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Archive for the ‘Liquidation Value’ Category

Carl Icahn’s former lieutenant Mark Rachesky has opened a position in Seahawk Drilling Inc (NASDAQ:HAWK), a stock I’ve covered in some detail (see the post archive here). Rachesky holds the position in his investment vehicle, MHR Fund Management LLC. Rachesky’s most recent 13F filing indicates he picked up around 1.2M shares for around $11.4M, which implies an average purchase price of about $9.72 per share. According to Business Insider:

Rachesky, 49, spent six years working for Icahn, including serving as a senior investment officer and chief investment advisor for his last three years at Icahn Holding Corporation. He left Icahn in 1996 and opened his own New York-based firm, MHR Fund Management, for which he still serves as president.

Rachesky is perhaps best known for his position in Lions Gate:

He first took a 5.9% stake in Lionsgate in August 2005, but he boosted his ownership to 14.1% as of last July and has rapidly increased the size of his position over the past two months—at the same time Icahn enhanced his own stake—after Lionsgate reported its disastrous third-quarter earnings. Up until last week, Rachesky’s investment in Lionsgate was passive, meaning he didn’t seek to influence the company’s operations. But now he’s an active investor in the studio.

The $11.4M holding in HAWK represents around 0.8% of Rachesky’s $1.4B fund.

Hat tip JG.

Long HAWK.

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Charlie Rose has a fantastic interview with Wilbur Ross, who played Willy Tanner (the dad) on Alf before becoming an investor in distressed businesses, most notably in the coal, steel and auto parts industries. This profile describes Ross’s start thus:

In 2001, when LTV, a bankrupt steel company based in Cleveland, decided to liquidate, Ross was the only bidder. Ross suspected that President Bush, a free trader, would soon enact steel tariffs on foreign steel, the better to appeal to prospective voters in midwestern swing states. So in February 2002, Ross organized International Steel Group and agreed to buy LTV’s remnants for $325 million. A few weeks later, Bush slapped a 30 percent tariff on many types of imported steel—a huge gift. “I had read the International Trade Commission report, and it seemed like it was going to happen,” said Ross. “We talked to everyone in Washington.” (Ross is on the board of News Communications, which publishes The Hill in Washington, D.C.)

With the furnaces rekindled, LTV’s employees returned to the job, but under new work rules and with 401(k)s instead of pensions. A year later, Ross performed the same drill on busted behemoth Bethlehem Steel. Meanwhile, between the tariffs, China’s suddenly insatiable demand for steel, and the U.S. automakers’ zero-percent financing push, American steel was suddenly red hot. The price per ton of rolled steel soared, and in a career-making turnaround, Ross took ISG public in December 2003.

After pulling off a quick turnaround in the twentieth century’s iconic business—steel—Ross set about doing the same with the troubled iconic industry of the nineteenth century. In October 2003, he outdueled Warren Buffett for control of Burlington Industries, a large textile company that failed in late 2001. In March 2004, he snapped up Cone Mills, which, like Burlington, was based in Greensboro, North Carolina, and bankrupt. As with the steel companies, the PBGC took over some of the pensions, the unions made concessions, and thousands of laid-off workers were recalled. Most important, debt was slashed. Today, International Textile Group has just about $50 million in debt, less than the two companies were paying in interest a few years ago.

In the Charlie Rose interview Ross discusses his analysis of LTV, which is basically a classic Graham net current asset value analysis:

Ross: We’re in the business not so much of being contrarians deliberately, but rather we like to take perceived risk instead of actual risk. And what I mean by that is that you get paid for taking a risk that people think is risky, you particularly don’t get paid for taking actual risk. So what we had done we analysed the bid we made, we paid the money partly for fixed assets, we basically spent $90 million for assets on which LTV had spent $2.5 billion in the prior 5 years, and our assessment of the values was that if worst came to worst we could knock it down and sell it to the Chinese. Then we also bought accounts receivable and inventory for 50c on the dollar. So between those combination of things, we frankly felt we had no risk.

Charlie Rose: And then next year you bought Bethlehem.

Ross: Yes, but before that even, what happened, out came BusinessWeek asking, “Is Wilbur Ross crazy?”

The joke was, right when everybody was saying, “This is too risky. It’ll never work,” the big debate in our shop was, “Should we just liquidate it and take the profit or should we try to start it up?” That’s how sure we were that we weren’t actually taking a risk, but I wanted to start it up because if you liquidate it you make some money, but you wouldn’t change the whole industry and you wouldn’t make a large sum as we turned out to do.

Watch the interview.

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Further to my Seahawk Drilling, Inc. (NASDAQ:HAWK) liquidation value post, I set out below the slightly more optimistic valuation of HAWK’s rigs if they can be sold as operating rigs. Here is a guide to the second-hand market for rigs (click to enlarge):

I’ve combined it with the list of HAWK’s rigs and their operating status from the July 2 Drilling Fleet Status Report to calculate the approximate second-hand market value of HAWK’s rigs:


Assumptions

Although a handful of HAWK’s rigs were built prior to 1980, I’ve assumed that the recent upgrades make the rigs saleable in the second-hand market. There is no market value for the 300′ MC (mat cantilever). 250′ MCs sell for around half the market price of 250′ ICs, so I’ve assumed that 300′  MCs might sell for half the price of 300′ ICs, which is $60M. I’ve also assumed that most of the cold-stacked rigs can be made operational with little expense, as Randy Stiller indicated in the presentation to the Macquarie Securities Small and Mid-Cap Conference. Stiller mentioned that two rigs require significant cap ex to be returned to operational status, although it isn’t clear which two or what “significant” means in practice. I’ve assumed that the 80′ MC is saleable only for scrap at $5M.

Valuation

I calculated that HAWK was worth around $154M in the more dour liquidation scenario, assuming that the rig value was $230M. This valuation suggests HAWK could be worth another ~$150M in rig value if most of the rigs can be sold as operational, which implies a liquidation value around $300M or around $25 per share. The risks are the cash burn and the Mexican tax issue, both of which I’ll examine in detail at a later date.

Hat tip John.

[Full Disclosure: I hold HAWK. 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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Seahawk Drilling, Inc. (NASDAQ:HAWK), which I’ve posted about before, has taken a pounding over the last few days, down over 11% just yesterday to close at $9.61. It seems crazy to me. HAWK is cheap as a going concern, but with its market capitalization at $113M, it’s now at a hefty discount to its liquidation value. Here’s how I figure it:

Here’s a list of HAWK’s rigs and their operating status from the June 9 Drilling Fleet Status Report:

There are two possible liquidation values for HAWK rigs. In the slightly more optimistic scenario, HAWK’s rigs are sold off as operating rigs to other drillers in the Gulf of Mexico. In the other more dour scenario, some of HAWK’s rigs are sold for scrap. HAWK is trading at a discount to both values.

Rig resale values

In March and April this year, ENSCO Plc (NYSE:ESV) sold three 300′ ILC rigs from the same vintage as HAWK’s rigs for ~$48M a piece (see press releases here and here). These are clearly higher specification and therefore more valuable than HAWK’s rigs, but the sales do provide some insight into recent market conditions. Here’s a chart from HAWK’s presentation (.pdf) to the Macquarie Securities Small and Mid-Cap Conference on June 15 and 16 showing comparable sales since 2004:

When 300′ ILCs have sold in the past for ~$48M, rigs comparable to HAWK’s have sold for around $15M each. HAWK is presently trading as if its rigs are worth only $6M each. Retired rigs have sold recently for between $5M and more. Hercules Offshore, Inc.’s (NASDAQ:HERO) 31 December, 2009 10K is illustrative:

Additionally, the Company recently entered into an agreement to sell our retired jackups Hercules 191 and Hercules 255 for $5.0 million each.

In June 2009, the Company entered into an agreement to sell its Hercules 100 and Hercules 110 jackup drilling rigs for a total purchase price of $12.0 million. The Hercules 100 was classified as “retired” and was stacked in Sabine Pass, Texas, and the Hercules 110 was cold-stacked in Trinidad. The closing of the sale of the Hercules 100 and Hercules 110 occurred in August 2009 and the net proceeds of $11.8 million from the sale were used to repay a portion of the Company’s term loan facility. The Company realized approximately $26.9 million ($13.1 million, net of tax) of impairment charges related to the write-down of the Hercules 110 to fair value less costs to sell during the second quarter of 2009 (See Note 12). The financial information for the Hercules 100 has historically been reported as part of the Domestic Offshore Segment and the Hercules 110 financial information has been reported as part of the International Offshore Segment. In addition, the assets associated with the Hercules 100 and Hercules 110 are included in Assets Held for Sale on the Consolidated Balance Sheet at December 31, 2008.

During the second quarter of 2008, the Company sold Hercules 256 for gross proceeds of $8.5 million, which approximated the carrying value of this asset.

The rigs have a resale value well beyond the price implied by the company’s stock. Not convinced they can all be sold as operating rigs? How about as scrap?

Scrap value

In this audio of the presentation to the Macquarie Securities Small and Mid-Cap Conference, Randy Stilley, the President and CEO of HAWK, says in relation to the slide below, that the value of the scrap steel and equipment on HAWK’s rigs is worth roughly $8M to $9M each:

Randy Stilley (at about 21 minutes into the presentation):

This is something that is just kind of amazing in a way. If you look at the underlying asset value of our rigs: five million dollars. The scrap value of a jackup is about eight or nine [million dollars], and that’s assuming that you get almost nothing for the steel and you just start taking stuff off of there; mud pumps, engines, top drives, cranes, draw works. If you start adding all that up, that alone is worth more than our current asset values based on our equity.

Now you can also say, “Well, if they’re not working, they’re not worth much,” and we’re not likely to just start cutting them up for scrap, but I think that’s kind of an interesting reference point that you don’t want to forget about because we’re trading at a very low value today.

Conclusion

If the ten cold stacked rigs are worth $80M in scrap, and the ten other operating rigs are worth $150M ($15M each), HAWK has $230M in rig value. Add HAWK’s $88M in cash and receivables, and deduct HAWK’s $164M in total liabilities, and HAWK is worth $154M in the most dour liquidation scenario. With a market capitalization of $113m, HAWK is trading at a hefty discount to this value, and HAWK is too cheap. It’s burning cash, it’s got a chunky payable to Pride and some Mexican tax issues, but subliquidation value never materializes without hair.

Hat tip BB.

[Full Disclosure: I hold HAWK. 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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Sahm Adrangi and Jeff Borack of Kerrisdale Capital have provided a guest post on Coventree Inc. (TSXV:COF.H). Kerrisdale Capital  is a private investment manager that focuses on value and special situations investments. Here’s their take on COF.H:

Coventree Inc. is a liquidation-oriented investment. When it was operational, the company was a Canadian specialty finance company that would package and sell non-bank asset-backed commercial paper. When the asset-backed commercial paper market shut down in August 2007 because of the credit crunch, Coventree ceased operations and announced that it would wind down its business. Management intends to distribute net proceeds to shareholders. Before it can do that, however, it must resolve ongoing litigation with the Ontario Securities Commission. Based on our estimates of Coventree’s potential liability from the lawsuits, ongoing expenses and timing of the litigation / distributions, we think that shares of Coventree are attractive.

Accounts managed by Kerrisdale currently hold Coventree stock, and we may buy or sell shares at any time. We will not disclose our sale if and when we sell, and we will not necessarily disclose that we have changed our thesis if we discover something faulty with our analysis at a later date.

All dollar amounts in this analysis are in Canadian dollars. Coventree trades on the Toronto Stock Exchange.

Assets

Coventree most recently published financial statements on May 6th for the period ending March 31, 2010:

The company has $84mm of cash. It has $5mm of Other Investments which are comprised of shares of Xceed Mortgage Corp., a publicly traded company on the Toronto Stock Exchange. The $3mm of promissory notes on the assets side of the balance sheet are offset by $3mm of limited recourse debentures on the liabilities side.

To be conservative, we’ll use a zero value for restricted cash, accounts receivable, other assets and income taxes receivable. That leaves us with a Net Asset Value of $85mm for Coventree. Here are the relevant adjustments and pro forma “Shareholders equity”, which equates to our Net Asset Value as of March 31, 2010.

Potential Losses

Our net asset value will be reduced by potential losses from the Ontario Securities Commission (OSC) case, legal expenses, and ongoing administrative costs. The potential loss from the OSC case will likely be lump-sum, while the legal expenses and administrative costs will probably be ongoing until distributions are made.

First we’ll deal with the lump-sum litigation expenses regarding the outcome of the OSC trial. In the Statement of Allegations, we see four primary allegations, two of which are substantially the same.

  • Coventree failed to disclose the fact that the third party rating service it relied upon for credit ratings “adopted more restrictive credit rating criteria”.
  • Coventree misled investors regarding exposure to US subprime housing markets.
  • Coventree failed to disclose liquidity-related disruptions to the market in a timely fashion.

We can see in the Canadian Securities Act that the maximum penalty for these offenses is the greater of $5mm or triple the profit made or losses avoided as a result of prohibited actions. It would be difficult to prove that the allegations resulted in Coventree making a profit or avoiding losses, so it seems like even in the worst case scenario, Coventree would be penalized $20mm ($5mm for four allegations). If this results in a $20mm loss, the equity per share is still ~$4.30. Coventree would therefore need to incur an additional $10mm of legal and liquidation expenses (compared to $2.2mm of legal expenses in the first quarter) for Coventree investors to realize a loss.

Here is a link to an article from the Canadian Press claiming that Coventree refused a $12mm settlement offer. As our base-case scenario, we’re going to assume that losses (excluding legal fees) total $12mm. Upside scenarios exist, including the possibility that COF is acquitted of all charges and is awarded a restitution payment to cover at least a portion of their legal fees. Reporters at the hearing have indicated to us that the facts of the case as presented in the opening hearings seem to favor Coventree. But the hearings are ongoing and will continue for the next few weeks. A schedule can be found on the OSC website.

Other expenses include legal fees, which will likely continue for the next few quarters, and some managerial fees. We will assume (and we believe this is conservative) that legal expenses continue to be $2mm per quarter until the end of 2010, and then subside. We estimate managerial fees will continue to be $530k per quarter for as long as the company takes to liquidate.

On the upside, one source of funds for the company is a pair of insurance policies protecting the directors and officers against securities claims. One policy provides coverage for $1mm minus a $35k retention, and the other provides $5mm with a $500k retention. The insurer with the $1mm limit has advised that it will provide coverage for a portion of the defense expenses up to the limit of the policy. Negotiations with both insurers are ongoing. Because of this D&O insurance, it is possible that a portion of the legal fees will be returned even if COF loses the case.


Timing

Coventree has agreed not to make any distributions until the OSC case has been settled and they have redundantly agreed to give the OSC 45 days notice before any distributions are made. Proceedings are expected to continue into October and November of this year.


Valuation

The assumptions behind our valuation table below include $2mm quarterly legal fees for the next 3 quarters and then smaller fees in subsequent quarters; a $530k quarterly expense indefinitely; a lump-sum litigation loss of $12mm; the smaller insurance policy paying out; and a discount rate of 15%. Below is the per-share present value of COF based on the quarter in which a distribution occurs (note that distributions will probably be made in multiple installments, whereas we are assuming a single lump-sum distribution):

If a distribution occurs in the first quarter of 2011, investors who buy at $3.74 will realize a 15% return on investment. But we also see that the NAV never falls below the present market cap of approximately $57mm, meaning investors wouldn’t suffer a real loss unless a) litigation losses are greater than we expect or b) this drags on far beyond 2012. If COF is acquitted, legal fees are returned by a cost order or insurance payout, and liquidation comes in the first quarter of 2011, shareholders could see a nearly 50% annualized return. Not bad for an investment uncorrelated with the rest of the market and with limited downside risk.


Conclusion

In conclusion, we’re expecting a return in the range of 15% with limited risk of loss and some respectable upside scenarios. The main risk is the opportunity cost as this is an illiquid investment and investors might not have an easy time getting out, especially if negative news is released regarding proceedings. But for investors with a 2-year+ time horizon, COF is a nice alternative to cash.

As usual, this email does not constitute investment advice or a recommendation of any sorts. Kerrisdale Capital may buy, sell or short any of the stocks mentioned at any time. I may be wrong; it would not be the first or last time.

LEGAL:

THIS COMMUNICATION IS FOR INFORMATIONAL AND EDUCATIONAL PURPOSES ONLY AND SHALL NOT BE CONSTRUED TO CONSTITUTE INVESTMENT ADVICE. NOTHING CONTAINED HEREIN SHALL CONSTITUTE A SOLICITATION, RECOMMENDATION OR ENDORSEMENT TO BUY OR SELL ANY SECURITY OR OTHER FINANCIAL INSTRUMENT OR TO BUY ANY INTERESTS IN ANY INVESTMENT FUNDS OR OTHER ACCOUNTS. THE AUTHOR HAS NO OBLIGATION TO UPDATE THE INFORMATION CONTAINED HEREIN AND MAY MAKE INVESTMENT DECISIONS THAT ARE INCONSISTENT WITH THE VIEWS EXPRESSED IN THIS COMMUNICATION. THE AUTHOR MAKES NO REPRESENTATIONS OR WARRANTIES AS TO THE ACCURACY, COMPLETENESS OR TIMELINESS OF THE INFORMATION, TEXT, GRAPHICS OR OTHER ITEMS CONTAINED IN THIS COMMUNICATION. KERRISDALE CAPITAL MANAGEMENT, LLC OR AFFILIATED ENTITIES MAY OWN SECURITIES OF OR OTHERWISE HAVE AN INVESTMENT RELATED TO ANY COMPANIES MENTIONED IN THIS COMMUNICATION. THE SENDER EXPRESSLY DISCLAIMS ALL LIABILITY FOR ERRORS OR OMISSIONS IN, OR THE MISUSE OR MISINTERPRETATION OF, ANY INFORMATION CONTAINED IN THIS COMMUNICATION.

[Full Disclosure:  I do no hold COF.H. 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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Michael B. Rapps of Geosam Capital Inc has provided a guest post on WGI Heavy Minerals Inc (TSE:WG).

Michael recently joined Geosam Capital Inc., a Toronto-based private equity firm that focuses on small-capitalization activist investments and distressed debt investments. Prior to joining Geosam Capital Inc., he practiced law for 3 1/2 years at Davies Ward Phillips & Vineberg LLP where he focused on M&A and securities law. He is a graduate of McGill University with a BCL and L.LB (Bachelors of Civil and Common Laws).

Here’s his take on WGI Heavy Minerals Inc (TSE:WG):

WGI Heavy Minerals (“WGI”) operates two businesses: (i) the mining and sale of abrasive minerals; and (ii) the sale of aftermarket replacement parts for ultrahigh pressure waterjet machine cutting systems. WGI trades at $0.40/share on the Toronto Stock Exchange under the symbol “WG”. There are 23,617,610 shares outstanding for a market cap of approximately $9.4 million. I believe the upside in WGI’s share price is at least +65% and the downside is at least +22%.

Abrasive Minerals

WGI’s principal mineral product is garnet, which is used as an abrasive in sandblast cleaning and waterjet cutting of metals, stone, concrete, ceramics, and other materials. The majority of the company’s garnet is supplied pursuant to a distribution agreement with an Indian supplier that was formerly owned by WGI (WGI sold this company in 2008 and distributed the proceeds of the sale, together with a portion of its cash on hand, to shareholders). The distribution agreement guarantees WGI a supply of a minimum amount of garnet annually, with additional amounts to be supplied as mining capacity expands. This distribution agreement expires at the end of 2016. WGI also obtains garnet from its own mining operations in Idaho. Abrasive minerals represent 80-85% of WGI’s sales.

Waterjet Parts

WGI manufactures and distributes aftermarket replacement parts for ultrahigh pressure waterjet cutting machines under the “International Waterjet Parts” brand. Waterjet machines are used to cut a variety of materials using a thin, high pressure stream of fluid, often in very intricate and complex shapes. Waterjet technology continues to improve and take market share from older technologies, such as saws. According to WGI, the company competes in this market with OEMs, such as Flow International, Omax, Jet Edge, KMT and Accustream. Waterjet parts represent 15-20% of WGI’s sales.

Book and Liquidation Value

Below is an estimate of WGI’s book value and liquidation value:


Assuming additional liquidation costs of $500,000, the liquidation value would be reduced to $0.54/share (or $0.49/share on a diluted basis). As you can see, WGI trades at a meaningful discount to both its estimated liquidation value and its book value.

Profitability

I generally prefer to rely on tangible asset values than estimates of future profitability when looking at an investment opportunity. In this case, WGI trades substantially below its book and liquidation values. However, it is also profitable. In 2009, WGI generated EBITDA of $1,896,449 as follows:


This implies an EV/EBITDA multiple of 1.8. Investors can argue about what an appropriate multiple is, but we would likely all agree that this multiple is too low. Applying an EV/EBITDA multiple of 5.0 (for the sake of conservatism), WGI’s equity value per share is $0.66/share (65% upside).


Catalyst

WGI has two large shareholders. Jaguar Financial Corporation owns 3,777,100 shares representing 16% of the outstanding shares (acquired at $0.35/share). Cinnamon Investments Limited owns 3,098,500 shares, representing 13.1% of the outstanding shares (a portion of these shares was acquired as recently as January 2010 at $0.41/share).

Jaguar is known in Canada as an activist investor and has launched a number of proxy contests and take-over bids to unlock value at Canadian companies. Jaguar recently successfully challenged the acquisition of Lundin Mining by Hudbay Minerals. In Q4 2009, Jaguar obtained a seat on WGI’s board and pushed for WGI to use a portion of it cash to repurchase shares, which it did in December 2009 (at a price of $0.395/share).

At WGI’s upcoming annual meeting, I would expect Jaguar and Cinnamon to vote against the confirmation of WGI’s shareholder rights plan. The plan was adopted after Jaguar announced its acquisition of shares but prior to the time Jaguar received a board seat. With 29.1% of WGI’s shares voting against the rights plan, there is a decent chance the rights plan will be defeated, allowing Jaguar to launch a take-over bid for WGI in order to put them in play (a tactic they use routinely). I would also expect Jaguar to push WGI to take additional value-enhancing actions, such as additional share buybacks, and for its patience to run out if such actions are not undertaken in the near term.

Risk

The principal risk I see in WGI relates to its Idaho mining operations. WGI’s disclosure indicates that the mineral resource at WGI’s operating mine in Idaho has been declining in recent years. Accordingly, WGI is undertaking exploration (and eventual development) of the lands contiguous to its current mine, which it believes contain additional garnet. A complete depletion of the existing garnet would negatively affect WGI as its Idaho mine currently contributes approximately 17% of revenues (although WGI increased the amount of garnet it receives annually from India last year, so this percentage should be lower now). Additionally, significant expenditures on exploration and development would reduce WGI’s cash on hand.

Conclusion

Given that WGI is a profitable and growing company, I would argue that WGI should trade at least at its book value (67-85% upside on a diluted/non-diluted basis) and we should look at its liquidation value to determine our downside protection (22-35% upside). On an EV/EBITDA basis, WGI should also trade at a minimum of $0.66/share, providing upside of at least 65%. In the case of an acquisition of each of WGI’s divisions, the upside could be even greater.

[Full Disclosure: I do not hold a position in WGI. 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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Farukh Farooqi, long-time supporter of Greenbackd, founder of Marquis Research, a special situations research and advisory firm (for more on Farukh and his methodology see The Deal in the article “Scavenger Hunter”) and Greenbackd guest poster (see, for example, Silicon Storage Technology, Inc (NASDAQ:SSTI) and the SSTI archive here) has launched a blog, Oozing Alpha. Says Farukh:

Oozing Alpha is a place to share event driven and special situations with the institutional investment community.

We welcome and encourage you to submit your top ideas (farukh@marquisllc.com).

The only limitation we impose is that your recommendations should not be widely covered by the sell side and must not have an equity market capitalization greater than $1 billion.

The ideas will no doubt be up to Farukh’s usual high standards. The blog is off to a good start: the color scheme is very attractive.

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I’ve exited the position in Forward Industries Inc (NASDAQ:FORD) at yesterday’s $3.23 close. I opened the position at $1.44 on July 20 last year. The stock is up 124.3% on an absolute basis and up 98% relative to the S&P500.

Post mortem

We started following FORD (see the 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.” At the time I said that I thought a better use of the cash on the balance sheet was a share buy-back or a dividend. Trinad Management had previously held an activist position in the stock, but had been selling at the time I opened the position and only one stockholder owned more than 5% of the stock. In late March LaGrange Capital Management filed a 13D notice for its position in Forward Industries Inc (NASDAQ:FORD) disclosing discussions with management regarding FORD’s “business and operations, financial performance, capital structure, governance, valuation, and future plans”. LaGrange is now the third largest shareholder with “just under 5% of all common shares.” At its $3.23 close yesterday, FORD has a market capitalization of $25.8M. My rough valuation pegs the Graham fire-sale liquidation value at around $20.0M or $2.50 per share. With the stock trading at a substantial 30% premium to that value and the business continuing to lose ground, I’m taking the money and running. More enterprising investors might want to hang around to see if LaGrange can squeeze some value out of a sale of the business.

The letter from LaGrange Capital Partners

LaGrange Capital Partners’ 13D notice with appended March 9 letter:

March 9, 2010

Mr. Douglas W. Sabra
Forward Industries Inc.
1801 Green Road, Suite E
Pompano Beach, FL 33064

Dear Doug,

Thank you and Jim for seeing me at the last minute. As we discussed, I am the General Partner at LaGrange Capital Partners Onshore, Offshore and Special Situations Yield Funds. LaGrange has been in business since 2000 and manages well over $100 million in assets. Our flagship fund has outperformed the S&P by approximately 7.6% per annum since inception.

LaGrange controls just under 5% of all common shares of Forward Industries, making us the third largest holder according to Bloomberg. To put it in perspective, we own approximately four times as many shares as the board (ex- Michael Schiffman), CEO and CFO combined. It is also worth noting that our shares were acquired for cash in the open market.

As a major investor, I am very concerned about the course of action presently being taken by this board and management team. To this end, I would like to discuss with you and the board of directors the company’s plans and LaGrange Capital’s desire for board representation as soon as possible.

Thank you for your time and consideration. I look forward to hearing from you, and can be reached at 212-993-7057.

Sincerely,

Grange Johnson

CC: John Chiste, Bruce Galloway, Fred Hamilton, Louis Lipschitz, Michael Schiffman

[Full Disclosure:  I do not 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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The superb Manual of Ideas blog has an article by Ravi Nagarajan, Marty Whitman Reflects on Value Investing and Net-Nets, on legendary value investor Marty Whitman’s conversation with Columbia Professor Bruce Greenwald at the Columbia Investment Management Conference in New York. I have in the past discussed Marty Whitman’s adjustments to Graham’s net net formula, which I find endlessly useful. Whitman has some additional insights that I believe are particularly useful to net net investors:

“Cheap is Not Sufficient”

At several points in the discussion with Prof. Greenwald, Mr. Whitman came back to a central theme:  It is not sufficient for a security to be “cheap”.  It must also possess a margin of safety as demonstrated by a strong balance sheet and overall credit worthiness.   In other words, there are many securities that may appear cheap statistically based on a number of common criteria investors use to judge “cheapness”.  This might include current year earnings compared to the stock price, current year cash flow, and many others.  However, if the business does not have a durable balance sheet, adverse situations that are either of the company’s own making or due to macroeconomic factors can determine the ultimate fate of the company.  A durable balance sheet demonstrates the credit worthiness a business needs to manage through periodic adversity.

Whitman also discusses an issue near and dear to my heart: good corporate governance, and, by implication, activism:

One other point that Mr. Whitman made while discussing corporate governance also applies to many net-net situations.  The true value of a company may never come out if there is no threat of a change in control.  This obviously makes intuitive sense because the presence of a very cheap company alone will not result in realization of value unless management is willing to act in the interests of shareholders either by liquidating a business that has no future prospects but a very liquid balance sheet or taking steps to improve the business.

Read the balance of the article at The Manual of Ideas blog.

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Jon Heller of the superb Cheap Stocks, one of the inspirations for this site, has published the results of his two year net net index experiment in Winding Down The Cheap Stocks 21 Net Net Index; Outperforms Russell Microcap by 1371 bps, S&P 500 by 2537 bps.

The “CS 21 Net/Net Index” was “the first index designed to track net/net performance.” It was a simply constructed, capitalization-weighted index comprising the 21 largest net nets by market capitalization at inception on February 15, 2008. Jon had a few other restrictions on inclusion in the index, described in his introductory post:

  • Market Cap is below net current asset value, defined as: Current Assets – Current Liabilities – all other long term liabilities (including preferred stock, and minority interest where applicable)
  • Stock Price above $1.00 per share
  • Companies have an operating business; acquisition companies were excluded
  • Minimum average 100 day volume of at least 5000 shares (light we know, but welcome to the wonderful world of net/nets)
  • Index constituents were selected by market cap. The index is comprised of the “largest” companies meeting the above criteria.

The Index is naïve in construction in that:

  • It will be rebalanced annually, and companies no longer meeting the net/net criteria will remain in the index until annual rebalancing.
  • Only bankruptcies, de-listings, or acquisitions will result in replacement
  • Does not discriminate by industry weighting—some industries may have heavy weights.

If a company was acquired, it was not replaced and the proceeds were simply held in cash. Further, stocks were not replaced if they ceased being net nets.

Says Jon of the CS 21 Net/Net Index performance:

This was simply an experiment in order to see how net/nets at a given time would perform over the subsequent two years.

The results are in, and while it was not what we’d originally hoped for, it does lend credence to the long-held notion that net/nets can outperform the broader markets.

The Cheap Stocks 21 Net Net Index finished the two year period relatively flat, gaining 5.1%. During the same period, The Russell Microcap Index was down 8.61%, while the Russell Microcap Index was down 9.9%. During the same period, the S&P 500 was down 20.27%.

Here are the components, including the weightings and returns of each:

Adaptec Inc (ADPT)
Weight: 18.72%
Computer Systems
+7.86%
Audiovox Corp (VOXX)
Weight: 12.20%
Electronics
-29.28%
Trans World Entertainment (TWMC)
Weight:7.58%
Retail-Music and Video
-69.55%
Finish Line Inc (FINL)
Weight:6.30%
Retail-Apparel
+350.83%
Nu Horizons Electronics (NUHC)
Weight:5.76%
Electronics Wholesale
-25.09%
Richardson Electronics (RELL)
Weight:5.09%
Electronics Wholesale
+43.27%
Pomeroy IT Solutions (PMRY)
Weight:4.61%
Acquired
-3.8%
Ditech Networks (DITC)
Weight:4.31%
Communication Equip
-56.67%
Parlux Fragrances (PARL)
Weight:3.92%
Personal Products
-51.39%
InFocus Corp (INFS)
Weight:3.81%
Computer Peripherals
Acquired
Renovis Inc (RNVS)
Weight:3.80%
Biotech
Acquired
Leadis Technology Inc (LDIS)
Weight:3.47%
Semiconductor-Integrated Circuits
-92.05%
Replidyne Inc (RDYN) became Cardiovascular Systems (CSII)
Weight:3.31%
Biotech
[Edit: +126.36%]
Tandy Brands Accessories Inc (TBAC)
Weight:2.94%
Apparel, Footwear, Accessories
-57.79%
FSI International Inc (FSII)
Weight:2.87%
Semiconductor Equip
+66.47%
Anadys Pharmaceuticals Inc (ANDS)
Weight:2.49%
Biotech
+43.75%
MediciNova Inc (MNOV)
Weight:2.33%
Biotech
+100%
Emerson Radio Corp (MSN)
Weight:1.71%
Electronics
+118.19%
Handleman Co (HDL)
Weight:1.66%
Music- Wholesale
-88.67%
Chromcraft Revington Inc (CRC)
Weight:1.62%
Furniture
-54.58%
Charles & Colvard Ltd (CTHR)
Weight:1.50%
Jewel Wholesale
-7.41%

Cash Weight: 8.58%

Jon is putting together a new net net index, which I’ll follow if he releases it into the wild.

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