Posts Tagged ‘Liquidation Value’

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

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

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

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

Smith is not the only investor interested in newspapers:

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

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

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

Smith’s m.o. is deep value:

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

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

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

Smith has a great track record:

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

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

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

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

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

Read the article.


Read Full Post »

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.


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.]

Read Full Post »

Mario Cibelli’s recent 13D amendment for Dover Motorsports Inc (NYSE:DVD) is interesting reading. Cibelli controls around 17.5% of DVD through Marathon Partners and Cibelli Capital Management. His most recent 13D amendment filed Wednesday annexes a letter setting out a (huge) case study of DVD “partly as a contribution to public education but also to obtain a clearly objective review of the Dover Motorsports situation for our own investment purposes:”

Via Fed-Ex

April 26, 2010

Trustees of RMT Trust
Michele M. Rollins
R. Randall Rollins
Henry B. Tippie
Board of Directors, Dover Motorsports, Inc.
Henry B. Tippie, Chairman
Denis McGlynn, Chief Executive Officer
Patrick J. Bagley
Kenneth K. Chalmers
Jeffrey W. Rollins
John W. Rollins, Jr.
R. Randall Rollins
Eugene W. Weaver
Dover Motorsports, Inc.
1311 N. DuPont Highway
Dover, Delaware 19903

RE: Dover Motorsports, Inc. Case Study

Dear Trustees of RMT Trust and Board Members:

Please find enclosed a study that we sponsored, partly as a contribution to public education but also to obtain a clearly objective review of the Dover Motorsports situation for our own investment purposes.

We believe this objective and thorough review confirms our position that Mr. Tippie has not been performing his duties satisfactorily, and cannot be relied upon to do so in the future. We recognize that Mr. Tippie’s past accomplishments are significant and worthy of admiration, but whatever tribute is due cannot be imposed on the company’s long-suffering shareholders. Under these circumstances, it is the fiduciary responsibility of the company’s directors as well as of the trustees of its controlling shareholder to act in the interest of those who rely upon them to assure the competent management of Dover Motorsports.

If you are reluctant to take the necessary actions yourselves, you should at least allow me to do so. As you know from our reports, I have made sound preparations to assume this responsibility.


Mario D. Cibelli
Managing Member


Cibelli’s DVD case study:

Isaac C. Flanagan

April 26, 2010

Dancing on the Deck of the Titanic:
Henry B. Tippie and Dover Motorsports, Inc.

As the first decade of the 21st century rapidly drew to a close, the motorsports industry in the United States faced shifting internal dynamics, and was buffeted by the macroeconomic environment. The third-largest public player in a sector whose decades-long cycle of consolidation was largely complete, Dover Motorsports, Inc. (NYSE: DVD) (“Dover Motorsports,” “Dover” or the “Company”) was not immune.

By the time Henry B. Tippie was elected Chairman of Dover’s Board of Directors in 2000 following the death of Company founder and Chairman John W. Rollins, he had distinguished himself through nearly fifty years of service to the Rollins family and their group of companies. In his career, Mr. Tippie had developed a reputation for consistently organizing and growing companies in a diverse group of industries, frequently taking them public. Mr. Tippie was known not only as a successful manager and a nimble rescuer of companies, but also as a leader with unimpeachable integrity. The University of Iowa described Henry Tippie in the following manner on the biographical web page entitled Who is Henry Tippie?:

“Integrity. Innovation. Impact.

Those words not only apply to the Tippie College and its offerings, they also apply to its benefactor, Henry B. Tippie. A native of Belle Plaine, Iowa, Henry Tippie is a man of integrity, who has built his personal and professional life on the principles of hard work and doing the right thing. He is a living and breathing illustration of the word ‘integrity.'”1

1 http://tippie.uiowa.edu/about/henry.cfm

It is in this context that the circumstances surrounding Dover Motorsports could have been confusing to those familiar with the situation starting in 2007. The management decisions made over a long period of time at Dover seemed contradictory to the legacy of both Mr. Tippie and the Rollins group of companies and left Dover at a major crossroads in 2009.

Company Description

Dover Motorsports, Inc., headquartered in Dover, Delaware, marketed and promoted motorsports entertainment in the United States via the following four raceways:

1. Dover International Speedway in Dover, Delaware

2. Gateway International Raceway near St. Louis, Missouri

3. Memphis Motorsports Park in Memphis, Tennessee

4. Nashville Superspeedway in Lebanon, Tennessee

The Sprint Cup Series was NASCAR’s premier racing series, with 36 races scheduled in 2009 and 36 more scheduled in 2010. Dover International Speedway hosted two Sprint Cup Series race weekends each year, and was the only one of the Company’s four tracks to host a Sprint Cup Series event. All four facilities hosted NASCAR Nationwide Series and Camping World Truck Series events, although these events drew much smaller crowds and generated significantly lower sponsorship, event-related, and broadcast television revenues compared to Sprint Cup events.

Dover Motorsports was one of three publicly traded racetrack operators, along with International Speedway Corporation (NASDAQ: ISCA) (“ISCA”) and Speedway Motorsports, Inc. (NYSE: TRK) (“SMI”). ISCA was controlled by members of the France family and SMI was controlled by O. Bruton Smith.

Motorsports Industry Overview


Founded by Bill France, Sr. in 1948, the National Association for Stock Car Auto Racing, Inc. (NASCAR) was the premier motorsports sanctioning body. NASCAR consisted of three national series (the NASCAR Sprint Cup Series, NASCAR Nationwide Series, and NASCAR Camping World Truck Series), a road racing series, and a variety of regional, local, and international racing series. The France family controlled the sanctioning body, and Brian Z. France served as CEO and Chairman of the Board of NASCAR.

By the fall of 2009, racetrack operations in the United States had begun to display many of the classic signs of sector maturity. Most significantly, nearly all of the country’s major media markets and population centers boasted an established NASCAR-affiliated track by this point, with the notable exception of New York City. Given the lack of de novo growth prospects and NASCAR’s outspoken reluctance to expand the current race schedule, profit-expansion opportunities were largely driven by more efficient marketing and management of tracks, offering enhanced experiences to race attendees, and successful acquisition and integration of competitors.

Pocono Raceway was owned by the Mattioli family with the asset held in a generation- skipping trust2, and the historic Indianapolis Motor Speedway, known for its open-wheeled racing, was owned by the George/Hulman family.

2 Speed Channel (6/13/04), reported by http://www.jayski.com

Corporate History

The Company was founded in 1969 as racetrack operator Dover Downs, and launched with a NASCAR Sprint Cup Series race won by Richard Petty. Dover Downs Entertainment, Inc., which included both the motorsports and gaming businesses, went public on the New York Stock Exchange in 1996 under the ticker symbol DVD. In 2002, the gaming portion of the Company’s operation was separated and went public on the New York Stock Exchange as Dover Downs Gaming & Entertainment, Inc. under the ticker symbol DDE. The Company’s motorsports operations were renamed Dover Motorsports, Inc. following the divestiture and retained the DVD ticker symbol. Despite the separation into two distinct businesses, the management teams of each company remained nearly identical.

Share Classes and Voting Structure

Dover Motorsports maintained a dual class share structure, which included common stock and Class A common stock. The Class A shares, owned by a small group of Rollins family members and management, carried ten votes per share. Common shares carried a single vote per share. Dividends on Class A shares could not exceed those of common shares, but under certain circumstances common dividends could exceed those of the Class A shares. In addition, the common and Class A common shares were part of a shareholder rights plan, also known as a “poison pill.” In the event that an outside investor accumulated over 10 percent of the company’s total shares, or tendered a takeover offer without prior approval, existing shareholders had the right to purchase additional shares in order to prevent a takeover.

RMT Trust

Following the death of John W. Rollins, Senior on April 4, 2000, Henry Tippie (at the time, Vice Chairman of Dover) was named executor of Mr. Rollins’ vast estate, and thereafter, Mr. Tippie possessed more than 50% voting control of the Company. The Last Will and Testament of John W. Rollins, Senior, established the RMT Trust as the primary vehicle to transfer assets to his wife, Michele M. Rollins. Among many of its stakes in property and operating assets, the RMT Trust held 8 million shares of Class A Common Stock in 2009, which represented approximately 39.4% of the voting control of Dover Motorsports. The Last Will and Testament stipulated that the RMT Trust would be administered by three trustees, presently Michele M. Rollins, R. Randall Rollins, and Henry B. Tippie. Through an agreement which renews annually, Michele Rollins and Randall Rollins yielded sole discretion over the voting power of shares held by RMT Trust to Henry Tippie. Therefore, at the behest of the Rollins, Henry Tippie maintained the dual role of Chairman of the Company and voting trustee of RMT Trust and was able to single-handedly determine the outcome of any and all shareholder votes. As the Company disclosed in its Annual Report:

“We are a controlled corporation because a single person…controls in excess of fifty percent of our voting power. This means he has the ability to determine the outcome of the election of directors at our annual meetings and to determine the outcome of many significant corporate transactions….Such a concentration of voting power could have the affect of delaying or preventing a third party from acquiring us at a premium.”

Business Overview

Key Executives

Henry B. Tippie, Chairman of the Board

Henry Tippie serves as Chairman of the Board of Dover Motorsports, as well as controlling Trustee of RMT Trust (Dover’s largest shareholder), and in these capacities exercises control over 54.4% of the combined voting power of the two classes of the Company’s common stock.

A Belle Plaine, Iowa farm boy, Henry B. Tippie enlisted in the United States Army Air Force at the age of 17, and enrolled at the University of Iowa upon completion of his military service. After earning his degree in Accounting in two years in 1949, Mr. Tippie pursued work as an accountant in Des Moines and Omaha, eventually earning his CPA in 1951. Shortly thereafter, he was hired by Delaware-based John W. Rollins, Associates as a controller. In his decades with the Rollins family and the diverse group of companies they control, Mr. Tippie has been instrumental in the growth and management of a number of firms across many unrelated industries.

For his many achievements in business, Mr. Tippie has been recognized with induction into the Horatio Alger Association of Distinguished Americans and has been the recipient of several distinguished alumni awards from the University of Iowa. In 1999, the University of Iowa renamed its College of Business Administration the Henry B. Tippie College of Business. The Henry B. Tippie College of Business was the first academic division of the University of Iowa to be named after an alumnus.

Mr. Tippie also serves as Chairman of the Board of Dover Downs Gaming & Entertainment and is a Director of three other public companies controlled by the Rollins family.

R. Randall Rollins, Director

In addition to his role as Trustee of RMT Trust and Director of Dover Motorsports and Dover Downs Gaming & Entertainment, Mr. Rollins was the Chairman of the Board of Rollins, Inc. (NYSE: ROL), Marine Products Corp. (NYSE: MPX), and RPC, Inc. (NYSE: RES) and maintained shared voting control of each of these public companies with his younger brother, Gary Rollins. As the eldest son of the late O. Wayne Rollins (brother of John W. Rollins, Senior) and as the sole Rollins family member involved with each of the five public companies controlled by the Rollins family, Mr. Rollins appeared to be the de-facto patriarch of the Rollins family.

Denis McGlynn, President, CEO and Director

Jeffrey W. Rollins, Director, son of John W. Rollins, Sr.

Kenneth K. Chalmers, Director

Patrick J. Bagley, Former CFO; Director

John W. Rollins, Jr., Director, son of John W. Rollins, Sr.

Eugene W. Weaver, Former SVP, Administration; Director

With the exception of Eugene Weaver, seven of the eight Directors of Dover Motorsports also served on the board of Dover Downs Entertainment. Mr. Tippie and Mr. McGlynn, maintained their respective directorships and/or management positions at Dover Downs Gaming & Entertainment as well, and received separate compensation from that entity.

DVD Directors – Overlap with Companies Controlled by the Rollins Family

Shareholder Concerns


Driving the consolidation wave of the late 1990’s through late 2000’s was Dover Motorsports’ largest competitor, International Speedway Corporation, or ISCA. Owning 13 active tracks, ISCA hosted 19 of the 36 NASCAR Sprint Cup Series races by 2009. By comparison, competitor Speedway Motorsports occupied a distant second place with eight racetracks, while Dover rounded out the third position with its four tracks and two Sprint Cup races. Consolidating a sizable portfolio of tracks and race dates under a single umbrella provided the leading players with sustainable competitive advantages in the form of superior ability to negotiate with NASCAR, lobby municipal and state governments and regulators, maintain pricing power for sponsorships and ticketing, and spread marketing and corporate expenses across a broader revenue base.

While the benefits of scale accrued to each of the top three market participants to some extent, International Speedway’s position as the industry leader had become increasingly difficult to challenge.

Dover Motorsports’ efforts to increase its size and competitive position, via both acquisitions and de novo expansion, were met with significant challenges. The 1998 acquisition of the Grand Prix Association of Long Beach for a pro-forma price of approximately $91 million included the Grand Prix of Long Beach, Gateway International Raceway and Memphis Motorsports Park. The Company later acquired the Grand Prix of Denver and Grand Prix of St. Petersburg and folded them into this business unit. These acquisitions resulted in a steady stream of asset impairments and goodwill writedowns of over $106 million between 2002 and mid-2009, and by 2005, only the Gateway and Memphis tracks remained part of Dover Motorsports.

In April 2001, Dover Motorsports inaugurated the Nashville Superspeedway, a 1.33 mile racetrack with a permanent seating capacity of 50,000, built at a cost of approximately $100 million (net of subsidies from the state of Tennessee). The facility was built for the purpose of attracting a NASCAR Sprint Cup Series race, which had yet to occur. In the 2009 NASCAR racing season, the Nashville Superspeedway played host to two NASCAR Nationwide Series races, the Pepsi 300 and Nationwide Auto Parts 300, and bore the unique distinction of being the only track to host two NASCAR Nationwide Series events without also hosting a Sprint Cup Series race.

By 2006, it was evident that Nashville would not attract a Sprint Cup series race, which resulted in nearly $20 million of asset impairments between 2006 and 2008.

In addition to the multitude of goodwill writedowns and asset impairments which occurred over the decade, it was believed that the Gateway, Memphis, and Nashville tracks collectively operated at a $5-$6 million annual loss and had never been profitable. An exact figure has never been available given the Company had never publicly provided any track level operating data or classified the Midwest assets as a separate operating unit.

Chairman Tippie’s business philosophy on cutting losses was highlighted in a 1999 interview from the Tippie School of Management at the University of Iowa.

“Being detail-oriented has always been important to me. I believe in getting all the facts, looking at different points of view, from different angles. It makes me a 24-hour “sleep on it” type of a decision-maker. I think it out, then go forward. If it doesn’t work, fine. I’m not one to stay with it if it doesn’t work– I cut my losses and try something else. I don’t let decisions keep me awake at night.”

“I’m probably at my best when things are toughest. When things get tough, I feel the need to organize and straighten things out. I’m strong on planning wherever I’m going. I’m also known as an ‘attack dog.’ I’m for attacking a problem, not running from it.”3

Declining Fundamentals

NASCAR experienced tremendous growth in popularity over a 15 year period, peaking at an estimated 75 million NASCAR fans in 2005. In the 2006 racing season, however, NASCAR began to experience declines in both television ratings and race attendance. Television ratings declined in 32 of 36 races, with declines of more than 10% for 16 of those races. In addition, NASCAR reports estimated that attendance decreased at a third of Sprint Cup races. At that time, it was estimated that fewer than half of the Sprint Cup races were sold out.45

The macro-economic fallout arising from the bursting of the United States’ housing bubble in 2007 continued to plague the consumer discretionary sector well into 2009. As a result, ticket demand for race events, corporate spending and sponsorship budgets, concession sales and other revenue streams generally remained soft across the motorsports industry, and Dover was no exception. Revenue and operating profit declines, which began in Fiscal 2006, had yet to reverse course. While the broad economic malaise affected Dover’s competitors as well, the Company’s lack of scale, its unprofitable tracks, and its reliance on a single facility (Dover) for its operating profit left the Company more vulnerable to undesirable economic conditions and underperformance. The reliance on a single track for its profits also subjected the Company to variability in results due to potential adverse weather conditions on its two Sprint Cup weekends per year.

Ticket sales presented a unique barometer for changing market conditions in the motorsports industry. Attendance at Dover International Speedway, never again sold out its 140,000 seated capacity, yet management continued to resist cutting ticket prices in 2009, opting instead to focus on package deals combining race admission, food and lodging.6 With 53% of NASCAR fans earning less than $50,000 annually, and 32% earning less than $30,000, many operators began to pay attention to what was becoming an increasingly elastic demand base.7 Competing racetracks aggressively cut prices in an attempt to revive volumes, with noteworthy examples such as Daytona International Speedway cutting grandstand prices to $40, the lowest level since 1996.8

The first wave of sponsorship terminations by corporate advertisers began in late summer and early fall 2008 with the abrupt exit of long-time supporters such as Chevron, General Motors and Chrysler. By July 2009, all four automobile manufacturers affiliated with the sport had reduced their support or announced plans to do so. Many of the sponsors who continued their involvement with NASCAR cut their commitments, forcing teams and track operators to seek multiple parties to split sponsorship deals.

While the early wave of sponsorship cancellations was weighted heavily towards the most beleaguered industries and marginal teams, by May 2009, speculation had begun that even brand-name players such as Jeff Gordon might be affected. Media sources were reporting that even DuPont chemical may not renew its NASCAR deal upon expiration, following other advertisers such as GM Goodwrench, Tide, Kodak, Jack Daniel’s and Jim Beam, among others.

Beyond the challenges faced by the prestigious Sprint Cup Series, the lower-tier events, such as the NASCAR Nationwide Series and Camping World Truck Series were hit even harder. With widespread sponsor exits and a number of teams sitting idle, industry observers are not convinced these lower tier series will survive in their current form over the intermediate term.

3 Business at Iowa, Henry Tippie Interview, Spring 1999

4 http://www.jayski.com/pages/tvratings2006.htm

5 USA Today, “NASCAR’s Growth Slows After 15 Years in the Fast Lane

6 Delaware News Journal, January 16, 2009

7 USA Today, “Tracks Go Extra Mile to Keep Fans Coming Back,” April 28, 2008

8 Revenues From Sports Venues, “Prices Drop for NASCAR Tickets in Daytona,” July 9, 2009

The slashing of corporate budget allocations to NASCAR, its raceways, races and teams led to multiplicative effects. As sponsor budgets fell, race teams were forced to cut their number of cars, number of races entered, merge with competitors, or cease operations altogether.

Many NASCAR track, event and team sponsors were in hard-hit sectors of the economy, such as automotive and construction. While some sponsorships were replaced by upstarts such as GoDaddy.com and Cash4Gold, serious questions remained about the ability of the industry to permanently replace lost revenue.

Transparency or Lack Thereof

The Company reported its financial results under a single operating segment, and did not disclose track-level information to any finer degree of granularity, making third-party analysis of the relative performance of various tracks a daunting task. The Company did not host an analyst day nor did its management participate in investor conferences. Dover Motorsports eliminated the Q&A portion of its quarterly earnings conference calls after the Q2 2008 event, eliminating the only public forum for shareholders to communicate with management. With no earnings guidance provided by the Company and minimal coverage provided by the equity research community, shareholders were seriously challenged to forecast future performance.

Failed Shift in Strategy

On January 28, 2009, Dover publicly announced it had entered into an agreement to sell Memphis Motorsports Park to Gulf Coast Entertainment, L.L.C. (“Gulf Coast”) for $10 million in cash, subject to financing conditions, with an expected closing date of April 30, 2009. Gulf Coast had announced its intention in September 2006 to build a major motorsports and entertainment facility in southern Alabama, with an initial expected completion date of fall 2009. By spring 2009, however, it became apparent that the financing for the Memphis acquisition might be at risk when Dover announced on April 24, 2009 that their agreement with Gulf Coast had been amended to provide for a closing on or before June 29, 2009. On July 8, 2009, Dover announced that Gulf Coast did not finalize its project financing in time for the scheduled June 29, 2009 closing date and further extended the closing date until September 29, 2009.

On September 30, 2009, the Company announced that its agreement to sell Memphis Motorsports Park to Gulf Coast had been terminated due to Gulf Coast’s inability to secure financing.

Public Market Valuation

From October 1, 2008 to October 1, 2009, Dover experienced a precipitous share price decline, falling nearly 72 percent, from $5.20 to $1.48 per share. This was more than double the percentage decline in the share prices of its two nearest competitors, International Speedway and Speedway Motorsports, whose share prices lost 30 percent and 26 percent, respectively.

While the $340 million price SMI paid for the New Hampshire International Speedway (a close comparable to Dover International Speedway) in 2008 may not be easily replicated in the environment of late 2009, even a fraction thereof would have eclipsed Dover’s total enterprise value, at that time, of roughly $91 million.

Investor Sentiment

By 2007, Dover’s outside shareholders had become increasingly concerned with the Company’s performance and strategy, voicing concerns about the Company’s prospects as a stand-alone entity. One of the most vocal shareholders was Marathon Partners, L.P., a New York City-based investment partnership founded by Mario Cibelli, the largest outside shareholder of the Company. In a series of letters addressed to Dover’s board of directors beginning in May 2007, Marathon articulated the concerns of Dover’s shareholders: namely, the Company’s weakened financial and operating position relative to its competitors and the resulting need to divest assets up to and potentially including the Company as a whole.

Marathon sent several letters to Dover’s board of directors during the period from 2007 to 2009. When Dover ultimately responded via letter on September 9, 2009, the Company’s General Counsel indicated that Dover had participated in merger talks with a consortium consisting of Speedway Motorsports and International Speedway, Dover’s primary competitors, on May 2, 2007. According to Dover Motorsports, the consortium offered to acquire Dover Motorsports for a five-cent per share premium to market value. Based on the May 1, 2007 adjusted closing price of $5.57, the stock went on to lose approximately seventy percent of its market value by late October 2009.

Voting Results of 2009 Annual Meeting

At the Company’s annual meeting which took place on April 29, 2009, shareholders voted on the re-election of three directors (including Mr. Tippie) and a stockholder proposal submitted by Marathon Partners to eliminate the Company’s poison pill.

Regarding Mr. Tippie’s re-election, 95.7 percent of the voting shares were cast in favor of Mr. Tippie’s re-election, with 4.3 percent of the votes being withheld. However, adjusting for the voting impact of the Class A shares, a very different result was apparent. Assuming all insiders had voted for the re-election of Mr. Tippie, the remaining non-insider votes would have totaled 65.2 percent withheld against Mr. Tippie’s re-election.

The number of “Withheld” votes related to the re-election of Chairman Tippie to the Board of Directors over his past three re-elections seemed to reflect a deterioration of support by outside shareholders.

Regarding the Stockholder Proposal, Marathon Partners argued in its supporting statement that the Rights Agreement served no other purpose than to arbitrarily limit the number of shares a current or prospective shareholder could own at 10% of the combined classes of stock.  Similar to the results of Mr. Tippie’s re-election, the vote of the non-insiders was drastically different than those of the insiders, with 90.7% of outside shareholders in favor of eliminating the poison pill.

Increasing Level of Shareholder Concern

Exchange Listing Warnings

On February 20, 2009, Dover Motorsports received a notice from the New York Stock Exchange indicating that it failed to meet the NYSE’s $75 million minimum market capitalization requirement and was in danger of being de-listed. On June 2, 2009, Dover received notice that it had regained compliance due to a reduction in minimum thresholds to $50 million. In early October of 2009, with a market capitalization of roughly $54 million, a mere 7.5 percent decline in the share price would once again put the Company in danger of being de-listed by the NYSE.

Suspension of Dividend

On July 29, 2009, Dover Motorsports announced that its Board of Directors voted to suspend the Company’s quarterly dividend on all classes of its common stock. As a result, Dover became the second Rollins-controlled public company in 2009 to suspend its regular dividend. The suspension of the dividend triggered the following salient provision in the Last Will and Testament of John W. Rollins, Senior.

“My wife shall have the power at any time and from time to time to require Trustee to convert any non income-producing property held at any time by the RMT to income producing property by delivering to Trustee a written direction to that effect.”9

Therefore, despite the Voting Agreement in force, the suspension of dividend enabled Ms. Rollins to compel Mr. Tippie to convert RMT Trust’s Dover shares from ‘non-income producing’ to ‘income producing’ at any time if so desired.

Debt Covenants

On August 21, 2009 the Company amended its revolving credit agreement with PNC Bank in order to avoid violating covenants attached to the revolver. As of the Company’s June 30, 2009 financial statements, $34.8 million was outstanding. The revised agreement increased interest rates on this facility to roughly LIBOR + 350 basis points, depending on certain external factors such as the current prime rate. In addition, the revised agreement granted the lender a lien on the Company’s assets and prohibited it from resuming its dividend.

Management Reticence to Discuss Sale

Setting itself apart from many companies which have wrestled with failed acquisitions and divestitures, concerns over debt repayment and de-listing notifications, Dover chose not to entertain any formal, public discussion of a potential sale process, nor did it publicly discuss the possibility of retaining an outside advisor to evaluate its options with respect to maximizing shareholder value. With the exception of CEO Denis McGlynn’s passing comment that “the Board has to look at [every potential offer]” during the Company’s July 24, 2008 earnings call (the Company’s final Q&A session), management had yet to publicly address the notion of a sale.

Management Non-Compete & Change in Control Provisions

As of the close of Fiscal Year 2008, the Company had $7.6 million to $9.2 million in contingent liabilities related to non-compete and change in control provisions relating to Dover’s senior management. Given the struggles endured by the Company, and subsequent evaporation of shareholder value, these agreements had appeared to become increasingly questionable. Independent observers may have wondered if a truly arms-length board would have continued to approve such agreements in the face of the Company’s ongoing challenges.

9 Last Will and Testament of John W. Rollins, Sr., paragraph 10(A)(1)

Strategic Alternatives

By October 2009, Dover Motorsports was at a crossroads with three simple options: it could maintain the status quo, continuing its present course of action and attempting to pay down debt out of cash flow; it could attempt to become a scale player through an acquisition or acquisitions, or it could retain a financial advisor and conduct a sales process.

Status Quo

Returning to profit growth via a “stay the course” strategy would first and foremost depend on a favorable macroeconomic environment. In the fall of 2009, industry observers expected headwinds to persist at least through 2010. Furthermore, the Company would need to sell its loss-generating business units in order to make more rapid progress on debt reduction and an eventual resumption of dividend payment. The failed sale of Memphis Motorsports Park to Gulf Coast Entertainment after nearly one year of public, and as much as three years of behind-the-scenes effort by the Company cast doubts on Dover’s ability to raise funds by selling any tracks except for its marquee asset, Dover International Speedway. With a strong likelihood of a continuing weak economic environment, incremental revenue and profitability expansion resulting from uplift in attendance, increased ticket prices and/or more favorable corporate sponsorship deals were becoming increasingly unlikely. In the event that NASCAR decided to reduce the number of races in future years, Dover Motorsports would potentially find itself at a disadvantage in its efforts to retain onto its Sprint Cup Series race weekends given its status as a small, independent operator.

During fiscal 2009, the Company was faced with a de-listing warning from the New York Stock Exchange which was only overcome due to a favorable change in requirements, and was forced to renegotiate its revolving credit agreement at less favorable terms when it appeared the Company would likely violate its debt covenants. Between these ongoing pain points, consolidation trends in the industry, and the Company’s position of weakness relative to its competitors, it was difficult to envision a scenario in which Dover Motorsports was capable of thriving as a stand-alone entity. By failing to articulate a forward-looking plan for a stand-alone Dover, management had done nothing to shed light on the viability of maintaining the status quo.


Dover Motorsports had an extremely limited ability to pursue acquisitions due to a minimal cash position and diminished ability to fund acquisitions using debt. The Company’s experience with the Grand Prix Association of Long Beach cast doubts about its ability to successfully integrate an acquisition regardless of financing considerations.

Sale of Company

As the third largest public racetrack operator in the US, Dover Motorsports’ most credible potential acquirers were International Speedway Corporation and Speedway Motorsports. Each company had the financial and organizational capabilities to acquire and successfully integrate Dover Motorsports into a larger platform.

Potential Acquirers

International Speedway Corporation (“ISC”):

International Speedway Corporation was far and away the dominant racetrack operator in the US from the late-1990’s onward. In addition to its 13 racetracks, ISC was unique among track owners in the fact that its controlling shareholder, the France family, also owns the NASCAR organization. International Speedway had been a key partner of NASCAR in its attempt to expand and modernize the sport of automobile racing, and the two organizations have worked in tandem for over a decade to increase the number of high profile races and penetrate new media markets. NASCAR’s France family controlled more than two-thirds of the voting stock of International Speedway, and the two companies shared many of the same individuals among their executive ranks. While some of ISC’s competitors have alleged that this situation violated antitrust statutes, the courts had thus far shown little willingness to sever the relationship between these companies.

In early 2007, ISC acquired the remaining 62.5 percent of Raceway Associates it did not already own, giving it 100 percent of the Chicagoland Speedway and its Sprint Cup race weekend, for approximately $102 million. By acquiring nine tracks from 1999 to 2009, International Speedway demonstrated its competence at successfully valuing, purchasing, integrating and operating a nationwide portfolio of racetracks.

Speedway Motorsports Incorporated (“SMI”):

Speedway Motorsports Incorporated became the first publicly traded racetrack operator in the United States following its Initial Public Offering on the New York Stock Exchange in 1995. After pursuing a multi-year strategy of growth through the acquisition and closure of tracks in order to obtain NASCAR race dates, SMI operated eight racetracks by the fall of 2009. Speedway Motorsports boasts one of the largest permanent seat totals in the motorsports industry, and the highest average number of seats per raceway. In addition to its primary business of selling tickets to racing events, sponsorship and advertising placement and concessions sales, Speedway was also involved in the marketing and distribution of licensed and unlicensed souvenir and apparel merchandise and also operated a racing broadcast network through its Performance Racing Network subsidiary.

In January 2008, Speedway Motorsports closed on the $340 million acquisition of New Hampshire International Speedway, a racetrack with striking similarities to Dover International Speedway. Both facilities were home to two Sprint Cup race weekends, although New Hampshire International Speedway seats roughly 40,000 fewer attendees. Furthermore, New Hampshire International Speedway occupied a lower tier of TV revenue participation than the Dover racetrack for one of its two Sprint Cup races.

In December 2008, SMI closed on its acquisition of Kentucky Speedway for $78 million. Although it was designed with Sprint Cup Series events in similar fashion to Dover’s Nashville track, the facility did not host a Sprint Cup race weekend at the time it was purchased. Given Speedway’s objective of hosting one or two Sprint Cup race weekends at each of its qualified facilities, this transaction gave SMI a powerful incentive to obtain additional Sprint Cup races through an acquisition.

Transaction Rationale

A buyout offer could potentially arrive in the form of an all-stock offer at a premium to the Company’s current trading price, with a potential share repurchase designed to neutralize the dilutive effects of an all-stock transaction. Given recent retrenchments in the share prices of Dover’s two publicly-traded competitors, shareholders would derive additional upside in a subsequent recovery. Given the events of the first decade of the 21st century, it would be hard for any observer to conceive of a scenario in which Dover shareholders would be more successful as a standalone entity. Swapping Dover’s shares for those of a competitor who possessed a lower likelihood of underperforming the overall motorsports industry would mitigate any potential argument questioning the wisdom of what could be viewed as “selling at the bottom.”

Potential Obstacles

External obstacles to a transaction would be minimal. NASCAR demonstrated a willingness to endorse these roll-up acquisitions by transferring the race event sanction agreements to the acquirer. Both International Speedway and Speedway Motorsports have made no secret of their desire to acquire additional racetracks which host Sprint Cup Series events.

Internal obstacles to a transaction would be more formidable. The poison pill and non-compete agreements would need to be overcome before any possible transaction. Ultimately, the one and only relevant barrier to a Company-saving transaction appeared to be Mr. Tippie. His acquiescence would facilitate the board’s clear-headed assessment of the Company’s situation and realistic future progress, potentially forming an independent special committee and retaining an advisor.

Which Way Forward?

By all measures, the trajectory of Dover Motorsports under Mr. Tippie’s control left much to be desired. The remaining question for board members in 2009 was “What now?” Would the Company be best served by putting its future in the hands of a larger, stronger competitor, or by hoping to prevail in a battle of David versus two Goliaths?

If a board member felt a merger was the best course of action, how would he or she go about convincing Mr. Tippie that the history of Dover Motorsports and the jobs of its employees would be best secured through a merger, and that this transaction would be a fitting coda to an illustrious career spanning over six decades?

If, on the other hand, you elected to stay the course, how would you respond to concerns that you had neglected the concerns of the shareholders?

Given R. Randal Rollins role as a Director of Dover, a Trustee of RMT Trust (the largest shareholder), and apparent patriarch of the Rollins family, how might non-family board members attempt to convince Mr. Rollins to effect change at Dover?

How might Mr. Rollins best alter the current path of Dover given the long-standing relationship between Mr. Tippie and the Rollins family?

Subsequent Events

On October 30, 2009, the Company announced that it was ceasing all operations at Memphis Motorsports Park and that it would not promote any events in Memphis in 2010. Concurrently with the announcement, the Company announced it secured approval from NASCAR to realign the Memphis Nationwide Series race to Gateway International Raceway and the Camping World Truck Series race to Nashville Superspeedway.

On November 2, 2009, the Company reported its quarterly earnings for the period ended September 30, 2009. At that time, the Company disclosed that it made a further asset impairment charge of $7.5 million related to Memphis Motorsports Park.

On November 9, 2009, Marathon Partners sent a letter to the Trustees of RMT Trust, offering to acquire RMT Trust’s 8,000,000 shares of Class A common stock for $2.35 per share, a 35% premium to the day’s closing price of $1.75. While a sale of RMT Trust shares would not have resulted in Marathon Partners controlling the Company, it would have resulted in a shift of control from Mr. Tippie to other Rollins family members and management.

On November 17th, 2009, Mr. Tippie responded via letter to Marathon Partners indicating that the three Trustees of RMT Trust had no interest in pursuing Marathon Partners’ offer.

On November 25, 2009, Marathon Partners submitted a shareholder proposal to Dover Motorsports, seeking to amend the Bylaws of Dover to eliminate the transferability restrictions of Dover’s Class A Common Stock.

On December 1, 2009 Kansas Entertainment, LLC, a 50/50 joint venture between International Speedway and Penn National Gaming, was selected by the Kansas Lottery Gaming Facility Review Board to develop and operate a Hollywood-themed entertainment destination overlooking Turn 2 at ISCA’s Kansas Speedway, with a planned opening of 2012. Included within the joint venture’s winning proposal was ISCA’s commitment to add a second Sprint Cup race to Kansas Speedway in 2011.

On December 11, 2009, the United States Court of Appeals for the Sixth Circuit affirmed the lower court’s ruling in which it dismissed, in its entirety, the civil antitrust action brought by Kentucky Speedway, LLC against ISC and NASCAR. Jerry Carroll announced on behalf of the plaintiffs that the founding track ownership group will not exercise remaining legal options in the case of Kentucky Speedway, which largely cleared the way for SMI to move a Sprint Cup date to Kentucky Speedway as early as 2011.

Mr. Tippie was awarded an honorary doctorate from the University of Iowa at their December 19, 2009 commencement ceremonies. In the official University of Iowa press release dated December 3, 2009, Dean Curt Hunter describes Mr. Tippie as follows:

“Henry Tippie is a man of humble demeanor but extraordinary achievement, and he is a role model for University of Iowa students,” said Hunter. “He has built his businesses the right away [sic], with hard work and ethical considerations always foremost. His generosity with the University ensures that he will continue to inspire our students for generations to come.”10

10 http://tippie.uiowa.edu/news/story.cfm?id=2248

Although the information contained in this case study has been obtained from public sources that the author believes to be reliable, the author cannot guarantee its accuracy. The case study is for academic purposes only, and does not constitute an offer or solicitation to buy or sell any securities discussed herein. Marathon Partners, LP supported the costs of completing this study and had an investment interest in Dover Motorsports, Inc. as of the time of this writing.

Read Full Post »

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.

Read Full Post »

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.


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.]

Read Full Post »

I’m considering launching a subscription-only service aimed at identifying stocks similar to those in the old Wall Street’s Endangered Species reports. Like the old Wall Street’s Endangered Species reports, I’ll be seeking undervalued industrial companies where a catalyst in the form a buy-out, strategic acquisition, liquidation or activist campaign might emerge to close the gap between price and value. The main point of difference between the old Piper Jaffray reports and the Greenbackd version will be that I will also include traditional Greenbackd-type stocks (net nets, sub-liquidation values etc) to the extent that those type of opportunities are available. The cost will be between $500 and $1,000 per annum for 48 weekly emails with a list of around 30 to 50 stocks and some limited commentary.

If you would like to receive a free trial copy of the report if and when it is produced in exchange for providing feedback on its utility (or lack thereof), would you please send an email to greenbackd [at] gmail [dot] com. If there is sufficient interest in the report I’ll go ahead and produce the trial copy.

Read Full Post »

Yesterday I ran a post on Dr. Michael Burry, the value investor who was one of the first, if not the first, to figure out how to short sub-prime mortgage bonds in his fund, Scion Capital. In The Big Short, Michael Lewis discusses Burry’s entry into value investing:

Late one night in November 1996, while on a cardiology rotation at Saint Thomas Hospital, in Nashville, Tennessee, he logged on to a hospital computer and went to a message board called techstocks.com. There he created a thread called “value investing.” Having read everything there was to read about investing, he decided to learn a bit more about “investing in the real world.” A mania for Internet stocks gripped the market. A site for the Silicon Valley investor, circa 1996, was not a natural home for a sober-minded value investor. Still, many came, all with opinions. A few people grumbled about the very idea of a doctor having anything useful to say about investments, but over time he came to dominate the discussion. Dr. Mike Burry—as he always signed himself—sensed that other people on the thread were taking his advice and making money with it.

Michael Burry’s blog, http://www.valuestocks.net, seems to be lost to the sands of time, but Burry’s techstocks.com “Value Investing” thread (now Silicon Investor) still exists. The original post in the thread hints at the content to come:

Started: 11/16/1996 11:01:00 PM

Ok, how about a value investing thread?

What we are looking for are value plays. Obscene value plays. In the Graham tradition.

This week’s Barron’s lists a tech stock named Premenos, which trades at 9 and has 5 1/2 bucks in cash. The business is valued at 3 1/2, and it has a lot of potential. Interesting.

We want to stay away from the obscenely high PE’s and look at net working capital models, etc. Schooling in the art of fundamental analysis is also appropriate here.

Good luck to all. Hope this thread survives.


Hat tip Toby.

Read Full Post »

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.

Read Full Post »

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.

Read Full Post »

Jae Jun at Old School Value has updated his great post back-testing the performance of net current asset value (NCAV) against “net net working capital” (NNWC) by refining the back-test (see NCAV NNWC Backtest Refined). His new back-test increases the rebalancing period to 6 months from 4 weeks, excludes companies with daily volume below 30,000 shares, and introduces the 66% margin of safety to the NCAV stocks (I wasn’t aware that this was missing from yesterday’s back-test, and would explain why the performance of the NCAV stocks was so poor).

Jae Jun’s original back-test compared the performance of NCAV and NNWC stocks over the last three years. He calculated NNWC by discounting the current asset value of stocks in line with Graham’s liquidation value discounts, but excludes the “Fixed and miscellaneous assets” included by Graham. Here’s Jae Jun’s NNWC formula:

NNWC = Cash + (0.75 x Accounts receivables) + (0.5 x  Inventory)

Here’s Graham’s suggested discounts (extracted from Chapter XLIII of Security Analysis: The Classic 1934 Edition “Significance of the Current Asset Value”):

As I noted yesterday, excluding the “Fixed and miscellaneous assets” from the liquidating value calculation makes for an exceptionally austere valuation.

Jae Jun has refined his screening criteria as follows:

  • Volume is greater than 30k
  • NCAV margin of safety included
  • Slippage increased to 1%
  • Rebalance frequency changed to 6 months
  • Test period remains at 3 years

Here are Jae Jun’s back-test results with the new criteria:

For the period 2001 to 2004

For the period 2004 to 2007

For the period 2007 to 2010

It’s an impressive analysis by Jae Jun. Dividing the return into three periods is very helpful. While the returns overall are excellent, there were some serious smash-ups along the way, particularly the February 2007 to March 2009 period. As Klarman and Taleb have both discussed, it demonstrates that your starting date as an investor makes a big difference to your impression of the markets or whatever theory you use to invest. Compare, for example, the experiences of two different NCAV investors, one starting in February 2003 and the second starting in February 2007. The 2003 investor was up 500% in the first year, and had a good claim to possessing some investment genius. The 2007 investor was feeling very ill in March 2009, down around 75% and considering a career in truck driving. Both were following the same strategy, and so really had no basis for either conclusion. I doubt that thought consoles the trucker.

Jae Jun’s Old School Value NNWC NCAV Screen is available here (it’s free).

Read Full Post »

Older Posts »

%d bloggers like this: