Hickok - Intangibly cheap

HICKA

Price: $1.85 (2/27/2012)

I ran across Hickok in the Walkers Manual and upon looking up their address realized I've driven past this place probably hundreds of times on the way to visit my grandparents while growing up.  I also used to drive near this area for a summer job I had during college as a painter.  To toss in another strange coincidence my brother works for a company that's located about a half mile east of Hickok.  So after realizing all of this how could I not look at the company?

To give some background Hickok is a company that manufactures automotive diagnostic equipment.  These are the sort of computers that your mechanic will have to read the diagnostic codes when the service engine light comes on.  Codes are specific to manufacturers so a shop that services domestic cars needs to have a Ford, Chevy, and Chrysler kit.

The company is small with 71 employees spread across two locations, Cleveland (what I referenced above), and Greenwood Mississippi.

So if the coincidences couldn't be enough at this point imagine my surprise when I realized this company was darn close to being a net-net as well.  Here is my worksheet:

There's more than a balance sheet

It's often heard in value circles that buying shares is buying a piece of a business.  Another expression is that we should be thinking like businesspeople.  These are two great expressions but rarely are they carried out.  Most of the time a few quick glances at a balance sheet or income statement are enough to get the Excel wheels turning.  And once Excel is roaring hours/days/weeks/months/lifetimes can be lost building financial models.

I think it's often useful to take a step back away from the financial statements after a very cursory overview and consider the question, "Would I buy this company outright if I had the ability?"  This is a loaded question, a lot depends on the price offered among other things.  But since the company is public we have a price and many investors never move beyond that point.  So the next question is "Would I buy this company outright at today's market price if possible?"  This seems like such a slam dunk question, especially in the case of a net-net.  Who wouldn't buy a company for less than working capital if given the opportunity?  Or even buying a company below book value, surely a nice margin of safety exists.

I wouldn't buy this company, and here's why

First off the company is losing money, but losses have been moderating and it's possible they will turn things around.  The problem is I think the environment they're operating in will make it hard to turn things around and be successful on a continual basis going forward.  This is of course what I'd be looking for as an owner, can this company turn around and operate profitably in the future?  If not will I be able to at least get my money back from the book value of assets?

The company's land and buildings are on the balance sheet with an original cost of $1.6m.  I'm not sure exactly when the building was purchased, the company was founded in 1915, and went public in 1959.  As I mentioned above I know the area, and only a fool would pay $1.6m for their location, especially today.  Hickok is located in a very undesirable area, a heavy industrial area that's seen better days.  Maybe they purchased the land and building during the better times when there wasn't as much overcapacity, maybe..

The problem is the value their facilities might have held when they were originally purchased is now gone.  Of course that's reflected in the balance sheet somewhat with the value of land/buildings/machinery depreciated down to $300k.  This would seem like a more appropriate amount but I still think it's too high.  If you look on Google Maps you can see that most of the area around Hickok is empty lots.  This is where knowing the backstory helps.

In parts of Cleveland there were problems with abandoned houses, drug dealers, and squatters.  The city started to take over abandoned homes and bulldozing the properties.  The lots are owned by the city and are available for sale if anyone wants them.  The problem is there are a lot of empty lots, and no one is really interested in buying.

The other problem is there are a lot of empty industrial buildings similar to Hickok's facilities up for sale as well.  I did a quick search and found a place with 3x the square footage of Hickok located less than a half mile away in a much more desirable location.  The property is listed for $499k or $3.78 per sq ft.  From the ad it looks like they throw in all the cranes and loading equipment as well, surely some scrap value there.

So what's my point?  The point is the location is in a bad neighborhood, an area with past problems so bad the city took over homes and demolished them.  An area with such a high industrial overcapacity that much better facilities can be found down the street for almost nothing.  These things don't mean that Hickok can't do well, but the odds are stacked against them.  Workers reporting to work drive past all of these things everyday.  I worked in a metal stamping shop in college, and the surroundings affect the workers.  Seedier parts of town don't attract the best talent, simply put.

The problem is none of this stuff is visible from a balance sheet, but it would be clear to a potential owner.  A potential owner would visit and see the location and start to think about having to move, or worrying about protecting the cars in the parking lot.  These are intangible costs, or intangible hurdles to an acquisition.  Sometimes as investors we wonder why a company isn't being bought out when everything appears in their favor, maybe there's a physical intangible known to everyone who visits but unknown to those of us who only read financial statements.

Summary

This has been a bit of an odd post, maybe different from most I do.  My point is that demanding a margin of safety isn't some sort of theoretical thing, there's a real world purpose to it.  If we demand a large margin of safety on our investments it compensates for some of these factors that are unknowable without local on the ground knowledge.  Some investments look incredibly risky from a financial statement point of view, but from a local knowledge standpoint might be entirely safe.  Other times something might look very safe on a 10-K but a bit of unknown local knowledge could make it terribly risky.

By definition a value investment is cheap, there is always a reason for cheapness.  I think most of the time we don't dig deep enough to understand or know why.  Understanding why a company might be cheap helps determine the margin of safety required.  I think understanding both of these points well is really the foundation of avoiding losses.  Many investors are surprised by events that shouldn't be all that surprising if we really understood what we were invested in.

Disclosure: No longer live in Cleveland, not a Browns fan, will cheer for the Indians if they make a playoff run.