Investigating an unlisted stock

Queen City Investments (QUCT.Pink Sheets)

Price: $992 (12/4/2011)

I've been engaged in an email conversation with a reader about some pink sheet stocks and one stock he mentioned was Queen City Investments.  The stock is like most pink sheet stocks in that they aren't required to file anything with the SEC making the hunt for information frustrating but often rewarding.

Pink sheet stocks have long fascinated me because it seems like a cult following will emerge around these companies.  A cult following is often a cruel irony, passionate shareholders in unlisted companies are usually minority holders without many rights whereas apathetic shareholders of listed companies have a lot more rights which they work hard to neglect.  A second feature of pink sheet stocks is they usually have a interesting story to go with them.  Rarely have I ever dug into a stock on the pinks and not encountered some sort of storyline that is essential to understanding the investment.  Oddly enough this seems limited to OTC/Pinks for some reason. I've never had to understand why some land deal to a brother-in-law's great aunt in 1978 was essential to an investment thesis for a listed company but often stories like this will manifest themselves in pink sheet stocks.

I think there's a common misconception that unlisted stocks are all penny stocks.  The unlisted market has everything, the typical junior miner penny stocks and on the other side community banks trading for $4,000 a share.  The downside is that for most unlisted stocks (unless they're temporarly part of a pump and dump) liquidity is limited or even non-existant.  Queen City Investments falls into the limited to impossible camp when it comes to liquidity.  As far as I can tell the last time Queen City traded was on November 1st with 10 shares.

One unlisted stock with a cult following and quite a back story is JG Boswell.  Boswell has been written up extensively from an investment point of view by Jon Heller over at Cheap Stocks.  If you're interested in understanding the history of the company and some history of California there's the 400pg book "The King of California" that dives into the nitty gritty details of the companies back story.  The book is great, the characters are colorful and entertaining, if you're interested in water rights, Central Cali, or Boswell I'd highly recommend it.  Like most pinks Boswell's investment thesis rests on a complex story which in part has roots in water rights granted in the 1930s.

Queen City Investments is a parent company to three different companies, a trust company, a California cattle ranch, and some commercial real estate holdings in California.  The appeal to the company is that it's asset rich, loaded with cash, securities, and land that's potentially undervalued.  What's nice about Queen City is that they aren't only a pile of assets they also have earnings from the trust management company.  Queen City was spun off from the Farmers and Merchants bank a number of years ago, the company is closely held by the Walker family.

There really isn't much to talk about in terms of the business operation because it's almost impossible to find information on the business.  The annual report I was able to dig up contained a few terse statements about the three holdings and not much else.  The best information I could find about the company was actually on the yahoo message boards.  Some posters have details on the cattle ranch which is approximately 25,000 acres, and some of the specific commercial holdings in LA.

All this leads to the question, how does one find information on these unlisted stocks?  For Queen City Investments I was able to dig up the 2010 annual report and proxy with some creative Googling.  Some unlisted stocks freely publish their financial reports on their website.  Personally I'd prefer investing in a company where I can easily find quarterly, or at least twice a year statements including an annual report.  I have the links to the Queen City reports below under Resources.

Valuation

I think the best way to approach Queen City Investments is to first show what a buyer is getting per share:

Liquid Assets
51.76 share cash
399.93 securities
37.80 in repo T bills

Semi-liquid
16.64 notes receivables
18.54 Locust LLC property
8.65 a share in cattle
294.86 a share in land

Liabilities
59.60 in notes payable
16.64 line of credit

125.34 total liabilities

Having these values gets us much closer to determining the value of the operations:

48.36 per share in earnings
43.35 in CFO
15.36 CFI, no capex to speak of

10 in dividends paid

Take all of this and break it apart and we find for the operations:

Current price: 992 current price
Remove the cash: 502.51
Remove the cattle, commercial property and land: 163.82
Add back in 50% of the debt (some of the debt presumably is tied to the property): 201.94

This means that the trust company is trading at 4.17x earnings
or 4.65x cash flow.

So a buyer at current prices can get the land and cash at book, and a trust that manages $2b in assets for 4.17x earnings or 4.65x cash flow, quite attractive!

A second way to look at this is building off the land value and working backwards.  From my searching I was able to find California ranch land selling in the $1500 an acre range.

An investor buys two shares ($1,984 paid), they receive

1 acre of ranch land valued at approx $1500
Cash and securities totaling $978.98
A bunch of commercial property and some cattle thrown in for free
And a trust business that throws off $48.36 a year in cash flow for free

Even if the commercial property and trust is hard to value exactly looking from the land perspective it's pretty clear this stock is undervalued.

So what's the catch?


This is the type of investment a value investor dreams of, tangible assets selling for nothing.  Of course with something like this there has to be a catch right?  Most investments that look this appealing on a listed exchange have some big hairy problem, usually not so for unlisted stocks.  There are two big problems stocks like this, the first is it's nearly impossible to buy shares, any quantity.  The company is closely held and current investors just aren't selling.  If we wanted to presume that a 10% position would allow someone influence enough to realize value building the position ($4.7m) would literally take years of buying 100% of every share offered in the market.

The second problem is closely related to the first in that this is a closely held company.  The Walker family has run Farmers and Merchants Trust and their associated companies for generations, they apparently like the comfort of being overcapitalized and it's unlikely they will suddenly have a change of heart.

Buying into Queen City Investments thinking that Mr Market will wake up and revalue suddenly is foolish, shares like this can and do stay cheap for years or even decades.  Value is often unlocked by corporate actions, a merger, or a buyout and often the controlling family is in no hurry to take action, instead they're content to plod along and collect dividends.

In the end Queen City is fascinating to look at, and a great example of the price of transparency and liquidity.  I don't own any shares or plan to buy any, but I'd love to hear from shareholders, or anyone who has more details on Queen City.

Resources:
Annual report: http://www.amstock.com/proxyservices/Files/AR16728.pdf
The 2010 proxy: http://www.amstock.com/proxyservices/Files/PS16728.pdf

Talk to Nate about Queen City Investments

Disclosure: No position.  If you click buy the book mentioned above I will receive a small commission from Amazon.com.  The price through the link is no different than if you visited on your own.