Greenbackd

Barnwell Industries, Inc. (AMEX:BRN) is exactly the kind of opportunity Greenbackd likes to find: a company trading at a discount to its liquidating value with an activist investor agitating for change. We estimate the company has a value in liquidation of around $55M, so its market cap of $29M (based on its November 28, 2008 close of $3.51) puts the company at a 46% discount to that value. Dr. Eric Jackson’s Ironfire Capital LLC, an “equity long biased and event-driven activist investment firm”, has sniffed the value and launched a “‘friendly’ activist campaign targeting the company to unlock shareholder value”.

About BRN

BRN, according to its website, is “principally engaged in the following activities:

• Oil and Natural Gas. Barnwell engages in oil and natural gas exploration, development, production and sales in Canada.
• Land Investment. Barnwell invests in leasehold interests in real estate in Hawaii.
• Real Estate Development. Established in January 2007, acquires house lots for investment and for the construction of turnkey single-family homes for sale”

Seems like an odd combination of businesses to us, which makes it a prime candidate for a bust up.

The value proposition

According to BRN’s most recent quarterly report, BRN has a reasonably healthy balance sheet and positive cash flow of operating activities of $8.7M for the three months ending June 30, 2008. Set out below is our summary analysis of the balance sheet (each “Carrying” column shows the assets as they are carried in the financial statements, and each “Liquidating” column shows our estimate of the value of the assets in a liquidation):

Our liquidating value estimate for BRN is around $53.9M, or $6.52 per share. As the table above demonstrates, most of BRN’s value is in its Property, Plant, and Equipment, which is carried at $25.50 per share. In our valuation, we’ve written down BRN’s Property, Plant and Equipment per share by 50% to $12.75. Our written down value for the other assets is set out in the table. These estimates are often too conservative, but it is the only way we get to sleep at night. This is especially so given that the company is carrying $26M in total debt. With its stock price at $3.51 (at its November 28, 2008 closing price), BRN is trading at 54% of its value in a liquidation, which strikes us as a sufficient margin of safety.

The catalyst

Ironfire Capital has a position in BRN but it is presumably too small to require Ironfire to file a 13D notice.  Its founder, Dr. Eric Jackson, perhaps best known for his Yahoo! campaign, has published a number of “prescriptions” for BRN to enhance shareholder value on the web. Ironfire Capital is an interesting activist investor because it uses “Internet-based social networking tools” to “amplify the impact” of its campaigns. Dr. Jackson also writes a blog about his particular brand of web-based shareholder activism called Breakout Performance and has provided his analysis of BRN in a June post. He has also written about his prescriptions for BRN on his Sharehowner Activism Wiki, which include the following:

“Simplify Corporate Structure

Barnwell’s three businesses (oil and gas, contract water drilling, and real estate/land investment) have no synergy. A simpler corporate structure would better allow the market to bid up the underlying value of the oil and gas business to reflect the doubling of the commodity pricing in the last year. Barnwell should sell its water drilling business, which is small and shrinking in revenues and earnings. If the company received 1x its revenues, its cash reserves would nearly double to $14MM, allowing a stock buyback and/or upping the dividend. Selling or spinning off the real estate business might also make sense to focus Barnwell as a small natural gas pure-play.

Reduce SG&A Costs

Over the last year, SG&A costs have gone up 50% to $3.2MM. Yet, revenues and gross profit only increased 28% and 27% respectively over that same period. Barnwell is growing its costs at twice the rate of its sales and profits. As they say in Business School, that’s not sustainable. It’s also not acceptable for a 65 person company. Selling off the water drilling business, which contributes little profit, is a step in the right direction to improving things here, but much more work is needed.

Do a Stock Buyback

The company did agree to pay out a 5 cent dividend recently. Hopefully, that will attract a new group of investors to the stock. However, a stock buyback is both prudent, given that the cash position has increased over the last year and the strength of gas and land development businesses, and would make the company more attractive by lowering further its price-earnings ratio.

Bring in Some New Blood to the Board

Barnwell’s board is large and long-tenured. RiskMetrics awarded Barnwell a Corporate Governance Quotient (CGQ) score that is lower than 70% of other energy companies. The board’s composition is part of the problem. Seven of the 11 directors are older than 64. Four of the directors have been on the board for more than a decade.

It makes sense to change the composition of the board. Some of the longstanding directors should step down now to make way for some new blood, but some of them shouldn’t be replaced. An 11-member board is too large for a $100MM company. Having fewer than 10 directors would lead to faster meetings with more participation and debate.

Better Align Executive Compensation with Performance

Executive compensation policy has also likely contributed to Barnwell’s lower CGQ score. Last year, the CEO was paid $1.2MM. He explained this by pointing to how the company’s profits increased by 200% that year, yet the stock price dropped in half over that same time. Stock price is due to external market conditions, not management. If a CEO doubles a company’s profit, that should be rewarded.”

Conclusion

At 54% of its written down value, BRN is very cheap. With Ironfire Capital agitating for change, we believe BRN presents an attractive opportunity for investment.

BRN closed on November 28, 2008 at $3.51. The S&P 500 Index closed on November 28, 2008 at 896.24.

[Disclosure: We do not presently have a holding in BRN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]