Archive for the ‘Liquidation’ Category

The CFAInstitute blog Inside Investing has a great post on the returns to negative enterprise value stocks. Alon Bochman, CFA has investigated the performance of all negative enterprise value (“EV”) stocks trading in the United States between March 30, 1972 and September 28, 2012. He used balance sheet data from Standard & Poor’s Compustat database and merged these data with price data from the database maintained by the Center for Research in Security Prices (CRSP). He then calculated historical EVs for every company every month, as well as matching forward 12-month returns. Says Alon:

I found 2,613 stocks that at one point or another traded at a negative enterprise value between 1972 and 2012 (Microsoft, unfortunately, was not among them). The list has one entry per stock-month. That is, a stock that has traded at a negative enterprise value three months in a row will appear on the list three times. Each time is a different investment opportunity with its own forward 12-month return. The average stock spent 10.17 months (not necessarily consecutive) in negative EV territory. Thus, the list shows a total of 26,569 opportunities to invest in negative EV stocks.

The average return across all 26,569 opportunities was 50.4%. That is, if you had diligently watched the market over the last 40 years and invested $1,000 into each negative EV stock each month, your average investment would be worth $1,504 after holding that investment for one year, not including trading costs, taxes, and so on. Not bad!

Most of the opportunities are in micro caps with limited liquidity:

Returns by Market Cap -- Negative EV Investing

Alon notes that these opportunities have come up with some regularity and have usually provided attractive returns but have on occasion lost a great deal as well:

Average 12M Returns on Negative EV Stocks by Entry Year

Read Returns on Negative Enterprise Value Stocks: Money For N0thing?

Order Quantitative Value from Wiley FinanceAmazon, or Barnes and Noble.

Click here if you’d like to read more on Quantitative Value, or connect with me on LinkedIn.

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FT.com’s Lex has an article (Sara Lee in play) on a possible bid for the food conglomerate Sara Lee (NYSE:SLE) by the old barbarians at the gates, Kohlberg Kravis Roberts:

Of course, a bid now might be opportunistic. Sara Lee has been without the architect of its restructuring since chief executive Brenda Barnes retired due to illness in August. Asset sales have brought debt down to moderate levels. And there is always a good price for a bad business. Sara Lee trades on about seven times prospective earnings before interest, tax, depreciation and amortisation – well below the double-digit multiples typical for attractive consumer goods acquisitions.

However, it is hard to see what might better be done with a collection of commoditised food businesses (bakery, meat processing and food service) and a low-growth coffee arm. Overall profitability has barely varied from a steady 8 per cent operating margin in two decades. Disposing of the North American bakery business, as management plans, should cause that to jump to 12 per cent, calculates CreditSights. But any sale also involves handing care of part of the Sara Lee brand to a third party, and buyers have not rushed to snap up an operation with expensive unionised labour. There seems little reason to linger at the gate.

I don’t think Lex will be buying the stock, but it’s still interesting. A portfolio of good brands with some commodity businesses thrown into the mix at ~7 times EBITDA. KKR could buy it, sell off the commodity businesses and do something with the brands (I don’t know, what am I, a PE guy?). It might be worth doing some work. Anybody got a buyout analysis they’d care to share?

No position.

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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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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.


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.


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.


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.


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.



[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.


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).


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.


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.


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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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
Audiovox Corp (VOXX)
Weight: 12.20%
Trans World Entertainment (TWMC)
Retail-Music and Video
Finish Line Inc (FINL)
Nu Horizons Electronics (NUHC)
Electronics Wholesale
Richardson Electronics (RELL)
Electronics Wholesale
Pomeroy IT Solutions (PMRY)
Ditech Networks (DITC)
Communication Equip
Parlux Fragrances (PARL)
Personal Products
InFocus Corp (INFS)
Computer Peripherals
Renovis Inc (RNVS)
Leadis Technology Inc (LDIS)
Semiconductor-Integrated Circuits
Replidyne Inc (RDYN) became Cardiovascular Systems (CSII)
[Edit: +126.36%]
Tandy Brands Accessories Inc (TBAC)
Apparel, Footwear, Accessories
FSI International Inc (FSII)
Semiconductor Equip
Anadys Pharmaceuticals Inc (ANDS)
MediciNova Inc (MNOV)
Emerson Radio Corp (MSN)
Handleman Co (HDL)
Music- Wholesale
Chromcraft Revington Inc (CRC)
Charles & Colvard Ltd (CTHR)
Jewel Wholesale

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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