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Archive for the ‘Liquidation Value’ Category

Last week I wrote about the performance of one of Benjamin Graham’s simple quantitative strategies over the 37 years he since he described it (Examining Benjamin Graham’s Record: Skill Or Luck?). In the original article Graham proposed two broad approaches, the second of which we examine in Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors. The first approach Graham detailed in the original 1934 edition of Security Analysis (my favorite edition)—“net current asset value”:

My first, more limited, technique confines itself to the purchase of common stocks at less than their working-capital value, or net-current asset value, giving no weight to the plant and other fixed assets, and deducting all liabilities in full from the current assets. We used this approach extensively in managing investment funds, and over a 30-odd year period we must have earned an average of some 20 per cent per year from this source. For a while, however, after the mid-1950’s, this brand of buying opportunity became very scarce because of the pervasive bull market. But it has returned in quantity since the 1973–74 decline. In January 1976 we counted over 300 such issues in the Standard & Poor’s Stock Guide—about 10 per cent of the total. I consider it a foolproof method of systematic investment—once again, not on the basis of individual results but in terms of the expectable group outcome.

In 2010 I examined the performance of Graham’s net current asset value strategy with Sunil Mohanty and Jeffrey Oxman of the University of St. Thomas. The resulting paper is embedded below:

While Graham found this strategy was “almost unfailingly dependable and satisfactory,” it was “severely limited in its application” because the stocks were too small and infrequently available. This is still the case today. There are several other problems with both of Graham’s strategies. In Quantitative Value: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors Wes and I discuss in detail industry and academic research into a variety of improved fundamental value investing methods, and simple quantitative value investment strategies. We independently backtest each method, and strategy, and combine the best into a sample quantitative value investment model.

The book can be ordered from Wiley FinanceAmazon, or Barnes and Noble.

[I am an Amazon Affiliate and receive a small commission for the sale of any book purchased through this site.]

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Zero Hedge has an article Buy Cash At A Discount: These Companies Have Negative Enterprise Value in which Tyler Durden argues that stock market manipulation has led to valuation dislocations, and gives as evidence the phenomenon of stocks trading with a negative enterprise value (EV):

With humans long gone from the trading arena and algorithms left solely in charge of the casino formerly known as “the stock market”, in which price discovery is purely a function of highly levered synthetic instruments such as ES and SPY or, worse, the EURUSD and not fundamentals, numerous valuation dislocations are bound to occur. Such as company equity value trading well below net cash (excluding total debt), or in other words, negative enterprise value, meaning one can buy the cash at a discount of par and assign zero value to all other corporate assets.

Just as the fact of your paranoia does not exclude the possibility that someone is following you*, you don’t need to believe in manipulation to believe that negative EV is a “valuation dislocation.” Negative EV stocks are often also Graham net nets or almost net nets, and so perform like net nets. For example, Turnkey Analyst took a look at the performance of negative EV stocks (click to enlarge):

Long story short: they ripped, but they were few (sometimes non-existent), and small (mostly micro), which means you would have been heavily concentrated in a few mostly very small stocks, and regularly carried a lot of cash. If you eliminated the tiniest (i.e. the smallest 10 or 20 percent), much of the return disappeared, and volatility spiked markedly. Says Wes:

A few key points:

  1. After you eliminate the micro-crap stocks, you end up being invested in a few names at a time (sometimes you go all-in on a single firm!)
  2. Sometimes the strategy isn’t invested.
  3. The amazing Bueffettesque returns for the “all firms” portfolio above are exclusively tied to micro-craps.

Here’s the frequency of negative EV opportunities according to Turnkey (click to enlarge):

No surprise, there were more following a crash (1987, 2001, 2009) and fewer at the peak (1986, 1999, 2007). If your universe eliminated the smallest 20 percent (the green line), you spent a lot of time in cash. If your universe was unrestricted (the red line), then you’d have had some prospects to mine most of the time. Clearly, it’s not an institutional-grade strategy, but it has worked for smaller sums.

Zero Hedge screened Russell 2000 companies finding 10 companies with negative enterprise value, and then further subdivided the screen into companies with negative, and positive free cash flow (defined here as EBITDA – Cap Ex). Here’s the list (click to enlarge):

Including short-term investments yields a bigger list (click to enlarge):

Like Graham net nets, negative EV stocks are ugly balance sheet plays. They lose money; they burn cash; the business, if they actually have one, usually needs to be taken to the woodshed (so does management, for that matter). Frankly, that’s why they’re cheap. Says Durden:

Typically negative EV companies are associated with pre-bankruptcy cases, usually involving large cash burn, in other words, where the cash may or may not be tomorrow, and which may or may not be able to satisfy all claims should the company file today, especially if it has some off balance sheet liabilities.

You can cherry-pick this screen or buy the basket. I favor the basket approach. Just for fun, I’ve formed four virtual portfolios at Tickerspy to track the performance:

  1. Zero Hedge Negative Enterprise Value Portfolio
  2. Zero Hedge Negative Enterprise Value Portfolio (Positive FCF Only)
  3. Zero Hedge Negative Enterprise Value (Inc. Short-Term Investments) Portfolio
  4. Zero Hedge Negative Enterprise Value (Inc. Short-Term Investments) Portfolio (Positive FCF Only)

I’ll check back in occasionally to see how they’re doing. My predictions for 2013:

  1. All portfolios beat the market
  2. Portfolio 1 outperforms Portfolio 2 (i.e. all negative EV stocks outperform those with positive FCF only)
  3. Portfolio 3 outperforms Portfolio 4 for the same reason that 1 outperforms 2.
  4. Portfolios 1 and 2 outperform Portfolios 3 and 4 (pure negative EV stocks outperform negative EV including short-term investments)

Take care here. The idiosyncratic risk here is huge because the portfolios are so small. Any bump to one stock leaves a huge hole in the portfolio.

* Turn around. I’m right behind you.

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Kinnaras Capital Management has sent a follow up letter to Media General Inc (NYSE:MEG) requesting the board “selloff MEG in its entirety and divorce this company from the inept management team currently at the helm.”

In its earlier letter Kinnaras expressed frustration with the performance of MEG, and urged the Board to “take advantage of the robust M&A market for both newspaper and broadcast television and to sell all operating units of MEG in order to retire existing corporate and pension debt and achieve a share price shareholders have rarely seen in recent years.”

MEG is a provider of local news in small and mid-size communities throughout the Southeastern United States. It owns three metropolitan and 20 community newspapers and 18 network-affiliated broadcast television stations Virginia/Tennessee, Florida, Mid-South, North Carolina, and Ohio/Rhode Island.

The initial letter included Kinnaras’s sum-of-the-parts valuation, which Kinnaras Managing Member Amit Chokshi sees at $9.75 per share against a prevailing price of around $4.60.

Here’s the follow up letter:

Kinnaras also has on its website its recommendations to MEG shareholders ahead of the proxy vote.

No position.

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Kinnaras Capital Management has sent an open letter to Media General Inc (NYSE:MEG) expressing frustration with the performance of the company and “urging the Board to take advantage of the robust M&A market for both newspaper and broadcast television and to sell all operating units of MEG in order to retire existing corporate and pension debt and achieve a share price shareholders have rarely seen in recent years.”

MEG is a provider of local news in small and mid-size communities throughout the Southeastern United States. It owns three metropolitan and 20 community newspapers and 18 network-affiliated broadcast television stations Virginia/Tennessee, Florida, Mid-South, North Carolina, and Ohio/Rhode Island.

The letter includes Kinnaras’s sum-of-the-parts valuation, which Kinnaras Managing Member Amit Chokshi sees at $9.75 per share against a prevailing price of around $4.60.

Here’s the letter:

It seems like a promising situation.

No position.

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Walter Schloss, one of Warren Buffett’s Superinvestors of Graham-and-Doddsville, has died at 95.

Says Bloomberg:

From 1955 to 2002, by Schloss’s estimate, his investments returned 16 percent annually on average after fees, compared with 10 percent for the Standard & Poor’s 500 Index.

His firm, Walter J. Schloss Associates, became a partnership, Walter & Edwin Schloss Associates, when his son joined him in 1973.

“He was a true fundamentalist,” Edwin Schloss, now retired, said today in an interview. “He did his fundamental analysis and was very concerned that he was buying something at a discount. Margin of safety was always essential.”

Buffett, another Graham disciple, called Schloss a “superinvestor” in a 1984 speech at Columbia Business School.

He again saluted Schloss as “one of the good guys of Wall Street” in his 2006 letter to shareholders of his Berkshire Hathaway Inc.

“Following a strategy that involved no real risk — defined as permanent loss of capital — Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500,” wrote Buffett, whose stewardship of Berkshire

Hathaway (BRK) has made him one of the world’s richest men and most emulated investors. “It’s particularly noteworthy that he built this record by investing in about 1,000 securities, mostly of a lackluster type. A few big winners did not account for his success.”

For more on Schloss and his outstanding record, see Walter Schloss, superinvestor.

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The Fall 2010 edition of the Graham and Doddsville Newsletter, Columbia Business School‘s student-led investment newsletter co-sponsored by the Heilbrunn Center for Graham & Dodd Investing and the Columbia Investment Management Association, has a fascinating interview with Donald G. Smith. Smith, who volunteered for Benjamin Graham at UCLA, concentrates on the bottom decile of price to tangible book stocks and has compounded at 15.3% over 30 years:

G&D: Briefly describe the history of your firm and how you got started?

DS: Donald Smith & Co. was founded in 1980 and now has $3.6 billion under management. Over 30 years since inception our compounded annualized return is 15.3%. Over the last 10 years our annualized return is 12.1% versus −0.4% for the S&P 500.

Our investment philosophy goes back to when I was going to UCLA Law School and Benjamin Graham was teaching in the UCLA Business School. In one of his lectures he discussed a Drexel Firestone study which analyzed the performance of a portfolio of the lowest P/E third of the Dow Jones (which was the beginning of ―Dogs of the Dow 30). Graham wanted to update that study but he didn‘t have access to a database in those days, so he asked for volunteers to manually calculate the data. I was curious about this whole approach so I decided to volunteer. There was no question that this approach beat the market. However, doing the analysis, especially by hand, you could see some of the flaws in the P/E based approach. Based on the system you would buy Chrysler every time the earnings boomed and it was selling at only a 5x P/E, but the next year or two they would go into a down cycle, the P/E would expand and you were forced to sell it. So in effect, you were often buying high and selling low. So it dawned on me that P/E and earnings were too volatile to base an investment philosophy on. That‘s why I started playing with book value to develop a better investment approach based on a more stable metric.

G&D: There are plenty of studies suggesting that the lowest price to book stocks outperform. However, only 1/10 of 1% of all money managers focus on the lowest decile of price to book stocks. Why do you think that‘s so, and how do people ignore all of this evidence?

DS: They haven‘t totally ignored it. There are periods of time when quant funds, in particular, use this strategy. However a lot of the purely quant funds buying low price to book stocks have blown up, as was the case in the summer of 2007. Now not as many funds are using the approach. Low price to book stocks tend to be out-of-favor companies. Often their earnings are really depressed, and when earnings are going down and stock prices are going down, it‘s a tough sell.

G&D: Would you mind talking about how the composition of that bottom decile has changed over time? Is it typically composed of firms in particular out of favor industries or companies dealing with specific issues unique to them?

DS: The bulk is companies with specific issues unique to them, but often there is a sector theme. Back in the early 1980‘s small stocks were all the rage and big slow-growing companies were very depressed. At that time we loaded up on a lot of these large companies. Then the KKR‘s of the world started buying them because of their stable cash flow and the stocks went up. About six years ago, a lot of the energy-related stocks were very cheap. We owned oil shipping, oil services and coal companies trading below book and liquidation value. When oil went up they became the darlings of Wall Street. Over the years we have consistently owned electric utilities because there always seem to be stocks that are temporarily depressed because of a bad rate decision by the public service commission. Also, cyclicals have been a staple for us over the years because, by definition, they go up and down a lot which gives us buying opportunities. We‘ve been in and out of the hotel group, homebuilders, airlines, and tech stocks.

Performance of the low-price-to-tangible book value:

Read the Graham and Doddsville newsletter Fall 2010 (.pdf).

Hat tip George.

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For a period from late 2008 through mid 2009 the GSI Group (PINK:LASR) was prima facie the cheapest stock on my net net screen, but I couldn’t pull the trigger because it was delinquent a few quarterly filings. The company entered Chapter 11 due to the technical default of not filing financial statements and is now an extremely interesting prospect post reorganization. The superb Above Average Odds Investing blog has a guest post from Ben Rosenzweig, an analyst at Privet Fund Management, titled The GSI Group (LASR.PK) – Another Low-Risk, High-Return Post Reorg Equity w/ Substantial Near-Term Catalyst(s), which really says it all. Here’s the summary:

Thesis Summary: Privet Fund LP is long GSIGQ common stock. Our post-emergence price target is $5.00 per common share, an internal rate of return of 123% based on closing price of $2.70 and right to purchase .99 shares for every 1 share currently owned at a price of $1.80 per share. The market has failed to fully price in the impact of the Plan of Reorganization that was confirmed on Thursday, May 27, 2010.

We believe GSI is an attractive investment opportunity for the following reasons:

  • Due to the efforts of the equity committee throughout the bankruptcy process, the pre-emergence equity holders will be able to maintain an 87% ownership in the post-emergence company, up from an initial distribution of 18.6% in the first Plan of Reorganization
  • The end markets for the Company’s precision technology and semiconductor products are coming out of the trough of a cycle and, as a result, GSI’s bookings have been increasing at an exponential rate
  • The purging of the previous management regime opens the door for an experienced operator to run the Company much more efficiently and make strategic decisions with a view toward enhancing the value of the enterprise
  • The significant reduction in debt gives management the needed flexibility to focus solely on improving operations. This should result in significant fixed cost leverage going forward as evidenced by the Q1 2010 EBITDA margin of 14%, a figure that previous management suggested was not achievable until the end of 2011
  • The current market valuation, which includes the right to buy .99 shares at $1.80 per share, implies a 2010 sales figure and discounted cash flow valuation that is simply not possible even if the Company’s financial performance does not follow through on the radical improvements that have been shown during the past two quarters

Read the post in full.

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Longterm Investing has a series of posts examining several scenarios in Seahawk (HAWK) following the recent conference call (see my post archive for the background). In particular, Neil has examined the effect of CEO Randy Stilley’s proposal to take on debt to buy rigs, rather than buyback stock. Here’s the analysis:

It’s important to understand how the risk-reward profile of HAWK is modified as they take on debt. In their quarterly call they indicated a strong preference for adding debt and adding rigs.

I’ve considered three scenarios.

1. HAWK retains their current leverage and uses asset sales to pay for operations. These asset sales will be at scrap values, around $7M per rig.

2. HAWK takes on 110M of debt and 50M of new assets. These new assets are 3M cash flow positive each quarter after interest. All of HAWKs rigs, new and old are security for this debt. It replaces the existing credit line. This amount of debt is below the scrap value of existing rigs + new asset value.

3. Hawk takes on $150M of debt and 50M of new assets. Similarly,  these new assets are 3M cash flow positive each quarter after interest. All of HAWKs rigs, new and old are security for this debt. It replaces the existing credit line. This amount of debt is about the liquidation value of current rigs and new rigs, net of liabilities.

The “good case” is where HAWK continues their current cash burn, as modified in the scenarios above, until a point in time when rig market values return to December 2008 levels.

The company values under each scenario are shown below assuming a return to December 2008 values in that period. The value added and subtracted by debt are shown along with the 40M residual value under case 2.

image

See the post.

Long HAWK.

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The NYTimes.com Business Day Media & Advertising section had a story last week about Randall D. Smith, a “pioneer in the hard knocks business of vulture investing” and his current focus on the newspaper industry:

Mr. Smith puts money into risky investments that few others will touch — and these days, that includes many newspaper and radio companies.

For the better part of a year, Mr. Smith has been quietly building a fledgling media empire. He has invested millions of dollars in small and midsize newspaper chains, as well several radio broadcasters.

His exact ambitions are unclear. But industry executives and analysts say Mr. Smith — who made money investing in troubled companies after the junk-bond market collapsed in the 1980s — is clearly betting that he can eke out profits despite the industry’s running troubles.

Smith is not the only investor interested in newspapers:

Mr. Smith is not the only vulture investor watching the media industry. A handful of hedge funds, as well as some big banks, are vying for ownership or have already gained controlling interests in newspapers across the country, including The Los Angeles Times, The Minneapolis Star Tribune and The Chicago Tribune.

Hedge funds have even grabbed stakes in supermarket tabloids like The National Enquirer and Star Magazine, as those companies have undergone rounds of restructurings.

Funds also gained the upper hand for the television broadcasting company Ion Media Network and the publishing and educational materials company Houghton Mifflin Harcourt.

Smith’s m.o. is deep value:

Vulture investors like Mr. Smith often buy up the debt of weak companies for pennies on the dollar, hoping to turn a profit when the companies go through bankruptcy or restructure their businesses. Often they hope to swap the debt for equity. But some analysts wonder how, or whether, the vultures can steer some of these companies through the unprecedented upheaval in the industry.

“These people have been bottom feeders, and they figure what they’re getting is still a valuable, though diminished, franchise and they’re willing to pay bottom dollar for it,” John Morton, a newspaper industry analyst, said of these investors. “But it’s unclear that this industry is going to get a whole lot better.”

Nonetheless, some big vulture investors seem to be betting that the industry’s worst days are over, or that, at the least, that further cost cutting or consolidation can slow the bleeding, analysts said.

Smith has a great track record:

But analysts and industry executives are keeping a particularly close eye on Mr. Smith. He has been one of savviest and stealthiest investors in the media realm in the past year and a half, they say.

Mr. Smith started his own brokerage firm, R.D. Smith & Company, in 1985, after spending years climbing the ranks of Bear Stearns. For the past decade or so, he has quietly tended to running money for himself and his family.

But in late 2008, he opened a new fund which surged an astonishing 187 percent last year. This year, however, the fund was up only 2.9 percent this year through the end of July, according to Absolute Return + Alpha, an industry magazine.

In a letter to investors in April, the firm said the fund held significant positions in 15 companies and that two of the current themes were distressed financials and media companies.

In recent months, Mr. Smith has built up a significant stake in MediaNews Group, a publishing company that owns The Denver Post and San Jose Mercury News, as well as The Journal Register, which controls 170 titles, including The New Haven Register and The Trentonian.

Read the article.

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Minyanville has an article analyzing Liberty Media Corp (Capital) (NASDAQ:LCAPA) on a sum-of-the-parts basis:

The key for investors: Liberty Capital stock trades at a 58% discount to the value of all the assets that back it. The stock recently sold for $48 [now $45], but the collection of assets it represents add up to $82 after debt, according to Robert Routh a media analyst with Wedge Partners.

What does a share of LCAPA represent?

As a tracking stock, Liberty Capital represents the value of the stock holdings of its parent Liberty Media in Sirius XM Radio, Time Warner Cable (TWC), Time Warner (TWX), Sprint Nextel (S), Viacom (VIA), Motorola (MOT), AOL (AOL), Live Nation Entertainment (LYV), and CenturyLink (CTL). All of this plus a few other stocks and the value of some media assets recently added up to $107 per share for Liberty Capital, calculates Routh, who regularly makes some great calls on media stocks. Subtract around $25 in debt, and you get an enterprise value of around $82 for Liberty Capital. That’s the tracking stock that sells for just $48.

Why the discount?

First of all, a lot of mutual funds cannot own tracking stocks, which reduces demand for the Liberty Capital tracker. Second, Liberty Capital is saddled with a “complexity discount” — meaning the situation is so confusing many investors just avoid it. Plus, there’s no guarantee the discount will ever go away.

Any catalysts?

For buy-and-hold investors, what might make that happen? One catalyst will be ongoing share buybacks, believes Scott Stevens of Strata Capital Management, which owns the Liberty Capital tracking stock. Stevens is worth listening to because Strata Capital Management was up 11.1% year-to-date net of fees as of August 17, compared to a 2% decline for the S&P 500. Next, believes Stevens, Liberty Capital has over $2 billion in cash, and it might use some of for an accretive acquisition

And eventually, Liberty Capital should be converted from a tracking stock to a regular asset-backed common stock, which would help the complexity discount go away. Malone should get the ball rolling on this front when he converts another stock tracking assets in the Liberty Media parent company. That tracker is Liberty Media Interactive (LINTA) which represents the Liberty Media’s home-shopping channel QVC and a stake in Home Shopping Network.

The conversion should happen around the end of this year or in the first quarter of 2011. That alone might wake other investors to the potential in Liberty Capital because it’s on the same track, and put a bid underneath the stock. A third Liberty Media tracker will also be converted at some point, or Liberty Starz Group (LSTZA) which represents Liberty Media’s Starz Encore pay TV channel. Another catalyst might be the sale of the Atlanta Braves by the end of 2011.

Read the article.

Nop positions.

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