Archive for October, 2009

Forward Industries Inc (NASDAQ:FORD) has fired its investment and engaged another. It looks like FORD is intent on spending the cash on its balance sheet, which is a shame. Rather than make an acquisition, they should focus on the work on their desk and pay a big dividend. There’s a half chance that the bank could suggest a sale of the company, but that seems unlikely. I can’t believe there are no activists out there willing to take on this company. It’s 40% off its 52-week high. It’s net cash. There are no big holders. Management’s not doing a bad job, but an acquisition is a ridiculous idea. This is an instance of a management trying to plow a dollar back into the business and turn it into fifty cents. I could use that dollar more profitably. Then again, I’d probably just spend it on pennywhistles and moonpies.

We started following FORD (see our post archive here) because it was trading at a discount to its net cash and liquidation values, although there was no obvious catalyst. Management appeared to be considering a “strategic transaction” of some kind, which might have included an “acquisition or some other combination.” Trinad Management had an activist position in the stock, but had been selling at the time we opened the position and only one stockholder owned more than 5% of the stock. The stock is up 36.8% since we opened the position to close yesterday at $1.97, giving the company a market capitalization of $13.4M. Following our review of the most recent 10Q, we’ve estimate the liquidation value to $19.5M or $2.47 per share.

Here’s a link to the announcement (it’s just a marketing announcement by the bank so I’m not going to repost it).

FORD is trading at a substantial discount to its liquidation and net cash values. The risk to this position is management spraying the cash away on an acquisition. A far better use of the company’s cash is a buyback, special dividend or return of capital. Another concern is Trinad Management exiting its activist position in the stock. Those concerns aside, I’m going to maintain the position because it still looks cheap at a discount to net cash.

[Full Disclosure:  We have a holding in FORD. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Following my Simoleon Sense interview with Miguel Barbosa, I’ve had a few requests for a post on Tom Evans. Here it is, hacked together like Frankenstein’s monster from all the public information I could track down:

Thomas Mellon Evans was a one of the first modern corporate raiders, taking Graham’s net current asset analysis and using it to wreak havoc on the gray flannel suits of the 40s and 50s. He’s not particularly well-known today, but he waged numerous takeover battles using tactics that are forerunners of those employed by many of the takeover artists of the 1980s and the activists of the 1990s and 2000s. Proxy battles? Check. Greenmail? Check. Liquidations? Check.

Born September 8, 1920 in Pittsburgh, and orphaned at the age of 11, Evans grew up poor. Despite his famous middle name (his grandmother’s first cousin was Andrew Mellon), he began his financial career at the bottom. After graduating from Yale University in 1931 in the teeth of the Great Depression, he landed a $100-a-month clerk’s job at Gulf Oil.

While his friends headed out in the evening, Evans would stay home reading balance sheets and looking for promising companies: those he could he could buy for less than the assets were worth in liquidation. Evans found such companies by calculating their “net quick assets,” the long forgotten name for “net current assets.” His friends teased him about his obsession and gave him a nickname: “Net Quick” Evans. From the 1944 Time Magazine article, Young Tom Evans:

With only some fatherly advice from Gulf’s Board Chairman, W. L. Mellon, Tom Evans made his way alone. For six years he saved money, like an Alger hero; and played the stockmarket, unlike an Alger hero. Thus he collected $10,000. He wanted to find and buy a family-owned business that had gone to pot. In the down-at-the-heels H. K. Porter Co., in Pittsburgh’s slummy Lawrenceville section, he found it. Once a No. 1 builder of industrial locomotives, Porter Co. was down to 40 workers.

Tom Evans bought up Porter bonds at 10 to 15 cents on the dollar, reorganized the company under 77B, and became president at 28.

From then on, Evan was the chief terror of the sleepy boardrooms of the era, much like Icahn would be 30 years later. As a connoisseur of deep value on the balance sheet, one has to admire his methods (From the New York Times obituary, Thomas Evans, 86, a Takeover Expert, Dies):

‘He was never really an operator; he was a financial guy — a balance sheet buyer,” one of his sons, Robert Sheldon Evans, told Forbes magazine in 1995. ”He would buy something for less than book value and figure the worst that could happen was he would liquidate it and come out O.K. What he didn’t want to do was lose money on the deal. If he knew his downside was covered, then he figured the upside would probably take care of itself.

”It was a very shrewd policy in the 50’s and 60’s, when there were highly inefficient markets: buying undervalued assets, running them for cash and selling off pieces. The 80’s leveraged buyout guys were just taking a lot of his deals to their logical extension.”

The book The White Sharks of Wall Street: Thomas Mellon Evans and the Original Corporate Raiders by Diana B. Henriques is an excellent biography on Evans. More than that, it describes many of the battles for corporate control in the 40s, 50s and 60s. In contradistinction to the takeover battles of the 80s, the dogfights in the 40s, 50s, and 60s were largely proxy fights, and in as much, should be familiar to today’s “activist investors.” James B. Stewart’s Let’s make a deal, his review of Henriques’ book, does it justice:

There are surely few phenomena more remarkable in American business than the periodic ability of cash-poor but swashbuckling newcomers, using little or none of their own money, to seize control of some of the country’s most valuable corporations. In its most recent, frenzied incarnation, dot-com entrepreneurs have exchanged stock in companies with few tangible assets and even fewer profits for control of established, profitable companies. Fifteen years ago, the currency was junk bonds rather than inflated stock. And before that, it was bank loans using a target’s assets as collateral.

Wall Street greets each wave of takeovers as the dawning of a new era. But the proposition that nothing has fundamentally changed is convincingly set forth in ”The White Sharks of Wall Street,” an engaging and thorough history of early corporate takeovers by Diana B. Henriques, a financial reporter for The New York Times. Her central character is Thomas Mellon Evans, who surfaces in what seems like nearly every trendsetting corporate battle from 1945 until his retirement in 1984, and whose tactics remain essential to practitioners of corporate warfare. Junk bonds? Greenmail? Scorched earth? Evans had been there long before investment bankers coined a catchy vocabulary to describe the maneuvers of people like T. Boone Pickens, Carl Icahn and Saul Steinberg.

Though Evans seems to have escaped the widespread public resentment and envy the others generated, and Henriques’s portrait is carefully nonjudgmental, it is difficult for a reader to work up much sympathy for him. He was ruthless, bad-tempered, usually indifferent to workers and communities. He repeatedly displayed what appears to be a criminal disregard for the antitrust laws (though he was never prosecuted). He divorced two wives (the second later committed suicide), and both times a replacement was conspicuously at hand long before any legal proceedings had begun. He betrayed two of his own sons in his quest for corporate dominance and wealth.

Yet as a deal maker Evans displayed a natural audacity and genius. In 1935, 24 years old and lacking any money to speak of, he decided he wanted to gain control of Pittsburgh’s struggling H. K. Porter Company, a manufacturer of steam locomotives. Inspired by a Fortune magazine account of Floyd Odlum, who became rich by using borrowed securities as collateral for loans to buy undervalued stock, Evans borrowed shares from a Mellon mentor, took out a loan and invested in Gulf Oil stock, then a Mellon enterprise. When Gulf’s stock rose handsomely as the nation emerged from the Depression, Evans used his profits to buy Porter bonds, then selling for a small fraction of their face value. When Porter finally had to declare bankruptcy and was reorganized, Evans, as the largest creditor, traded his bonds for equity and became the largest shareholder. Porter, essentially acquired for junk bonds, would be Evans’s vehicle for most of his life.

I highly recommend The White Sharks of Wall Street: Thomas Mellon Evans and the Original Corporate Raiders by Diana B. Henriques for fans of deep value and activist investment.

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We’ve just completed an interview with Miguel Barbosa of the wonderful Simoleon Sense. Go there now, and get trapped in an endless loop as you are recirculated back here and so on.

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Yesterday was the record date for the first dividend in the liquidation of Leadis Technology Inc (NASDAQ:LDIS). The dividend is likely to be approximately $0.93 per share. The board estimates that “if we are able to dispose of substantially all of our non-cash assets, the aggregate amount of all liquidating distributions that will be paid to stockholders will be in the range of approximately $0.93 to $1.20 per share of Leadis common stock.” After the initial $0.93 dividend, the remaining dividends will be in the range of nil to $0.27 ($1.20 less $0.93). LDIS closed yesterday at $0.99. If the stub starts trading tomorrow at $0.06 ($0.99 less $0.93), it becomes an interesting security offering the potential for some substantial upside.

The definitive proxy filings have the detail:

How much can stockholders expect to receive if the Plan of Dissolution is approved at the special meeting?

At this time, we cannot predict with certainty the amount of any liquidating distributions to our stockholders. However, based on information currently available to us, assuming, among other things, no unanticipated actual or contingent liabilities, we estimate that over time stockholders will receive one or more distributions that in the aggregate range from approximately $0.93 to $1.20 per share. This range of estimated distributions represents our estimate of the amount to be distributed to stockholders during the liquidation, but does not represent the minimum or maximum distribution amount. Actual distributions could be higher or lower.

This estimated range is based upon, among other things, the fact that as of August 31, 2009, we had approximately $28.6 million in cash, cash equivalents, restricted cash equivalents and short-term and non-current investments. In addition, subsequent to August 31, 2009, we received approximately $3.2 million in connection with the sale of certain assets to IXYS Corporation. We expect to use cash of approximately $2.3 million to satisfy liabilities on our unaudited balance sheet after August 31, 2009. In addition to converting our remaining non-cash assets to cash and satisfying the liabilities currently on our balance sheet, we have used and anticipate using cash for a number of items, including but not limited to: satisfying capital leases and other contractual commitments. In addition to the satisfaction of our liabilities, we have used and anticipate continuing to use cash in the next several months for a number of items, including, but not limited to, the following:

• ongoing operating expenses;

• expenses incurred in connection with extending our directors’ and officers’ insurance coverage;

• expenses incurred in connection with the liquidation and dissolution process;

• severance and related costs;

• resolution of pending and potential claims, assessments and obligations; and

• professional, legal, consulting and accounting fees.

We are unable at this time to predict the ultimate amount of our liabilities because the settlement of our existing liabilities could cost more than we anticipate and we may incur additional liabilities arising out of contingent claims that have not been quantified, are not yet reflected as liabilities on our balance sheet and have not been included in the estimated range of potential distributions, such as liabilities relating to claims that have not been resolved and claims or lawsuits that could be brought against us in the future. If any payments are made with respect to the foregoing, the estimated range of distributions to stockholders will be negatively impacted and less than estimated. If the ultimate amount of our liabilities is greater than what we anticipate, the distribution to our stockholders may be substantially lower than anticipated. Therefore, we are unable at this time to predict the precise nature, amount and timing of any distributions due in part to our inability to predict the ultimate amount of our liabilities. Accordingly, you will not know the exact amount of any liquidating distributions you may receive as a result of the Plan of Dissolution when you vote on the proposal to approve the Plan of Dissolution. You may receive substantially less than the low end of the current estimate.

For some further background, see Shake&Bake’s take on LDIS.

Hat tip Joseph.

[Full Disclosure:  We have a holding in LDIS. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Digirad Corporation (NASDAQ:DRAD) has filed its 10Q for the quarter ended September 30, 2009.

We started following DRAD (see our post archive here) because it was an undervalued asset play with a plan to sell assets and buy back its stock. The stock is up more than 167% since we started following it to close yesterday at $2.35, giving the company a market capitalization of $36.1M. We last estimated the liquidation value to be around $32.5M or $1.73 per share. We’ve now increased our valuation to $32.9M or $1.77 per share following another very good quarter for DRAD. Year-to-date, DRAD has generated over $3.4M in cash from operations. DRAD has also started buying back stock under its previously announced $2M stock repurchase plan.

The value proposition updated

DRAD has continued its good year, generating $3.4M in operating cash flow year-to-date. Our updated estimate for the company’s liquidation value is set out below (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

DRAD Summary 2009 9 30Off-balance sheet arrangements and contractual obligations: The company hasn’t disclosed any off-balance sheet arrangements in its most recent 10Q.

The catalyst

DRAD’s board has announced a stock buyback program:

The Company also announced that its board of directors has authorized a stock buyback program to repurchase up to an aggregate of $2 million of its issued and outstanding common shares. Digirad had approximately 19 million shares outstanding as of December 31, 2008. At current valuations, this repurchase plan would authorize the buyback of approximately 2.1 million shares, or approximately 11 percent of the company’s outstanding shares.

Chairman of the Digirad Board of Directors R. King Nelson said, “The board believes the Company’s direction and goals towards generating positive cash flow and earnings coupled with an undervalued stock price present a unique investment opportunity. We are confident this will provide a solid return to our shareholders.”

According to the most recent 10Q, the company has now started to buy its own stock, albeit a relatively small amount:

On February 4, 2009, our Board of Directors approved a stock repurchase program whereby we may, from time to time, purchase up to $2.0 million worth of our common stock in the open market, in privately negotiated transactions or otherwise, at prices that we deem appropriate. The plan has no expiration date. Details of purchases made during the nine months ended September 30, 2009 are as follows (Edited to fit this space.):

DRAD Buy Back Detail 2009 09 30


DRAD is now trading at a reasonable 24% premium to its $32.9M or $1.77 per share in liquidation value. It’s off about 20% from its peak, and looks likely to continue to drop. We’re generally sellers of secondary securities trading at a premium to liquidation value, but DRAD seems to have the started generating cash. We’d like to see where it can go. We can see no other reason to cease holding DRAD in the Greenbackd Portfolio and so we’re going to maintain the position for now.

[Full Disclosure:  We do not have a holding in DRAD. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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The FT Alphaville blog has a post, The US stock market is overvalued by 40%, based on a recent research report, The US Stock Market: Value and Nonsense About It, from Andrew Smithers of London-based research house Smithers & Co.

According to the FT Alphaville blog, Smithers says there are only two ‘valid’ ways to value the market. One is by using a cyclically adjusted PE ratio and the other by using the Q ratio, which compares the market capitalisation of companies with their net worth, adjusted to current prices. Both techniques yield the same answer: the stockmarket is overvalued by around 40%.

Smithers explains:

As the valid measures of the US market show that it is currently around 40% overvalued, some ingenuity is needed to claim otherwise. The EPS for the past 12 months on the S&P 500 is $7.51 so, with the index at 1071, it is selling at a trailing PE of 142. This is far higher than it has ever been before, as the previous end month record is a PE of 47. But current multiples are no guide to value; when depressed, or elevated, they need to be adjusted to their cyclical norm.

This is how the cyclically adjusted PE (”CAPE”) is calculated and when its current value is compared with long-term average, using the geometric means of EPS and cyclically adjusted PEs,6 it shows that the market is 37.7% overpriced using 10 years of earnings’ data and 45% if 20 years are used. This method is therefore of no use to those who sell shares, or have made faulty claims about value in the past. The following are among the most common approaches to circumventing the problem this presents. Some produce relatively small distortions, but these can amount to a substantial degree of misinformation when combined.

Go to the The FT Alphaville blog post, The US stock market is overvalued by 40%.

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In a new paper Value vs Glamour: A Global Phenomenon (via SSRN)  The Brandes Institute updates the landmark 1994 study by Josef Lakonishok, Andrei Shleifer, and Robert Vishny investigating the performance of value stocks relative to that of glamour securities in the United States over a 26-year period. Lakonishok, Shleifer, and Vishny found that value stocks tended to outperform glamour stocks by wide margins, but their earlier research did not include the glamour-driven markets of the late 1990s and early 2000s. The paper asks, “What effect might this period have on their conclusions?” To answer that question, The Brandes Institute updated the research through to June 2008, examining the comparative performance of value and glamour over a 40-year period, and extending the scope of the initial study to include non-U.S. markets, to determine whether the value premium is evident worldwide.

The research focuses on our favorite indicator, price-to-book value, but also includes price-to-cash flow, price-to-earnings, sales growth over the preceding five years and combinations of the foregoing. Here is The Brandes Institute’s discussion on price-to-book:

Lakonishok, Shleifer, and Vishny on price-to-book

The Brandes Institute  hewed closely to Lakonishok, Shleifer, and Vishny’s methods, described on page 3 of the paper:

First, the sample of companies as of April 30, 1968 was divided into deciles based on one of the criteria above. Second, the aggregate performance of each decile was tracked for each of the next five years on each April 30. Finally, the first and second steps were repeated for each April 30 from 1969 to 1989.

We start with the price-to-book criterion as an example. First, all stocks traded on the NYSE and AMEX as of April 30, 1968 were sorted into deciles based on their price-to-book ratios on that date. Stocks with the highers P/B ratios were grouped in decile 1. For each consecutive decile, P/B ratios decreased; this cuilminated in stocks with the lowest P/B values forming decile 10.

In essence, this process created 10 separate portfolios, each with an inception date of April 30, 1968. The lower deciles, which consisted of higher-P/B stocks, represented glamour portfolios. In contrast, the higher deciles – those filled with lower-P/B stocks – represented value portfolios.

From there, annual performance of deciles 1 through 10 was tracked over the subsequent five years. Additionally, new 10-decile sets were constructed based on the combined NYSE/AMEX sample as of April 30, 1969, and every subsequent April 30 through 1989. For each of these new sets, decile-by-decile performance was recorded for the five yeras after the inception date. After completing this process, the researchers had created 22 sets of P/B deciles, and tracked five years of decile-by-decile performance for each one. Next, [Lakonishok, Shleifer, and Vishny] averaged the performance data across these 22 decile-sets to compare value and glamour.

As the chart below indicates, [Lakonishok, Shleifer, and Vishny] found that performance for glamour stocks was outpaced by performance for their value counterparts. For instance, 5-year returns for decile 1 – those stocks with the highest P/B ratios – averaged an annualized 9.3%, while returns for the low-P/B decile 10 averaged 19.8%. These annualized figures are equivalent to cumulative rates of return of 56.0% and 146.2%, respectively.

Value Glamour 1

[Lakonishok, Shleifer, and Vishny] repeated this analysis for deciles based on price-to-cash flow, price-to-earnings, and sales growth. The trio found that, for each of these value/glamour criteria, value stocks outperformed glamour stocks by wide margins. Additionally, value bested glamour in experiments with groups sorted by select pairings of P/B, P/CF, P/E, and sales growth.

The Brandes Institute update

The Brandes Institute sought to extend and update Lakonishok, Shleifer, and Vishny’s findings. They replicated the results of the Lakonishok, Shleifer, and Vishny study to validate their methodology. When they were satisfied that there was sufficient parity between their results and Lakonishok, Shleifer, and Vishny’s findings “to validate our methodology as a functional approximation of the [Lakonishok, Shleifer, and Vishny] framework,” they adjusted the sample in three ways: First, they included stocks listed on the NASDAQ domiciled in the US. Second, they excluded the smalles 50% of all companies in the sample. Finally, they divided the remaining companies into small capitalization (70% of the group by number) and large capitalization (30% of the group by number):

To expand upon [Lakonishok, Shleifer, and Vishny’s] findings we begin with our adjusted sample, which now includes data through 2008. Specifically, we added decile-sets formed on April 30, 1990 through April 30, 2003 and incorporated their performance into our analysis. This increased our sample size from 22 sets of deciles to 36. In addition, the end of the period covered by our performance calculations extended from April 30, 1994 to April 30, 2008.

Exhibit 3 compares average annualized performance for U.S. stocks from the 1968 to 2008 period for deciles based on price-to-book. Returns for deciles across the spectrum changed only slightly in the extended time frame from our replicated [Lakonishok, Shleifer, and Vishny’s] results. Most notably, the overall pattern of substantial value stock outperformance persisted. During the 1968 to 2008 period, performance for decile 1 glamour stocks averaged an annualized 6.9% vs. an average of 16.2% for the value stocks in decile 10. Respective cumulative performance equaled 39.6% and 111.9%.

Value Glamour 2

Set out below is the comparison of large cap and small cap performance:

Value Glamour 3The paper concludes that the value premium persists for the world’s developed markets in aggregate, and on an individual coutry basis. We believe it is more compelling evidence for value based investment, and, in particular, asset based value investment.

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