Thanks to the efficient market we're presented with a $200 bill laying on the ground that most investors claim doesn't exist. The $200 bill is in the form of the Fortune Industries going private offer. My previous post on Fortune is in the top five for most read posts, which I find strange given this is a tiny penny stock. Since July when I last posted on Fortune nothing has changed, and yet everything has changed.
I first want to make a small note about these little tenders. A lot of investors are dismissive about making a few hundred dollars on an odd lot tender. They're considered the realm of pip-squeak investors. Sure $200 isn't going to move the needle of any portfolio, but it is real money. Step back and consider, where else can you make $200 for reading for a half hour and clicking a mouse a few times? Think $200 isn't worth much? You could buy 88 NYC Subway trips, 134 Fillet-o-fish sandwiches, or four cases of a craft beer with $200.
The basics of this deal are very simple. Fortune is going dark again and they're cashing out shareholders who own less than 501 shares at $.61 a share. Unfortunately given the company's history the unanswered questions are, who will be cashed out and will this deal actually complete?
To answer this we need to take a look at the developments over the past eight months. Originally Fortune was going to cash out shareholders who held 500 shares or less at the end of March 2012. Management who owned less than 1% of the outstanding stock engineered a deal where they would end up owning 71% of the company. Shareholders who owned 39% of the company would own 8.6% after this deal.
The company claimed that shareholders would continue to hold a consistent 'economic interest' in the company even with the reduced ownership percentage. To shareholders who just care about trading a piece of paper, the economic interest would indeed be the same. If one were to place a multiple on the current earnings, and then place the same multiple on the earnings under the new structure the same economic interest is retained. Unfortunately shareholding isn't just owning a piece of paper, it's actual ownership in a business. Management is taking control of this company, throwing up smoke and mirrors and telling shareholders everything is alright. Additionally I'm not sure how any shareholder can get comfortable with a management team that has worked so hard and creatively to outright steal the company from shareholders.
Last year everything looked like it was going according to plan for the going dark transaction until Carter Fortune's death in August of 2012. Readers of the previous post will remember that Mr Fortuned owned perpetual preferred stock that the company was trying to rid themselves of. As part of the transaction the preferred stock would be converted into shares that the current executives would control. Mr Fortune would receive payment for his preferreds.
After Fortune's death the company entered into a merger agreement with Ide Management Group a nursing home operator. In leu of the going dark the company was now planning on engaging in a reverse merger, and a divesture of the human resource company as a way to rid themselves of the preferred stock. Small shareholders would no longer be cashed out, they'd now own a nursing home operator. This transaction wasn't any better for shareholders, they would now own a different business than they originally set out to buy with different management.
The Ide deal was terminated this year for an unknown reason without consequence to the company. This left Fortune with a problem, they no longer had an exit strategy to get rid of the preferred stock, a bank owned the preferred stock, and Carter Fortune the controlling person for those shares had passed away.
So the company did pulled out the going private agreement from last year, changed some dates and filed it with the SEC. Herein lies the problem, while the filing date, and the date for the shareholder meeting to vote on the agreement have been changed nothing else has. This means the company is still claiming they will only cash out shareholders who owned less than 500 shares on March 26th of 2012 and who continue to hold those shares. A lot has changed in the past eight months, and it's likely the shareholder base has turned over a lot. Will cashing out those holders from last year still be enough to get the company under the magic 300 limit to go dark? It's unknown, and unfortunately the company's management is less than friendly when asked about this.
If after reading this you think the deal is going to close, and the current odd-lot holders will be cashed out it's worth picking up 500 shares. On something like this I consider the gamble worth it, I own odd-lots in two accounts. But keep in mind this isn't a slam dunk deal, there's a good chance the company could go dark and anyone purchasing after March 26th 2012 will still have their shares. To that there's consolation that this company is cheap. Right now they're on pace to earn about $.06 this year, and with shares at $.19 that's a P/E of 3x. Not to mention they're trading below NCAV.
One other point, in the proxy it states that shareholders are allowed to request the full copy of the fairness opinion on the original deal. I have a digital copy of the full fairness opinion if anyone's interested.
Talk to Nate about Fortune
Disclosure: Long some odd-lots of Fortune
Looking for value in the overlooked margins of the market.
Thanks for posting. The merger agreement states: "Each record and beneficial owner of the Company Common Stock (the “Holder”) holding fewer than five hundred one (501) shares thereof on the date of the Merger Agreement and until immediately prior to the effective time of the Merger (the “Effective Time”..."
ReplyDeleteAnd "effective time" seems to be defined as the closing date, which has not yet been set.
Am I missing something?
Sort of, the date of the merger agreement originally was March 26th 2012, so according to this document a shareholder needed to own 500 shares back then to be cashed out. The problem is so much has changed since then it's almost inconceivable that the company won't change the date, that's the speculation aspect of this.
DeleteHi Nate,
ReplyDeleteI looked into this too after noticing the (seemingly) enormous arbitrage opportunity for odd-lots. Then I read the proxy and realized it was only for shareholders on 26-Mar-2012, so scratched the arb idea off the list.
Then I did some more thinking... "What about just being a shareholder "in the dark?"
And then about 6 hours of research and math later... yeesh, good god no.
There are so many issues of insider dealing and maltreatment of minority shareholders in the light of public SEC filings, my skin crawls thinking what they would do to you as a non-reporting company.
I don't even know where to begin here:
1. Carter Fortune basically issued a predatory loan to the Company in the depths of the recession. There have been numerous times to refinance out of the preferred stock loan, but the Company repeatedly elected not to. He basically stole 40% of the equity in this Company over the last 4 years. I know you see this all the time when you evaluate these microcaps, but this just sickens me.
2. Tena (CEO) and Randy (CFO) are basically doing an LBO of the Company. Except unlike most LBOs, all the benefits of leverage accrue only to Tina/Randy but the risks are borne by all shareholders. The proxy & fairness opinion justify the deal by basically saying, "You idiot public shareholders were screwed anyway if we didn't do this deal, so tough luck." ("Explanation ***"). The fair thing to do here would involve having a levered HoldCo vehicle owned by CEP and Fortune Industries would dividend cash pro-rata up to (i) CEP (ii) Public Shareholders, but "fair" does not seem to be in their lexicon here.
3. CEP (purchasing entity owned 46% by Tena, 32% by Randy, and 22% by Carter Fortune's estate) will own 91.2% and minority public shareholders will own 8.8%. Per the proxy, Large Block Holders currently have ~5m shares, so that means there will be 56m pro forma shares outstanding after converting Carter Fortune's preferred into common equity. Pro Forma net income will be about $1m (pro forma for the CapBank Term Loan and Carter Seller Note), so that's a Pro Forma EPS of $0.017 (11.5x P/E).
4. I have no clue where to start my rant on the Nursing Home Company backdoor-IPO fiasco, but since it's not happening, I'll keep it short -- what group of independent advisors or BoD can say with a straight face that this proposal makes the slightest bit of sense? No pro forma ownership %. No financial figures. No brief description of the Nursing Home Assets. "For shareholders who want to be in a publicly traded vehicle." WTH? Who writes this stuff? The only justification is Explanation ***.
5. Class Action Suit voluntarily dismissed without explanation. Did the Plaintiff suffer an "accidental" slip-and-fall? Did the Plaintiff "find" a briefcase full of unmarked bills? Inquiring minds want to know how a lawsuit like this could so quickly and effortlessly be withdrawn.
6. I've got a suspicion for why they wouldn't just buy-out the minority shareholders -- after all, paying $0.61/sh for the remaining 5m shares is only $3m, and the Company just raised $7m from CapBank at only 6% interest.
Here's the thinking: "That 8.8% ownership is zero-cost money held by suckers who can't wait to get diluted to <5% over the next 5 years via stock-based compensation at low-low 'dark company' share prices."
Anyway, the whole thing is insane because it's done so brazenly and out-in-the-open.
This is a great comment, and I'm glad you posted it. I have looked at the company and ran into all the things you mention, I actually debated on which direction to take this post. Do the management is shady and stealing this thing outlining what you have, or go with the odd-lot potential. I elected to highlight the odd-lot.
DeleteThe March 26th date is technically what's in the document, but I can't imagine that they wouldn't have to change that because the shareholder base has changed so much since the initial offer. There's also the second possibility here which is the company will just cash out owners of 500 or less regardless at the time of the merger. This seems crazy, but it has happened with other odd-lot tenders, it just depends on the company and how closely they look into the shareholder list.
Your points #4 and #5 are well worth mulling over. I wondered the same thing about the class action lawsuit. There is no other way to describe Tena and Randy other than thieves at the expense of shareholders.
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ReplyDeleteOK, so I just went back and read the comments by you and JJK from your old FFI post. I could have saved myself a lot of breath by just saying "ditto" to what JJK said :). My head just about rocked-off from all the nodding I was just doing.
ReplyDeleteI got the answer to my 300 shareholders question (answer - no hard-and-fast requirement to get under 300, plus JOBS pushes it up to 1500 holders so we're much more unlikely to get up that high).
But now I've got another question -- what happened to our friend JJK?! This has class action written up / down / sideways.
I'm surprised this wasn't your #1 most clicked-on idea since you're the only person who's discussed it.
I haven't forgotten about this company.
ReplyDeleteI've contacted the company several times to schedule a call with management, but so far I've been unsuccessful. Unfortunately, they are incorporated in Indiana and the money involved here is small, so no lawyer is likely to take up our cause regardless how egregious management's actions are.
The company's response to date:
"I have forwarded your email to the management team. In the interest of Regulation FD, at this time they will not be engaging in any one-on-one conversations with shareholders. Please continue to watch for additional SEC filings for further information regarding the transaction. I’m sorry I cannot be more helpful in answering your questions."
I had read the Kraft Report, which explained how this was a 'fair' transaction and emailed the company the following questions 6 months ago.
The 4 stated benefits of the transaction:
• "The transaction will remove the preferred stock from the capital structure, improving the common shareholder liquidity preference position by $15.0 million on a net basis."
On a net basis, that is true. For large block shareholders, the transaction does not improve their lot due to massive dilution.
• "The preferred stock creates a perpetual liability, which will be eliminated and replaced with a finite period debt obligation."
The benefits of this debt, accrue to insiders (management-shareholders). In the early years, less than nothing flows to unaffiliated large block shareholders. But they will share in the liability when the sub is merged into the company.
• "The transaction provides a liquidity event for the majority of the shareholders of record that otherwise might not be gain full liquidity at a full price due to the thinly-‐traded nature of the stock."
While small shareholders of record are being treated much more fairly than large shareholders, they comprise a tiny fraction of the shareholder base.
• "The transaction aligns management incentives with the interests of the remaining shareholders."
Remaining shareholders have been treated poorly. While taking out the Preferred for $12.3M was an excellent business decision, the shareholders who own 37% of the company aren't enjoying any of the benefits of that move.
The rest ot the email:
ReplyDelete"The purpose of the breakeven analysis was to determine the MVIC value at which the remaining common shareholders would be financially indifferent to the transaction under the premise of a 100% sale."
The table on Page 28 spells it out. I didn't know how one can dilute large shareholders down to 8.5% ownership and maintain that it is fair.
If the company was sold without a transaction and the Preferred got full face value, the large equity holders would get the stated amount in that table. The MVIC used did not comprise the 61 cents small shareholders are getting, or the 52 cent 6-mo average, but some lower arbitrary number. Taking out the Preferred was very accretive to the company, but large loyal shareholders were not deemed fit to share in the bounty of that very good move. A great deal of effort was expended on making the numbers look respectable though, with the value of the pfd often shifting to make the desired point (i.e., large unaffiiated shareholder should be happy, they are gaining a little over the long run).
Well, as a large shareholder, am I indifferent to the transaction as currently proposed? No, I am not. With "no transaction", management's base case for the next 4 years shows EPS of $0.13, $0.13, $0.15. $0.21 (av 15.5 cents EPS). "With the transaction", cash flow actually goes down slightly the next 4 years, and since I'm diluted down to 22% of my original ownership, I will now average 3 cents annually over the next 4 years. Hard to remain indifferent, and the market agrees, as the stock has lost about 75% of its value.
One thing should be very clear, I'm not at all opposed to the pfd takeout, (I love that part of the deal), it's just that more benefit should have accrued to large shareholders who actually own the company and not all accrue to management who owned very little pre-transaction.
If CEP was on the hook for the $12.3M and was actually paying for the shares they are receiving that would be one thing. But that liability is being transferred to the company after the merger.
I want management to be aligned with non-affiliated large shareholders, but I also want them dealing fairly with us. If they cut a good deal, all shareholders should benefit, not just a select few.
Maybe I'm missing something here, so I'd like this explained to me. Can I schedule a few minutes with someone in senior management? I know other large shareholders who are also not happy. I'd prefer to remain a long term shareholder here because the company shows great promise (especially ex the pfd's), but the way we have been treated in this transaction makes me more than a little bit uneasy. If more of the bounty could be shared (i.e., less dilution), we could all have a nice ride with this company.
Nice email JJR -- I agree with everything you wrote.
ReplyDeleteIt seems to me that the Fairness Opinion basically boils down to what I call Explanation *** =
"We shopped the Company and found zero 3rd parties who were willing to buy the Company for an Enterprise Value north of $27m [i.e. the face value of Carter Fortune's Preferred]. If the Bank forcibly seizes Carter Fortune's Preferred and sells the business at a fire-sale price south of $27m to pay off Carter Fortune's defaulted bank loan, Large Block Shareholders will get zero. Therefore since a positive number is > $0 for Large Block Shareholders, the CEP transaction is a fair deal."
The problem with this thought process is that it is anathema to the whole point of a "fairness opinions" = just because the controlling shareholder CAN dictate which transaction gets done by virtue of his majority vote, the fairness opinion is to demonstrate that minority shareholders obtain FAIR VALUE for their ownership stake.
The very fact that the COMPANY could engage in the exact same transaction as the CEP HoldCo deal (hey, as you pointed out, the Company is the one incurring the debt and paying the for transaction & financing fees after all!) but not dilute the shareholders down to an infinitesimal % is reason alone that this is not a fair deal.
Nate, I always like your ideas. Who's is technically voting the majority block? Would be greatly appreciated if you could shed light on that point. Thank you. Alexander
ReplyDeleteThe 3/26/2012 deal announcement date should no longer be in effect because the deal that date pertains to was canceled last year and replaced with the aborted reverse merger plan. The date of the announcement of the deal currently being contemplated is 2/13/2013. If the date of the merger announcement is not changed from 3/26/2012, I think it would be fair to make a complaint to the SEC. When the deal originally announced was canceled, the date that it was announced became irrelevant even though the deal as originally conceived has been revived many months later.
ReplyDeleteEnjoyed the post and the comments.
ReplyDeleteI was in this for the odd lot arbitrage in 6 accounts (I love these for my 4 kids accounts - trying to infect them with the investor virus!) and was shocked to see it trading north of $.61 the other day. No idea why, but sold out for a quick 3 bagger in less than a week. Now if i could only annualize that (and put more money to work...)
I see COSH is doing a tender. No mention of odd lot preference yet, but if there is, it is worth $200 (5%) at present prices...
In my review of the financial information from operations, the reason EBITDA is growing, isn't because of top line growth, but rather, stripping out the service to client.
ReplyDeleteThis will in the end cause the demise of the company, as the erosion of customer base continues because of very little service support.
Lastly, the requirements of the bank financing is very stringent, and when the erosion of customers accelerates, they will eventually be in default of the loan.
I am still tracking these odd lot situations (in here Special Situation Investments) and quite a few off them still appear to be profitable. Which is a bit surprising, keeping in mind that odd lots have been widely popularized by Seeking Alpha authors.
ReplyDelete