theme.  I strongly believe an investor buying a number of Japanese net-nets at well below NCAV will be satisfied with their returns in three to five years.  I embarked on the great Japanese investment project, and it's still in progress.  Unfortunately Schwab is a bit more restrictive in what I can purchase, so I've pared back my expectations, but the process is still ongoing.  I actually purchased two new Japanese net-nets tonight.  I'll have a follow up on this in the next few weeks.

Nexeya (ALNEX.France) - A defense contractor in France that is a classic two pillar stock.  The stock has run up quite a bit since I posted, but improved results have also come out and the stock is still cheap.  Not much else to be said about them beyond what was already said in my initial post.

Precia (PREC.France) - A weighting (scale) manufacturer with global reach based in France.  The company is expanding quickly overseas especially in India.  Sales in the Eurozone are slow, but sales outside of Europe are growing fast.  For the fast growth and high ROE the company is rewarded with a P/E of 9x and shares trade at book value.  I liked the company when I first wrote them up, and I still like them increasing my position two weeks ago.

Solitron Devices (SODI) - I have written about Solitron a number of times on the blog.  I was so frustrated by the undervaluation I went as far as writing the CEO a letter urging action and rallying support through the blog.  Solitron responded to the shareholder outcry with a share buyback and the initiation of an annual meeting next summer.  The shares are still extremely cheap.

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Disclosure: Long all companies mentioned!

What's your real business? The National Stockyards story

Ever wonder how companies get their names?  Older companies usually have descriptive names while newer ones have names generated by marketing departments.  A name like National Can describes what the company did well.  A name like Accenture means nothing, and says nothing about what its employees do.  Sometimes a company moves beyond their name, this is the case with the National Stock Yards (NSYC) company.

Based on the name National Stock Yards should be doing something with cattle, and they do.  The company owns two subsidiaries, the Oklahoma National Stockyards, and the St Louis National Stockyards.  The St Louis Stockyards closed in the late 1990s due to declining cattle volume, while the Oklahoma stockyards are still in operation.  If National Stockyards were simply a cattle operation it would be easy to pull national beef pricing data and expectations and estimate a value for the company. Fortunately there is more to the story.

What makes National Stockyards interesting is the small set of businesses they own and operate.  The company runs the namesake livestock auction, a livestock warehouse rental business, office rentals, a legacy holding in a railroad, an equity interest in a golf course, and a large real estate development interest.  From what I could tell the railroad is defunct and exists in name only, but they still claim an ownership interest.

The company's cattle operations provide the top live revenue, but the livestock operations don't totally cover their cost.  Over the past two years the company has lost money on their livestock and livestock real estate operations.  In 2009 the company made a slight profit.  The company's auction operations profitability is closely linked to cattle sales.  The auction house gets a cut of each animal sold, fewer animals auctioned means lower revenues.  It doesn't help National Stock Yards that American beef consumption has been falling since 1970.  Beef consumption is to levels that haven't been since in the last 40 years; as Americans cut the red meat National Stock Yards suffers.  The following chart illustrates very well why National Stock Yards was able to have multiple facilities for years, and then why they eventually closed one, and run the other two days a week.

The interesting twist with National Stock Yards is what appears to be a cattle story is more of a real estate story.  The company closed down their St Louis stock yards in the late 1990s which left them with close to 600 acres of developable real estate.  Since the 1990s the company has developed and sold off more than half of that real estate.  A portion of the real estate was swapped for an equity interest in a golf course located on their land.  The golf course is held on the books at $0.  Any savvy investor can recognize that even a money losing golf course has a value of more than $0.

The real story at National Stock Yards is the future real estate development in Illinois (East St. Louis, right across the river).  The two states of Illinois and Missouri are in the process of building a new bridge across the Mississippi, the location crosses National Stock Yards land.  The company has sold a number of plots to the state over the past few years as part of the bridge building effort.  As a condition of the sale the state has put money into a trust to develop water and sewer connections on the company's land.  The state also agreed to demolish unused buildings at the state's expense.  Understanding the impact the bridge will have to National Stock Yards is difficult without a picture:

The company's land is located in or right near the blue circle with "3" on both sides, to the left of the "Fairmont City" label.  For the bridge to be completed the highway has been re-aligned and new interchanges built, one exit will provide ready access to the company's real estate.  The new bridge and connections should be open to traffic in 2014.

All of this is to say that the portion of undeveloped real estate left is highly salable, and is in a desirable location.  Some readers (most from the MidWest) will dispute my last sentence citing the proximity to East St Louis.  Painting with a broad brush, East St Louis is a very depressed and crime-ridden city, and real estate in East St Louis is about as valuable as real estate in the inner city of Detroit.  I initially wrote off the value of the company's land when I read where it was located until I took a look on Google Maps.  The company's real estate is a few miles outside of the ghetto-ish area, and abuts farmland.  The Illinois side of St Louis turns rural very quickly as one travels away from the Mississippi.

It's probably possible to get a very accurate valuation of the land for sale by calling a commercial broker in the area.  In the absence of the actual listed value I looked for some rough comps in the area.  I also took the values from the land sales to the state and come up with a valuation range:

The first value is the current book value of the property, $12,242 per acre.  The last two prices are actual comps in the area, the middle two numbers are values at which the company has sold pieces of the land to the state.  One 10 acre plot went for $247,000, and a three acre plot went for $107,000, both sales were in the past two years.

Sometimes real estate companies can end up with pie in the sky valuations when the price of one valuable piece of property is extrapolated out to the rest of the holdings.  A situation like that is possible with National Stock Yards, but I found a line in the annual report to be reassuring in this regard: "Management estimates that the fair value of the Company's St. Louis real estate is in excess of its carrying value and demolition costs.."

The best way to value National Stock Yards is on a sum of the parts basis.  The stockyards themselves throw off a few hundred thousand in operating cash flow a year, and have a book value of about $4m. I have no idea what a stockyard could be worth to a buyer, if there are any, so I'll just take book value at face value.

The company's share of the golf course is worth something although an exact value is probably impossible to obtain considering the carrying cost is zero.  The golf course is an equity investment, and unfortunately the annual report doesn't have a statement of equity.  There are a few lines showing beginning equity, dividends accrued and ending equity.  If the golf course is the only equity investment then they're accounting for a $100-$300k change in equity per year.  Maybe the interest is worth $500k, or maybe a million, either way it's a bonus to the valuation.

The final piece is the real estate holdings in East St Louis.  If we assume all of the land is worth the lowest price IDOT paid it's worth $6.5m, double the carrying cost.

Add up $4m, $6.5m and $1m and the company is potentially worth $11.5m.  Given that their market cap is currently $7.2m I'd say they're trading at a sizable discount.  If the company can sell any of their holdings for more than $25k an acre the valuation quickly becomes more appealing.

Lastly it's worth noting that in the past when the company has sold real estate holdings they generally pay out almost all of the proceeds as a dividend.  They paid a $35 p/s dividend in 2009 and a $12 p/s dividend in 2010.  I won't speculate on what future dividends could be, but they could be large.

If you're looking for more information on National Stock Yards you'll need to buy a share for $166 and call the Treasurer with proof of ownership for a copy of their latest annual report.  Of course financial information is available on Unlistedstocks.net along with details on 68 other unlisted companies as well.

Disclosure: I own one share as a tracker position.

Investing like a lender

I recently wrote a post where I discussed using a bond investor approach to evaluating equities.  I've continued to think about that post since writing it, and wanted to write a follow up extending that line of thinking further.  This post could really be thought of as the second half to my bond investor post.

A bond investor is buying a security issued by a company on the market.  The bond investor is worried about losing money and ensuring the business has enough operating earnings to cover interest costs.

A lender is one step closer to the business than a bond investor.  The bond investor is buying what the company is offering, a lender is taking a look at a given company and evaluating what to offer them.  A company wants or needs capital and they're at the mercy of the lender.  The bond investor is at the mercy of the company.  Thinking through this subtle difference can be helpful in making investment decisions.

The best way to apply this thinking is to ask the question "would I loan this company money, how much, and where on the seniority ladder?" when looking at a potential investment.  Asking questions like this can root out all sorts of seemingly tiny problems that have the potential to grow into large problems.

I like to take the lender approach when looking at net-nets if possible.  Obviously net-nets have large unencumbered asset balances, so it would be relatively simple to make them a loan correct?  Not exactly.  A lender is worried about collateral quality and the borrower's ability to pay.  The ability to pay concerns the borrower's operations.  If operations are slowly melting away, the company's current assets could be at risk.  It's hard without having a frame of reference to know if current assets are at risk in a poorly performing net-net.  Using the lending framework makes it easier.  Think through how much you'd potentially lend to a given net-net, and think about how long the company would be able to pay your rate.  Next think about what might have to happen before your money is at risk.  It seems like a bit of a jump for an equity investment, but it really isn't.  Given a net-net that doesn't have debt, the equity is the most senior claim.  The "interest" you'd receive is the earnings yield.  Maybe the company isn't earning anything, would you be happy loaning a company money for no return?  The loan would be similar to a zero-coupon bond, would you issue something like that to the company?

Often using the lending framework I'm able to flush out small details that make me really uncomfortable with an investment.  There have been two investments recently where using this framework would have been very helpful.  In the first instance I didn't think like this and I ended up with a slight loss.  The loss could have been greater but I realized my mistake quickly and sold very quickly.  The second, which I'll detail below was an investment where I wasn't completely comfortable and I avoided a loss.

Some readers will be familiar with Eagle Hospitality Trust.  The company was a REIT that owned a series of hotels in the Midwest.  The trust fell on hard times and cancelled their common stock and began to run into problems with their lender.  A lot of things happened during the financial crisis, but their debt eventually ended up with the Fed who sold it to Blackstone.  Operations never righted themselves and Blackstone threatened to foreclose on the properties if the trust couldn't sell them first.

The trust had some preferred shares outstanding, and writeups I'd seen online talked about how the preferreds could be worth up to $15 per share depending on the outcome of the hotel sale.  This was really enticing because the shares were trading at $5 apiece.  To add to the intrigue the trust is a dark company, requiring a share purchase and proof of ownership to get financial statements.  When the company distributed the financials they included a disclaimer stating that the following information was confidential and shareholders weren't allowed to discuss or share it with anyone.  So all online writeups were of the cloak and dagger variety.  As I stated, I have the financials, my email is below, hint hint.

The thesis on Eagle was that the hotels would sell for some rich valuation and the remaining cash and receivables would end up going to the preferred shareholders.  The potential reward on this investment was significant, it was exciting.  I kept looking at it and thinking that I could double or triple my money in a short period of time.  Then I started to look at Eagle from the lender perspective.

My first thought was why would Blackstone agree to let Eagle sell the properties and pay back their loan at a discount?  Some people thought it was because Blackstone were a bunch of nice guys, and by doing so Blackstone would juice their fund's IRR.  My concern was that the hotels might not be worth as much, or be as salable as initially thought.  I thought about this from the perspective of would I lend Eagle any of my own money, and how much, and at what rate, and what asset would back it?

The problem is when I started to think like a lender I couldn't get comfortable that I'd be guaranteed to get my money back.  The company was losing money so they wouldn't be able to pay any interest.  The hotels were spoken for by Blackstone and I was left with some cash and miscellaneous items that might or might not have value.  What I couldn't escape was that while there was the potential for a huge upside there was also the potential for a complete loss.  Not just a 5% or 10% loss, but a 100% loss.  If the hotels went to Blackstone, Eagle would be left with nothing.  As a claim holder at the bottom of the chain I had a claim on nothing if the hotels didn't sell for a high value.  Eagle would have been a great investment if I was in Blackstone's shoes, buying cash producing hotels at a discounted valuation.

I never got comfortable with Eagle and never increased my tracker position.  I owned 10 shares at $5, so I was in for $50.  This week the news came out that Eagle was unable to sell their properties and just turned them over to Blackstone.  They stated they expected to deplete the rest of their cash winding down operations and expected to make no distributions.  I sold my 10 shares for $.12 apiece. No need to feel bad, I can handle a $50 loss, the lessons learned were worth much more than $50.

I'm happy that I avoided a bigger loss, but it was just as likely that a positive outcome could have happened with Eagle.  Alternatively I could have been sitting here with my $50 that turned into $150 wishing I mortgaged the house to invest.  The truth is we never know the future, but in the face of uncertainty I want to work on what I can control, avoiding losses, instead of shooting for large gains.

Talk to Nate