In the aftermath of catastrophic losses on Horsehead Holdings (ZINC) a number of value investors have been asking themselves what went wrong. Some have said the culprit has been the use of a sum of the parts valuation.
Horsehead Holdings is a Pittsburgh, PA based company that specializes in zinc oxide processing. Famed value investor Monish Pabrai found the investment during the depths of the financial crisis trading for less than net current asset value. As the economy, and the company's shares recovered Pabrai continued to talk about the investment, and it transformed from a deep value playt to one with a great management team and an attractive story. The company supposedly had a best in class processing system that allowed them to process zinc cheaper than peers and as a result once their factory was operational they'd mop the floor with their competition.
Unfortunately the company hit a perfect storm. Zinc prices declined and at the same time the company's next generation system experienced continual failures and needed of costly repairs. To make matters worse the company had a risky balance sheet loaded with debt expiring in the near term. These factors collided and the company now trades for mere pennies down from $15.18 earlier this year. They missed a debt payment and will most likely be entering bankruptcy soon.
One narrative I've heard a few times out of the investment is that a sum of the parts valuation methodology is dead, or worthless. A sum of the parts is where an investment is valued on individual pieces of the company rather than the company as a whole. For Horsehead their next generation plant had a market value, along with two other ancillary businesses they owned. Investors looked at this situation as good downside protection because in theory management could sell the side businesses to fund the construction issues.
I don't believe the sum of the parts valuation methodology is worthless, but I do believe it's misapplied. I want to explore applications and uses in this article.
Let's consider a very simple example. Imagine you had a bike, a shoulder bag, a cell phone, and nice rain coat. What is it worth? This is a simple question, you could find the value for each item separately online. With eBay or Craigslist you could probably find each exact item in the same condition and determine within a few dollars the true market value for this entire collection. If you were to go through this exercise and determine the collection is worth $1,500 and someone offered you $1,000 to buy the ensemble you'd probably think "that's crazy, I can sell each item individually for more than $1,000." That is the essence of a sum of the parts valuation.
But take a step back, if you have all of those items you also have all of the pieces needed to be a bicycle messenger. And maybe that's why you do have all of those pieces, it's because you make deliveries on your bike. Now the situation is different, by using all of these items you might earn $10/hr, or $1,600 per month. If someone were to offer you $1,000 for the ensemble you'd laugh because by putting the pieces together and using them to generate an income would result in $1,600 per month until you decide to stop riding.
The second example is why in most cases a sum of the parts makes no sense. A company's parts, their factories, their land holdings, their machinery, any other assets are much more valuable as an operating entity as opposed to being parceled off. And the reason all of those assets are together in the first place is because at some point someone tried to make a go of being an operating entity. The mandate for those assets is to work together and to create something, that is their purpose.
A sum of the parts makes sense in two situations, the first is if the company has excess assets that on their own are extremely valuable. Consider our messenger example, what if I said you also owned a set of rare historic bikes in addition to the messenger setup? These bikes are stored in your garage and never used for deliveries. If you were not emotionally attached to those bikes you could potentially sell them for thousands apiece without affecting your messenger job.
The second situation when a sum of the parts could be appropriate is when management has made it clear they are willing to part with significant portions of their operations in an effort to streamline/refocus/monetize their company.
If management views their assets as available for sale, and actually sells them when given an attractive offer then it's reasonable for investors to view them as the same.
The key to a sum of the parts analysis is that management needs to be willing to monetize their assets. A company with an extremely valuable piece of land that they are unwilling to sell because it was purchased by the CEO's great grandfather has a value thats determined by the company's use of it. Management is the key to unlocking value at companies with valuable assets.
In an issue of the Oddball Stocks Newsletter I wrote about Du Art Films, a film processing company located in New York. The company owns an extremely valuable plot of land in Manhattan that is underutilized. They could sell their land to a developer to build a skyscraper for many times their market cap. They own other valuable assets as well. The reason shares trade so cheaply is that management has been unwilling to monetize those assets. But there are indications this could be changing as management is quite advanced in age, and shareholders are agitating for change. But without management being willing to do anything it's likely these assets will remain undervalued for a while. Du Art is a typical sum of the parts situation, a set of valuable assets that are at the whim of management.
If a company has excess salable assets and a management that appears willing to sell them then a sum of the parts could be appropriate. If a company is simply a collection of unrelated assets and there is a management team willing to monetize them then a sum of the parts could be appropriate. If a company has entrenched management that has a "down with the ship" mentality a sum of the parts valuation definitely isn't appropriate.
In general it's best to look at a potential investment through a number of different valuation lenses. If a company comes up cheap when using multiple investment approaches then there's a very strong chance that it's truly cheap overall. But if a company appears expensive using every approach except one, and that one approach says it's blindingly cheap it's probably best to look deeper or look elsewhere.
Like anything, a sum of the parts valuation methodology is appropriate in some situations, but no appropriate in all situations across the board.
Looking for value in the overlooked margins of the market.
Recent podcasts
I have been podcasting with Fred Rockwell for a while now on the topic of micro cap stocks. If you haven't subscribed to the podcast I'd recommend you do so on iTunes, Android, or RSS.
Here are a series of links to some recent episodes. We are always looking for new guests, if you want to be on the show please get in touch!
Andrew Walker: Rangeley Capital
Thompson Clark: Microcap Millionaires
Tim Eriksen: Eriksen Capital
Lenny Grover: Screener.co
Christian Ryther: Cureen Capital
Myself on banks and free cash flow
Chris DeMuth: Rangeley Capital
Here are a series of links to some recent episodes. We are always looking for new guests, if you want to be on the show please get in touch!
Andrew Walker: Rangeley Capital
Thompson Clark: Microcap Millionaires
Tim Eriksen: Eriksen Capital
Lenny Grover: Screener.co
Christian Ryther: Cureen Capital
Myself on banks and free cash flow
Chris DeMuth: Rangeley Capital
Maui Land and Pineapple, a case of cheap assets depending on where you sit in the capital structure.
Whether or not a company is cheap can change depending on where an investor sits in the capital structure. A company with enviable assets out of reach to investors is just a dream, not a great investment.
Maui Land and Pineapple (MLP.NYSE) is the type of company investors dream of owning. Imagine being able to say you own a bit of land in Hawaii in the form of a nature preserve, resort, utilities and commercial real estate. That's what Maui Land and Pineapple investors can claim. The company owns 23,000 acres of land on Maui, a magnificent island paradise sitting in the middle of the Pacific. The company also owns and operates the Kapalua Resort, and manages a private nature preserve.
The company specializes in property management, and real estate sales. They are focused on selling real estate parcels at the resort, not hotel rooms for weekend vacationers. Beyond their resort real estate the company owns and operates two public water utilities. They also own and lease commercial property to businesses on the island. The company has their fingers in everything related to real estate, sales, leasing, development, preservation, agriculture, and extraction.
A familiar theme in the investing community is "undervalued real estate." The theme is often that the market doesn't appreciate the true value of a company's real estate. Sometimes this is because the real estate is held on the books at historical cost and no one noticed. But more often it's because the real estate is being utilized by the company in a sub-optimal manner and investors don't have faith it's true value will be realized.
Maui Land and Pineapple fits both descriptions. The majority of their 23,000 acres are held on their balance sheet at historical cost. The stated value for their 23,000 acres is $5.15m, or approximately $221 per acre. This is because the majority of the company's land was purchased between 1911 and 1932 and held at those values. The value for investors is if management is willing to sell off their excess holdings.
Selling real estate is the modus operandi of Maui Land and Pineapple. The majority of the company's revenue is due to their real estate sales. From parcels as small as an acre to larger tracts the company is continually selling it's holdings.
In the trailing nine months the company generated $20m in revenue, $12m from outright land sales, $4m from leasing activity, $2.4m from their utilities, and $1.1m from resort amenity sales. They have a market cap of $94m and are selling for slightly more than 10x trailing nine months net income.
The company's book value is negative due to an accumulated deficit, but is likely grossly understated. I haven't done a deep dive into the value of the land (you'll see why below), but a recent sale took place at $480k per acre. If one were to estimate the land was worth 1/3rd of that price, and that only 12,000 acres were salable the company should be worth $1.9b, yes, billion with a "b".
There are good assets, good recent earnings, so what's the issue? This should be a screaming buy. A company that is selling for hundreds of book value if they sold off half their land.
The problem is that the storyline might be true, but it is unlikely that equity investors will be the ones recovering the value.
The nature of real estate is that if it isn't levered it's very hard to make a return, or at least that's what real estate management companies tend to believe. Secondly it's hard to extract the value from real estate without selling it. One route to extract value is to borrow against real estate holdings and finance whatever ventures one believes are more worthwhile. And finance they have, Maui Land and Pineapple is no stranger to the world of debt. They have $40m of revolving debt that is due this year including a $25m loan to Wells Fargo, a $14m AgCredit loan and $400k headed to First Hawaiian Bank.
Unlike equity investors lenders don't get to share in the upside when they make a loan to a company, they are primarily concerned with receiving their money back. There is no doubt that Wells Fargo, AgCredit and First Hawaiian Bank made prudent loans to Maui Land and Pineapple, even if the company ends up on shaky footing. Those three lenders have liens against all of the company's assets, the utilities, the land, the resort, and the commercial space. If Maui Land and Pineapple were to declare bankruptcy the lenders would be the new owners of valuable real estate among other things.
It's uncertain as to how the company will pay their $40m in debt coming due this year. In their most recent filing the company states that "Absent the sale of some of its real estate holdings or refinancing, the Company does not expect to be able to repay the outstanding balance of the revolving line of credit on the maturity date." The company will either need to refinance their loans or sell a considerable amount of real estate, or do both to meet their debt maturity this year.
At the Microcap Conference in Philadelphia in November Chris DeMuth spoke about looking for investments with constrained counter parties. When a counter party is constrained they're often forced into making uneconomic decisions. A savvy investor can take advantage of a situation like that and purchase assets or earnings at considerable discounts. The issue with an investment in Maui Land and Pineapple is an equity investor is buying into a company that is a constrained counter party. The clock is ticking for the company to either refinance their debt or be forced into real estate sales by the summer.
On the surface Maui Land and Pineapple appears like it could be an attractive investment with valuable land and cheap earnings. But a deeper dive reveals a company that is a constrained counter party. The real investment opportunity is for anyone looking to buy Hawaiian real estate on Maui at attractive prices, or anyone in the position to make a secured loan to the company in the next few months.
Maui Land and Pineapple (MLP.NYSE) is the type of company investors dream of owning. Imagine being able to say you own a bit of land in Hawaii in the form of a nature preserve, resort, utilities and commercial real estate. That's what Maui Land and Pineapple investors can claim. The company owns 23,000 acres of land on Maui, a magnificent island paradise sitting in the middle of the Pacific. The company also owns and operates the Kapalua Resort, and manages a private nature preserve.
The company specializes in property management, and real estate sales. They are focused on selling real estate parcels at the resort, not hotel rooms for weekend vacationers. Beyond their resort real estate the company owns and operates two public water utilities. They also own and lease commercial property to businesses on the island. The company has their fingers in everything related to real estate, sales, leasing, development, preservation, agriculture, and extraction.
A familiar theme in the investing community is "undervalued real estate." The theme is often that the market doesn't appreciate the true value of a company's real estate. Sometimes this is because the real estate is held on the books at historical cost and no one noticed. But more often it's because the real estate is being utilized by the company in a sub-optimal manner and investors don't have faith it's true value will be realized.
Maui Land and Pineapple fits both descriptions. The majority of their 23,000 acres are held on their balance sheet at historical cost. The stated value for their 23,000 acres is $5.15m, or approximately $221 per acre. This is because the majority of the company's land was purchased between 1911 and 1932 and held at those values. The value for investors is if management is willing to sell off their excess holdings.
Selling real estate is the modus operandi of Maui Land and Pineapple. The majority of the company's revenue is due to their real estate sales. From parcels as small as an acre to larger tracts the company is continually selling it's holdings.
In the trailing nine months the company generated $20m in revenue, $12m from outright land sales, $4m from leasing activity, $2.4m from their utilities, and $1.1m from resort amenity sales. They have a market cap of $94m and are selling for slightly more than 10x trailing nine months net income.
The company's book value is negative due to an accumulated deficit, but is likely grossly understated. I haven't done a deep dive into the value of the land (you'll see why below), but a recent sale took place at $480k per acre. If one were to estimate the land was worth 1/3rd of that price, and that only 12,000 acres were salable the company should be worth $1.9b, yes, billion with a "b".
There are good assets, good recent earnings, so what's the issue? This should be a screaming buy. A company that is selling for hundreds of book value if they sold off half their land.
The problem is that the storyline might be true, but it is unlikely that equity investors will be the ones recovering the value.
The nature of real estate is that if it isn't levered it's very hard to make a return, or at least that's what real estate management companies tend to believe. Secondly it's hard to extract the value from real estate without selling it. One route to extract value is to borrow against real estate holdings and finance whatever ventures one believes are more worthwhile. And finance they have, Maui Land and Pineapple is no stranger to the world of debt. They have $40m of revolving debt that is due this year including a $25m loan to Wells Fargo, a $14m AgCredit loan and $400k headed to First Hawaiian Bank.
Unlike equity investors lenders don't get to share in the upside when they make a loan to a company, they are primarily concerned with receiving their money back. There is no doubt that Wells Fargo, AgCredit and First Hawaiian Bank made prudent loans to Maui Land and Pineapple, even if the company ends up on shaky footing. Those three lenders have liens against all of the company's assets, the utilities, the land, the resort, and the commercial space. If Maui Land and Pineapple were to declare bankruptcy the lenders would be the new owners of valuable real estate among other things.
It's uncertain as to how the company will pay their $40m in debt coming due this year. In their most recent filing the company states that "Absent the sale of some of its real estate holdings or refinancing, the Company does not expect to be able to repay the outstanding balance of the revolving line of credit on the maturity date." The company will either need to refinance their loans or sell a considerable amount of real estate, or do both to meet their debt maturity this year.
At the Microcap Conference in Philadelphia in November Chris DeMuth spoke about looking for investments with constrained counter parties. When a counter party is constrained they're often forced into making uneconomic decisions. A savvy investor can take advantage of a situation like that and purchase assets or earnings at considerable discounts. The issue with an investment in Maui Land and Pineapple is an equity investor is buying into a company that is a constrained counter party. The clock is ticking for the company to either refinance their debt or be forced into real estate sales by the summer.
On the surface Maui Land and Pineapple appears like it could be an attractive investment with valuable land and cheap earnings. But a deeper dive reveals a company that is a constrained counter party. The real investment opportunity is for anyone looking to buy Hawaiian real estate on Maui at attractive prices, or anyone in the position to make a secured loan to the company in the next few months.
Announcing the Toronto Microcap Conference
Sometimes the best bargains in the market are the easiest to overlook. While everyone is searching for value in esoteric places there is a developed market within driving distance from the US that speaks English (mostly) and does business with the US that's hitting new lows. Yet investors write off Canada because the perception is the Canadian market is 100% gold mining and resource companies.
For example, did you know there are 798 non-resource, non-oil and gas companies in Canada trading for less than book value? All of these are micro cap companies, off the radar and un-investable for some of the largest and best known Canadian funds. Canada is a hot bed of value, 22% of their market trades for less than book value. Compare that to the US where only 11% of the market trades for less than book value.
Maybe you aren't as interested in absolutely cheap companies and want growth, there are plenty of cheap growing companies in Canada. There are a number of companies with 25% year over year revenue growth trading for less than 5x EV/EBITDA. In the US there are only nine, and a few of them are China based US listed companies with dubious financials.
It can be hard work to comb through dozens or hundreds of companies looking for a diamond in the rough of potential investment candidates. There has to be a better way, and there is.
Imagine a setting with 40 hand selected companies that offer excellent investment potential where you can speak directly to management in an one on one setting. Combine that with dozens of well known speakers and hundreds of like minded investors, all gathered in the same place, all with the same goal, find the best opportunities. We did just that in Philadelphia in November 2015 and now we're bringing the same format to Canada.
In April 2016 we will be hosting The Microcap Conference at the Hilton in downtown Toronto.
The conference starts Monday, April 11th at 1pm with speakers and company presentations. The afternoon is completed with a happy hour, dinner, and keynote presentation. Tuesday is packed full of presentations by well known investors, fund managers, and companies as well as one on one sessions with company management. We end the conference with another happy hour giving you time to network and share ideas with fellow investors. We'll have plenty of time to network throughout the conference.
You can find more information as well as sign up to attend here.
I'm looking forward to seeing you in Toronto!
For example, did you know there are 798 non-resource, non-oil and gas companies in Canada trading for less than book value? All of these are micro cap companies, off the radar and un-investable for some of the largest and best known Canadian funds. Canada is a hot bed of value, 22% of their market trades for less than book value. Compare that to the US where only 11% of the market trades for less than book value.
Maybe you aren't as interested in absolutely cheap companies and want growth, there are plenty of cheap growing companies in Canada. There are a number of companies with 25% year over year revenue growth trading for less than 5x EV/EBITDA. In the US there are only nine, and a few of them are China based US listed companies with dubious financials.
It can be hard work to comb through dozens or hundreds of companies looking for a diamond in the rough of potential investment candidates. There has to be a better way, and there is.
Imagine a setting with 40 hand selected companies that offer excellent investment potential where you can speak directly to management in an one on one setting. Combine that with dozens of well known speakers and hundreds of like minded investors, all gathered in the same place, all with the same goal, find the best opportunities. We did just that in Philadelphia in November 2015 and now we're bringing the same format to Canada.
In April 2016 we will be hosting The Microcap Conference at the Hilton in downtown Toronto.
The conference starts Monday, April 11th at 1pm with speakers and company presentations. The afternoon is completed with a happy hour, dinner, and keynote presentation. Tuesday is packed full of presentations by well known investors, fund managers, and companies as well as one on one sessions with company management. We end the conference with another happy hour giving you time to network and share ideas with fellow investors. We'll have plenty of time to network throughout the conference.
You can find more information as well as sign up to attend here.
I'm looking forward to seeing you in Toronto!
Reading, resolutions and "research"
"Please don't bother me right now, I'm reading about railcar loading trends for 1842, the year of the great hog debacle. I think I can see parallels between that and the current coal environment." Ever run into a value investor like that? Head so deep in a history book that everything current is just a repeat of the past? Reading is to value investing as ice skates are to hockey.
Reading is so embedded in the value investing mantra that I've seen debates break out over who reads the more. One of Warren Buffett's protege investors was mis-quoted in an interview saying he read 500 pages a day. Soon message boards were full of posts positing that if Buffett deputies read 500 pages a day then that must be the path to success. It wasn't long before legions of investors were burned out trying to plow through the equivalent of a Stephen King novel a day, seven days a week barely giving themselves time to eat or use the restroom, let alone think about what they were reading! Eventually said deputy clarified that they only read 500 pages a week, but the damage had been done.
This is the time of the year when investors are making resolutions "I'll research more before making the next investment." "I won't sell as quickly" "I'll be more patient" "I won't chase story stock" etc. One resolution many will make is they want to read more and deepen the research before investing.
By nature I'm a goal type of person, I'm first born, and driven (often go together), and like to accomplish things, even fabricated goals. For years I'd set new year gold. I'd build little systems to hit my goals and once I accomplished them I'd fall off my system for the rest of the year leaving the goal just a memory. The goals were nice milestones, but at each goal I either realized it wasn't worth pursing the activity further, or I was discontent and set another goal further afield.
As I've knocked down goal after goal and grown older I've realized there's a better way. Instead of setting fixed goals each year I now strive to build sustainable systems. For example, a few years ago I set a weekly goal of running a certain number of miles. I found myself in two situations, I'd run 80% of the miles the first three days of the week and then I'd slack off and do an easy run on Friday to make my goal. Or I'd be busy Mon-Wed and Thursday and Friday would run too much putting myself at risk for injury trying to reach the weekly goal. The better way is to say that I plan on exercising three to four days a week. Since I'm not holding myself to an arbitrary number I can be satisfied if I get outside a consistent number of days. The beauty of this system is that it's sustainable, run (or exercise) three days a week. If I'm tired maybe I'll walk, or in the summer I might swap a run with a bike ride, but regardless I am out exercising, not maintaining a spreadsheet.
I've spoken in the past about building an investing system. You need to invest in a way that fits your personality. This is where reading comes into play. There are many different ways to be a value investor. Value investing is simply buying something of a measurable value for a substantial discount to that measurable value. The thing is that to do this you don't need to keep your nose in a book constantly, even if Buffett does.
Have you ever seen someone say the following: "I'm interested in value investing, what should I do?" and the response is to throw a library of value investing books at the person asking a question. "Oh you need to read all of Buffett's letters, plus Security Analysis, plus thirty other books and 10-Ks and 10-Qs and the Farmers Almanac back to 1910 and then you'll be ready to begin.."
The approach we use to teach value investing is strange, almost foreign compared to most other things we learned in life. Consider a sport. The student is taught a number of basic rules and techniques and then told to practice. As they practice and improve they are then taught more difficult techniques. Or what about a pilot? Piloting a plane is complicated, but a pilot learns the basics first then gets in a plane and practices with a teacher. Once they know the basics they learn by doing. Almost any type of learning I can think of follows this same pattern. Discover the basics, practice, improve, learn more, practice more, improve etc.
Yet in the world of investing we have it backwards. We tell a beginning student to read expert level books and never dip their toe in the pool until they've mastered the material. Value investing is no more complicated compared to flying a plane, yet we're treating it like rocket science.
Maybe we do this because investing is a serious business where we're putting our money into something with the potential for a loss. It's ironic that we hesitate to invest money where a potential for loss exists but where there's also a potential for gain, because most of our money is spent on things that are a 100% loss. If I spend money on a burger and a beer, I enjoy it for a few minutes and after that the money's gone for good. Sure, it converts into energy for a bit, but a few hours later I'm hungry again and need to consume more food (money turned into energy). Same with almost anything else, food, electric for the house, gas for the car and on and on. Consumers regularly part with the majority of their paycheck, or in some cases more than their paycheck for 'spent' things. Items that have no potential for gain. Yet when it comes to investing, where a potential for gain exists people are like deer in the headlights because they might lose money. It's nothing to walk into a dealer and spend $25k on a car, but save $200 a month..yikes!
One does not need to be a rocket scientist to be a successful investor. A simple index fund will result in a gain given enough time. If an investor wishes to explore the value side of the world basic screens are a great start. Buy 50 stocks trading for 75% of book value and sell when they hit 1.25x, rinse, repeat. Will this investor buy bad companies, yup, will they own duds, yup, will it work out over time, yup.
In the new year I'd advise you to ditch resolutions to read more (unless you don't read at all, which is unlikely if you're reading this) and instead treat investing like any other activity. Learn the basics, then practice and improve. Once the basics have been mastered move into the next level, add more complicated techniques and work on mastering those. Continue to improve and master each technique before moving to the next. It's possible you might never advance beyond the basics, but that's alright, master those basics and stay at a level that you're comfortable with. Investors get into trouble when they venture far from their abilities. Sometimes you'll need a book or two to cross the chasm between what you know and what you want to do, that's when it's appropriate to shove your nose in a book. But not before you're at that chasm.
Let me make a few concrete recommendations. If you're new to investing I'd make sure you understand how financial statements work before committing any money. You don't need a Masters level education to understand financial statements, just the ability to read and understand the mechanics. The heuristic I learned was this: The income statement shows if a company can price their products for more than it costs to make them. The cash flow statement shows if they're lying, and the balance sheet is a snapshot in time of this process.
If you have been at this for a while look to add a new technique this year. Maybe it'll be spin-offs, or options, or liquidations. Make it specific, not broad. Don't say "I'll invest in special situations", be specific "I'll invest in a liquidation". Then do what's necessary to learn the basics and practice.
Practice is what internalizes the book knowledge we've read. Reading without practicing holds little value. Yet we can learn a lot that's not in a book through practice and experience. Don't get lost in the weeds reading about the details, get out there and experience it!
So how does research fit into my investing system? I outline my full process here.
Reading is so embedded in the value investing mantra that I've seen debates break out over who reads the more. One of Warren Buffett's protege investors was mis-quoted in an interview saying he read 500 pages a day. Soon message boards were full of posts positing that if Buffett deputies read 500 pages a day then that must be the path to success. It wasn't long before legions of investors were burned out trying to plow through the equivalent of a Stephen King novel a day, seven days a week barely giving themselves time to eat or use the restroom, let alone think about what they were reading! Eventually said deputy clarified that they only read 500 pages a week, but the damage had been done.
This is the time of the year when investors are making resolutions "I'll research more before making the next investment." "I won't sell as quickly" "I'll be more patient" "I won't chase story stock" etc. One resolution many will make is they want to read more and deepen the research before investing.
By nature I'm a goal type of person, I'm first born, and driven (often go together), and like to accomplish things, even fabricated goals. For years I'd set new year gold. I'd build little systems to hit my goals and once I accomplished them I'd fall off my system for the rest of the year leaving the goal just a memory. The goals were nice milestones, but at each goal I either realized it wasn't worth pursing the activity further, or I was discontent and set another goal further afield.
As I've knocked down goal after goal and grown older I've realized there's a better way. Instead of setting fixed goals each year I now strive to build sustainable systems. For example, a few years ago I set a weekly goal of running a certain number of miles. I found myself in two situations, I'd run 80% of the miles the first three days of the week and then I'd slack off and do an easy run on Friday to make my goal. Or I'd be busy Mon-Wed and Thursday and Friday would run too much putting myself at risk for injury trying to reach the weekly goal. The better way is to say that I plan on exercising three to four days a week. Since I'm not holding myself to an arbitrary number I can be satisfied if I get outside a consistent number of days. The beauty of this system is that it's sustainable, run (or exercise) three days a week. If I'm tired maybe I'll walk, or in the summer I might swap a run with a bike ride, but regardless I am out exercising, not maintaining a spreadsheet.
I've spoken in the past about building an investing system. You need to invest in a way that fits your personality. This is where reading comes into play. There are many different ways to be a value investor. Value investing is simply buying something of a measurable value for a substantial discount to that measurable value. The thing is that to do this you don't need to keep your nose in a book constantly, even if Buffett does.
Have you ever seen someone say the following: "I'm interested in value investing, what should I do?" and the response is to throw a library of value investing books at the person asking a question. "Oh you need to read all of Buffett's letters, plus Security Analysis, plus thirty other books and 10-Ks and 10-Qs and the Farmers Almanac back to 1910 and then you'll be ready to begin.."
The approach we use to teach value investing is strange, almost foreign compared to most other things we learned in life. Consider a sport. The student is taught a number of basic rules and techniques and then told to practice. As they practice and improve they are then taught more difficult techniques. Or what about a pilot? Piloting a plane is complicated, but a pilot learns the basics first then gets in a plane and practices with a teacher. Once they know the basics they learn by doing. Almost any type of learning I can think of follows this same pattern. Discover the basics, practice, improve, learn more, practice more, improve etc.
Yet in the world of investing we have it backwards. We tell a beginning student to read expert level books and never dip their toe in the pool until they've mastered the material. Value investing is no more complicated compared to flying a plane, yet we're treating it like rocket science.
Maybe we do this because investing is a serious business where we're putting our money into something with the potential for a loss. It's ironic that we hesitate to invest money where a potential for loss exists but where there's also a potential for gain, because most of our money is spent on things that are a 100% loss. If I spend money on a burger and a beer, I enjoy it for a few minutes and after that the money's gone for good. Sure, it converts into energy for a bit, but a few hours later I'm hungry again and need to consume more food (money turned into energy). Same with almost anything else, food, electric for the house, gas for the car and on and on. Consumers regularly part with the majority of their paycheck, or in some cases more than their paycheck for 'spent' things. Items that have no potential for gain. Yet when it comes to investing, where a potential for gain exists people are like deer in the headlights because they might lose money. It's nothing to walk into a dealer and spend $25k on a car, but save $200 a month..yikes!
One does not need to be a rocket scientist to be a successful investor. A simple index fund will result in a gain given enough time. If an investor wishes to explore the value side of the world basic screens are a great start. Buy 50 stocks trading for 75% of book value and sell when they hit 1.25x, rinse, repeat. Will this investor buy bad companies, yup, will they own duds, yup, will it work out over time, yup.
In the new year I'd advise you to ditch resolutions to read more (unless you don't read at all, which is unlikely if you're reading this) and instead treat investing like any other activity. Learn the basics, then practice and improve. Once the basics have been mastered move into the next level, add more complicated techniques and work on mastering those. Continue to improve and master each technique before moving to the next. It's possible you might never advance beyond the basics, but that's alright, master those basics and stay at a level that you're comfortable with. Investors get into trouble when they venture far from their abilities. Sometimes you'll need a book or two to cross the chasm between what you know and what you want to do, that's when it's appropriate to shove your nose in a book. But not before you're at that chasm.
Let me make a few concrete recommendations. If you're new to investing I'd make sure you understand how financial statements work before committing any money. You don't need a Masters level education to understand financial statements, just the ability to read and understand the mechanics. The heuristic I learned was this: The income statement shows if a company can price their products for more than it costs to make them. The cash flow statement shows if they're lying, and the balance sheet is a snapshot in time of this process.
If you have been at this for a while look to add a new technique this year. Maybe it'll be spin-offs, or options, or liquidations. Make it specific, not broad. Don't say "I'll invest in special situations", be specific "I'll invest in a liquidation". Then do what's necessary to learn the basics and practice.
Practice is what internalizes the book knowledge we've read. Reading without practicing holds little value. Yet we can learn a lot that's not in a book through practice and experience. Don't get lost in the weeds reading about the details, get out there and experience it!
So how does research fit into my investing system? I outline my full process here.
SFB Bancorp - Too cheap to ignore, especially for activists
"Value is its own catalyst" is a common saying amongst value investors. When a stock is marginally cheap investors need to pound the table, concoct 80 page power point presentations and create elegant narratives to sell the story. When a stock has landed in value territory it's valuation is the story. Such is the case with SFB Bancorp (SFBK) a bank in Tennessee that languished on the edge of the pink sheets until the discrepancy between the market price and book value became too great. A fund discovered the stock and started to build a position. The rest as they say is history.
I've talked about the idea with Colin, the Managing Director for Trondheim Capital numerous times. SFB Bancorp was an idea that appeared in the second issue of the Oddball Stocks Newsletter. The full writeup sample is below.
I had the chance to interview Trondheim Capital and Meixler Investment Management about the bank, why this is a good investment, and what they wish to achieve. Before getting into the interview I want to outline the investment case for SFB Bancorp in sentence or two.
SFB Bancorp is a holding company for Security Federal Bank in Elizabethton, TN. The bank has $60m in assets with a 41% Tier 1 ratio. They have $37m in loans and $19m in cash and securities. Equity is approximately $14.593m against a market cap of $12m. They trade for 82% of book value. The bank is profitable and has been for years. They never incurred a loss during the financial crisis and asset quality is pristine.
The bank's President embodies the community banker saying of "I know my bad loans by name." I spoke with Carmella Price and asked about a non-performing loan and was given a list of the seizable assets such as a high end power boat that were negotiated as collateral for the loan. Price certainly knew the bad loan by name, and was on top of the resolution.
The bank has a mediocre 5% return on equity, mainly due to their significant over capitalization. If the bank were to use their capital to buyback shares, or extend credit it's feasible that they could earn over 10% on their equity without much effort.
Lastly, this isn't a cheap bank sitting on the sidelines waiting for someone to notice them. As you'll see in the interview below a number of funds are already involved and working to close the valuation gap.
How did the bank come into being?
It was founded in 1963 as a mutual. The founder's son (Bill Hampton) told me that his father (Peter Hampton) started it partially to generate more work for his law practice. I assume that means the title and escrow work. They demutualized and went public in May 1997. In 2003 they terminated the securities registration and moved to the pink sheets.
How can a bank so small survive?
Non-interest expenses were only $1.79 million in 2014. Of that, $1.064 million was compensation. They brought in $2.65 million in net interest income and non-interest income, so that leaves a respectable profit. East Tennessee is obviously a cheap part of the country from a compensation perspective.
When most investors look at SFBK their first thought is most likely "so many securities and not enough lending.." do you feel increased lending is what they need?
No. They say their market is too competitive and I believe them. Credit union competition always comes up. They have a culture of conservative lending which is one of the great things about them. They made money throughout the recent depression and bought back ten percent of outstanding shares in 2009.
Why are they so conservative?
That seems to be a part of the culture, inherited from the founder. I think it's admirable that they've let the loan book decline. It peaked in 2006! Hired help will grow for the sake of growth; an ownership mindset seems to result in conservatism at least with regard to credit risk. Now, interest rate risk and the idea of buying back stock instead of building a low-yielding bond portfolio is the area where we differ with management.
What's the ownership structure like?
The founder's son and family own about 25%. There's an ESOP that owns about 11%. The President of the bank subsidiary, Carmella Price, owns about 4%. Together that's 39% for what I call the insiders. Bill and Carmella are on the board with three directors who own less than 1% combined. Then there is Trondheim Capital, Meixler Investment Management, and a private investor named Jack Rubens. The three of us "outsiders" wrote a letter to management in July about capital allocation, and we informed them that our combined holdings were about a quarter of the company.
What's the opportunity for investors?
First, the bank is trading below book value even though it's profitable and overcapitalized. We estimate that the discount is close to 20%, but book value may understate both the liquidation and intrinsic values. Given the discount and overcapitalization, they should be buying back stock. At 12/31/14 equity was 23% of assets and Tier 1 was 41%.
Is there something better the bank can do with their excess cash?
Buy back stock below liquidation value, below tangible book value, below value as an acquisition target. Any of those ways that you look at it, repurchases below these intrinsic value would be a good use of surplus capital.
Are they a potential acquisition target? If so why? If not why not?
I think what we are seeing recently is that every bank is an acquisition target to an equal or larger size bank that wants to get economies of scale. I spoke with the founder of another bank in eastern Tennessee who already made one acquisition and wants to make more.
Is it possible to buy a significant stake?
There are shares offered in the open market. I'm surprised that micro cap investors aren't smarter about finding ways to buy stakes in tiny companies, the way Buffett used to do. In most states, companies are required to send a shareholder list to a shareholder. You could look for someone who owns the same quantity of shares you are looking to buy and make them an offer. I've never been offended by someone wanting to buy something I own.
In an ideal scenario what would you like to do at the bank?
At a minimum, we think that shares should be repurchased to close the gap between the share price and intrinsic value. This would reduce surplus capital, boost ROE, and reduce the interest rate risk if it was funded by selling some of the long duration treasury/muni paper. We also think that the significant shareholders who aren't insiders should have board representation.
Are you like most Wall Street activists who want to strip companies of their assets and leave the carcass to flail in the wind? (Security Federal Bank plays a vital role in their local community, is this something you'd keep?)
That criticism makes more sense with a non-financial company. With a bank that has surplus capital and too much lending competition, it's just so obvious that capital should be returned. Especially when shares are trading at a discount.
Can you walk us through why share buybacks are better than dividends or lending?
I actually found a compilation of all of the Buffett annual report comments on share repurchases and sent it to the President of the bank. It is so obvious that's what you need to do, provided that shares are below intrinsic value and that you have surplus capital, i.e. no investment opportunities that are superior to that. If you are a banker and you've sized up your lending market as being too competitive - which I perfectly respect - you are in the situation where you do not have a better use for the capital.
Is there a limit to what the bank can buy back?
Well, there's obviously a limit in terms of remaining well-capitalized and maybe another threshold of what the regulators are comfortable with. And obviously you want to stay within those limits. We are just talking about low hanging fruit here. See how much stock you can buy back at a huge discount using capital that's currently supporting fixed income instruments at one or two percent yields.
Have you talked to management about your ideas? What did they say?
As I mentioned, we sent a letter jointly with two other large outside shareholders about the repurchase idea. They sent a letter thanking us, saying that they are "in the process of updating the Company's strategic plan" and would be "discussing these topics and others with our financial advisors." Polite, but vague and non-committal.
What's managements plan for the bank?
That is not something they have wanted to share with us. It would be great to have a conversation with them where we compare the share repurchase plan with whatever plan that they have in mind and see which one results in higher IRR to shareholders, especially across a range of economic and interest rate scenarios. I think it would be tough to beat share repurchases at a discount.
This writeup is from the July 2014 issue of the Oddball Stocks Newsletter, it's unaltered from the original publishing.
Disclosure: Long SFBK
I've talked about the idea with Colin, the Managing Director for Trondheim Capital numerous times. SFB Bancorp was an idea that appeared in the second issue of the Oddball Stocks Newsletter. The full writeup sample is below.
I had the chance to interview Trondheim Capital and Meixler Investment Management about the bank, why this is a good investment, and what they wish to achieve. Before getting into the interview I want to outline the investment case for SFB Bancorp in sentence or two.
Investment Snapshot
SFB Bancorp is a holding company for Security Federal Bank in Elizabethton, TN. The bank has $60m in assets with a 41% Tier 1 ratio. They have $37m in loans and $19m in cash and securities. Equity is approximately $14.593m against a market cap of $12m. They trade for 82% of book value. The bank is profitable and has been for years. They never incurred a loss during the financial crisis and asset quality is pristine.
The bank's President embodies the community banker saying of "I know my bad loans by name." I spoke with Carmella Price and asked about a non-performing loan and was given a list of the seizable assets such as a high end power boat that were negotiated as collateral for the loan. Price certainly knew the bad loan by name, and was on top of the resolution.
The bank has a mediocre 5% return on equity, mainly due to their significant over capitalization. If the bank were to use their capital to buyback shares, or extend credit it's feasible that they could earn over 10% on their equity without much effort.
Lastly, this isn't a cheap bank sitting on the sidelines waiting for someone to notice them. As you'll see in the interview below a number of funds are already involved and working to close the valuation gap.
Interview
How did the bank come into being?
It was founded in 1963 as a mutual. The founder's son (Bill Hampton) told me that his father (Peter Hampton) started it partially to generate more work for his law practice. I assume that means the title and escrow work. They demutualized and went public in May 1997. In 2003 they terminated the securities registration and moved to the pink sheets.
How can a bank so small survive?
Non-interest expenses were only $1.79 million in 2014. Of that, $1.064 million was compensation. They brought in $2.65 million in net interest income and non-interest income, so that leaves a respectable profit. East Tennessee is obviously a cheap part of the country from a compensation perspective.
When most investors look at SFBK their first thought is most likely "so many securities and not enough lending.." do you feel increased lending is what they need?
No. They say their market is too competitive and I believe them. Credit union competition always comes up. They have a culture of conservative lending which is one of the great things about them. They made money throughout the recent depression and bought back ten percent of outstanding shares in 2009.
Why are they so conservative?
That seems to be a part of the culture, inherited from the founder. I think it's admirable that they've let the loan book decline. It peaked in 2006! Hired help will grow for the sake of growth; an ownership mindset seems to result in conservatism at least with regard to credit risk. Now, interest rate risk and the idea of buying back stock instead of building a low-yielding bond portfolio is the area where we differ with management.
What's the ownership structure like?
The founder's son and family own about 25%. There's an ESOP that owns about 11%. The President of the bank subsidiary, Carmella Price, owns about 4%. Together that's 39% for what I call the insiders. Bill and Carmella are on the board with three directors who own less than 1% combined. Then there is Trondheim Capital, Meixler Investment Management, and a private investor named Jack Rubens. The three of us "outsiders" wrote a letter to management in July about capital allocation, and we informed them that our combined holdings were about a quarter of the company.
What's the opportunity for investors?
First, the bank is trading below book value even though it's profitable and overcapitalized. We estimate that the discount is close to 20%, but book value may understate both the liquidation and intrinsic values. Given the discount and overcapitalization, they should be buying back stock. At 12/31/14 equity was 23% of assets and Tier 1 was 41%.
Is there something better the bank can do with their excess cash?
Buy back stock below liquidation value, below tangible book value, below value as an acquisition target. Any of those ways that you look at it, repurchases below these intrinsic value would be a good use of surplus capital.
Are they a potential acquisition target? If so why? If not why not?
I think what we are seeing recently is that every bank is an acquisition target to an equal or larger size bank that wants to get economies of scale. I spoke with the founder of another bank in eastern Tennessee who already made one acquisition and wants to make more.
Is it possible to buy a significant stake?
There are shares offered in the open market. I'm surprised that micro cap investors aren't smarter about finding ways to buy stakes in tiny companies, the way Buffett used to do. In most states, companies are required to send a shareholder list to a shareholder. You could look for someone who owns the same quantity of shares you are looking to buy and make them an offer. I've never been offended by someone wanting to buy something I own.
In an ideal scenario what would you like to do at the bank?
At a minimum, we think that shares should be repurchased to close the gap between the share price and intrinsic value. This would reduce surplus capital, boost ROE, and reduce the interest rate risk if it was funded by selling some of the long duration treasury/muni paper. We also think that the significant shareholders who aren't insiders should have board representation.
Are you like most Wall Street activists who want to strip companies of their assets and leave the carcass to flail in the wind? (Security Federal Bank plays a vital role in their local community, is this something you'd keep?)
That criticism makes more sense with a non-financial company. With a bank that has surplus capital and too much lending competition, it's just so obvious that capital should be returned. Especially when shares are trading at a discount.
Can you walk us through why share buybacks are better than dividends or lending?
I actually found a compilation of all of the Buffett annual report comments on share repurchases and sent it to the President of the bank. It is so obvious that's what you need to do, provided that shares are below intrinsic value and that you have surplus capital, i.e. no investment opportunities that are superior to that. If you are a banker and you've sized up your lending market as being too competitive - which I perfectly respect - you are in the situation where you do not have a better use for the capital.
Is there a limit to what the bank can buy back?
Well, there's obviously a limit in terms of remaining well-capitalized and maybe another threshold of what the regulators are comfortable with. And obviously you want to stay within those limits. We are just talking about low hanging fruit here. See how much stock you can buy back at a huge discount using capital that's currently supporting fixed income instruments at one or two percent yields.
Have you talked to management about your ideas? What did they say?
As I mentioned, we sent a letter jointly with two other large outside shareholders about the repurchase idea. They sent a letter thanking us, saying that they are "in the process of updating the Company's strategic plan" and would be "discussing these topics and others with our financial advisors." Polite, but vague and non-committal.
What's managements plan for the bank?
That is not something they have wanted to share with us. It would be great to have a conversation with them where we compare the share repurchase plan with whatever plan that they have in mind and see which one results in higher IRR to shareholders, especially across a range of economic and interest rate scenarios. I think it would be tough to beat share repurchases at a discount.
Interested in learning more about banks? Buy my book The Bank Investor's Handbook (Kindle and paperback available)
Oddball Stocks Newsletter Investment Writeup
This writeup is from the July 2014 issue of the Oddball Stocks Newsletter, it's unaltered from the original publishing.
Disclosure: Long SFBK
Opt-Sciences - Going dark an excuse to operate in the dark
If you hang around small caps long enough you'll eventually hear the complaint from companies that "it costs too much to be public." Sometimes this statement is true. For very small and unprofitable companies being public is costly and a financial burden. But these are rare cases, usually the cost of being public is an excuse management likes to tout to justify deregistering their securities from the SEC and "going dark" allowing them to operate in obcurity..
A company I've owned and followed for years, Opt-Sciences (OPST) filed their Form 15 on November 4th. The Form 15 is a document that notifies the SEC that a company intends to terminate their security registration. A company can do this if they have less than 300 shareholders of record. A shareholder of record is a shareholder who has possession of a physical stock certificate. If you own shares of a company in a brokerage account your name will never appear on the company's shareholder register. Rather the aggregated owner, Cede & Co, will appear on the shareholder register. Small companies like to go dark through this loophole. They might have thousands of shareholders with brokerage holdings, but these brokerage holdings only count as one registered owner. Most small companies have less than 300 shareholders with physical certificates.
Small companies will readily pay dividends and mail reports to shareholders who own shares in street name but when it comes time to determine if a company has enough shareholders to remain public or not companies will claim that street holders are not real shareholders. I know this is patently false as I've talked to CFO's of companies I own in street name, and they can see the number of shares I own and the name associated with my street holdings.
Opt-Sciences is a familiar name for small cap value investors. The company manufacturers anti-glare coating for aircraft instrument displays. The company has traded below book value since the financial crisis. The last time they traded for more than book for an extended period of time was in the mid to late 1990s. They are profitable and their balance sheet is loaded with cash and marketable securities. If one backs out their excess cash and securities the company has some eye-popping returns on equity and an extremely low P/E.
The company has a book value of $20.54 and earned $1.40 for the first nine months of 2015. Management expects the fourth quarter to generate about $.30 in earnings, for $1.70 in earnings for the full year. If you back out 75% of their cash and securities, which is $11.93 per share the company trades for 4.4x earnings. Ex-cash the company earns above 20% on their equity, although this could be misleading depending on how old their facilities are. It's possible they've depreciated all of their plant resulting in an artificially high ROE.
With the market at elevated levels it isn't often an investor finds a company at 4.4x earnings and trading for less than book value.
The reason that the stock is cheap is also the reason that going dark is a bad idea for the company. Opt-Sciences is cheap because management controls 66% of the company through a trust and another 6% directly for a 72% insider ownership stake. The Chairman is the head of the trust, while his son-in-law is the CEO. The beneficiaries of the trust are the CEO's wife and her brother, who is also on the board. The board consists of three members, the Chairman (trustee), CEO and his brother-in-law (trust beneficiary). The proxy claims the CEO has no control over the shares held in the trust, but these three family members appear to be on good terms, and it's laughable to say that the CEO's comments about the company wouldn't influence his wife's decisions or that the family wouldn't talk about the company at family gatherings.
Shareholders seem to have lost hope that value will ever be realized at the company and have been unwilling to trade shares for more than book. I don't blame any shareholders for giving up hope, there isn't much reason to hope with Opt-Sciences. While the company is generating good returns management is keeping the rewards to themselves. They don't buyback shares, and don't pay a dividend.
The company's Form 15 filing was terse. It contained no information as to why the company was going dark and didn't provide any details for the owners of the other 28% of the company who aren't insiders. The lack of communication speaks volumes as to how management thinks of the company. They act as if this is a small private company with a few nuisance shareholders hanging on.
As of January 2015 the company had 316 registered shareholders, 16 more than is required to go dark. Since then the company hasn't repurchased any shares, or announced any reverse splits to reduce their shareholder count under 300. It's possible the company is going to go dark illegally with more than 300 shareholders and hope the SEC just doesn't care.
I hope that Opt-Sciences will continue to publish financial reports for shareholders, but I'm skeptical. I've seen this pattern in the past where companies with large cash holdings go dark. Going dark can be a precursor to management sticking their hands in the cookie jar and looting the cash pile. When a company files with the SEC salaries and compensation and insider trades must be disclosed. In the world of dark stocks companies fly fast and loose without rules. Allegations of insider trading are rampant as well as managements with less than 100% ownership interest stealing 100% of the company's economic interest for themselves through high salaries and undisclosed perks.
It's possible that Opt-Sciences will be a good mannered dark company, but it's just as likely they'll fall off the face of the earth and shareholders will wonder what happened to their investment as management pillages the plunder.
The company is cheap but I'd wait to see how the going dark transaction plays out. Will the company continue to provide updates to shareholders? Or will shareholders be forced into suing the company for an annual report that they're legally entitled to have? A huge red flag is that they're proceeding to go dark with what appears to be more than 300 shareholders without any communication or plan to reduce that number. It could be a sign that the company believes they can do what they want.
My messages is "buyer beware" to investors interested in this company. It appears cheap at first glance, but the lack of meaningful communication with investors as well as the blank going dark filing leave me leery. This has all the markings of a company about to enter the value graveyard.
Disclosure: No position
A company I've owned and followed for years, Opt-Sciences (OPST) filed their Form 15 on November 4th. The Form 15 is a document that notifies the SEC that a company intends to terminate their security registration. A company can do this if they have less than 300 shareholders of record. A shareholder of record is a shareholder who has possession of a physical stock certificate. If you own shares of a company in a brokerage account your name will never appear on the company's shareholder register. Rather the aggregated owner, Cede & Co, will appear on the shareholder register. Small companies like to go dark through this loophole. They might have thousands of shareholders with brokerage holdings, but these brokerage holdings only count as one registered owner. Most small companies have less than 300 shareholders with physical certificates.
Small companies will readily pay dividends and mail reports to shareholders who own shares in street name but when it comes time to determine if a company has enough shareholders to remain public or not companies will claim that street holders are not real shareholders. I know this is patently false as I've talked to CFO's of companies I own in street name, and they can see the number of shares I own and the name associated with my street holdings.
Opt-Sciences is a familiar name for small cap value investors. The company manufacturers anti-glare coating for aircraft instrument displays. The company has traded below book value since the financial crisis. The last time they traded for more than book for an extended period of time was in the mid to late 1990s. They are profitable and their balance sheet is loaded with cash and marketable securities. If one backs out their excess cash and securities the company has some eye-popping returns on equity and an extremely low P/E.
The company has a book value of $20.54 and earned $1.40 for the first nine months of 2015. Management expects the fourth quarter to generate about $.30 in earnings, for $1.70 in earnings for the full year. If you back out 75% of their cash and securities, which is $11.93 per share the company trades for 4.4x earnings. Ex-cash the company earns above 20% on their equity, although this could be misleading depending on how old their facilities are. It's possible they've depreciated all of their plant resulting in an artificially high ROE.
With the market at elevated levels it isn't often an investor finds a company at 4.4x earnings and trading for less than book value.
The reason that the stock is cheap is also the reason that going dark is a bad idea for the company. Opt-Sciences is cheap because management controls 66% of the company through a trust and another 6% directly for a 72% insider ownership stake. The Chairman is the head of the trust, while his son-in-law is the CEO. The beneficiaries of the trust are the CEO's wife and her brother, who is also on the board. The board consists of three members, the Chairman (trustee), CEO and his brother-in-law (trust beneficiary). The proxy claims the CEO has no control over the shares held in the trust, but these three family members appear to be on good terms, and it's laughable to say that the CEO's comments about the company wouldn't influence his wife's decisions or that the family wouldn't talk about the company at family gatherings.
Shareholders seem to have lost hope that value will ever be realized at the company and have been unwilling to trade shares for more than book. I don't blame any shareholders for giving up hope, there isn't much reason to hope with Opt-Sciences. While the company is generating good returns management is keeping the rewards to themselves. They don't buyback shares, and don't pay a dividend.
The company's Form 15 filing was terse. It contained no information as to why the company was going dark and didn't provide any details for the owners of the other 28% of the company who aren't insiders. The lack of communication speaks volumes as to how management thinks of the company. They act as if this is a small private company with a few nuisance shareholders hanging on.
As of January 2015 the company had 316 registered shareholders, 16 more than is required to go dark. Since then the company hasn't repurchased any shares, or announced any reverse splits to reduce their shareholder count under 300. It's possible the company is going to go dark illegally with more than 300 shareholders and hope the SEC just doesn't care.
I hope that Opt-Sciences will continue to publish financial reports for shareholders, but I'm skeptical. I've seen this pattern in the past where companies with large cash holdings go dark. Going dark can be a precursor to management sticking their hands in the cookie jar and looting the cash pile. When a company files with the SEC salaries and compensation and insider trades must be disclosed. In the world of dark stocks companies fly fast and loose without rules. Allegations of insider trading are rampant as well as managements with less than 100% ownership interest stealing 100% of the company's economic interest for themselves through high salaries and undisclosed perks.
It's possible that Opt-Sciences will be a good mannered dark company, but it's just as likely they'll fall off the face of the earth and shareholders will wonder what happened to their investment as management pillages the plunder.
The company is cheap but I'd wait to see how the going dark transaction plays out. Will the company continue to provide updates to shareholders? Or will shareholders be forced into suing the company for an annual report that they're legally entitled to have? A huge red flag is that they're proceeding to go dark with what appears to be more than 300 shareholders without any communication or plan to reduce that number. It could be a sign that the company believes they can do what they want.
My messages is "buyer beware" to investors interested in this company. It appears cheap at first glance, but the lack of meaningful communication with investors as well as the blank going dark filing leave me leery. This has all the markings of a company about to enter the value graveyard.
Disclosure: No position
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