I'm always impressed by the winning research, analysts will go into lengthy discourses about why the cost of toilet paper is going to increase because taxi drivers in London are now using iPhones. The thoroughness and depth of research is impressive. These research reports remind me of a quote by Jean-Marie Eveillard in the book The Value Investors: "After I retired in 2006, I helped teach a value investing course at Columbia University. I had about 12 students, and what struck me was that 11 out of 12 thought qualitative analysis had to involve 25 pages of writing. What I tried to stress to them was that they needed to think hard and then list no more than three to four strengths and weaknesses of the business."
The only compensation I receive for my own investment research is what returns I make as a result. If I were paid to write reports maybe I'd have a different perspective, but as it stands I want to do the least amount of work to achieve acceptable results. My entire investing philosophy can be summed up in the following phrase "purchase real assets cheaply, and earnings cheaper." The beauty with value investing is a simple thesis can be just as effective as a 450 page tome. As long as an investor buys cheaply enough, and has patience to see the idea through they will do well.
Many of my investments fall into three categories, low price to book value stocks, net-nets, or cash boxes, which could also be considered low EV or negative EV stocks. There has been a lot of discussion on negative EV stocks recently as the CFA Institute came out with a research article regarding them. The author's research showed that the average return was 50.4% for all negative EV stocks, and 60.5% for stocks with market caps under $50m.
I would guess some of the return is due to benign neglect on the part of value investors. Investors understand low book value stocks, or net-nets. These are companies selling for less than the sum of their assets, machinery, buildings, real estate etc. A negative EV stock is easy to grasp, it's a giant pile of cash with some semblance of a business attached. While easy to understand, my impression is negative EV stocks are the ones value investors avoid the most. There was a lively discussion at OTC Adventures about this recently, with most commenters disagreeing with me that these types of stocks should be considered.
The main objection to a low or negative enterprise value stock is "what will happen to the cash?" and secondly that if an investor isn't in a position to control the company their cash value should be discounted, or possibly not even considered at all. Only in the equity markets can an investor convince themselves that $1 is only worth $.80 or $.50 or something less. After my posts on book value, and the discussion at OTCAdventures I think I'm done trying to convince people that assets, and especially cash have value. Instead I am going to continue to hope that people sell their cash to me at a discount, I'll hold it for a while, and then sell for full value, which according to the research happens fairly often.
The company I want to talk about in this post is fairly typical of a negative enterprise value stock. Titanium Holdings (TTHG) isn't a junior mining company, or anything related to metals, they're a pile of cash with a cleaning supply business attached.
The company is located in Texas and operates Cleaning Ideas Corp, a janitorial supply chain. The company's market cap is $1.061m. The company has $1.8m in cash, giving them a negative EV of $800k or so. The company also happens to be a net-net, their NCAV is $2.8m, so they are currently selling for 37% of NCAV, quite a discount.
The company's cleaning supply business makes up a small portion of the company's current assets, about $1m spread across accounts receivable and inventory. The cleaning supply subsidiary also has $250k in fixed assets on the balance sheet.
The company has no earnings to speak of. Last year they had an operating loss of $46k, and the year before an operating loss of $50k. At the rate they're losing money it will take a decade or more before they burn through their cash pile. The company's earning history is spotty, they have years of profits mixed with losses stemming back to 2006, which is as far back as I looked. The company's most recent profits were in 2009 and 2010, where they earned close to $100k each year.
It would be foolish to think the cleaning supply business will ever be anything spectacular, but they might return to profitability in the future. Maybe they eventually sell, who knows.
If we forget about the cleaning supply business we're left with a pile of cash and some marketable securities. The marketable securities are a small foray that the CEO had into attempting to diversify the cash. The pattern of investments shows a CEO who wants to earn some returns, but is afraid to take on too large of a position, the investments are 3% of assets.
There are two questions investors should be asking themselves about Titanium Holdings:
- Is this company really only worth 37% of NCAV?
- Is their $1.8m worth of cash really only worth $1m or less when the cleaning supply business is factored in?
For me both answers are no, and while I don't love the business, I do love the valuation, so I opened a position.
"That is one of the mysteries of our business, and it is a mystery to me as well as to everybody else. We know from experience that eventually the market catches up with value. It realizes it one way or another." - Benjamin Graham Senate Testimony 1955
Disclosure: Long Titanium Holdings
Hey Nate,
ReplyDeleteInteresting find.
I've just briskly looked through their annual financial reports, and it seems to me that their total capex, including 'investment in partnership', is far greater than depreciation. This makes the annual "burning of cash", i.e the net loss, seems lower than it truly is.
I hope 'investment in partnership' isn't a deceptive way of streaming out cash for the owners here.
I believe the investment partnership is for the ownership of some securities they hold. There was a situation they were in where they were required to pay a certain amount for an investment they made. The investment went south, but they still had to dump cash into it. I believe the remainder of that has been sold in the past year.
DeleteI suffer from the same affliction Nate. In the resource space there are actually a few heavily discounted net cash plays, but I still haven't pulled the trigger. Given the exceptional returns, I should just always buy them.. but I don't.
ReplyDeleteTake Africo Resources for example. It combines the worst of narratives, gold, africa, exploration. Yet it trades at 40-50% of net net cash. Its basically just a bank account at a steep discount. The main (poor argument) for not buying Africo is that my exposure to the mining sector is already 15% of my portfolio.
Floris,
DeleteI've never been comfortable with the resource plays, I'm not sure why. There are some exceptional deals right now, but I'm not even at the party.
Nate
Good post, Nate. I never said cash isn't valuable, only that it should be discounted based on the time frame and probability that a minority investor will receive its benefit.
ReplyDeleteSometimes the discount should be almost zero.
Good post, thanks for the idea. How do you get comfortable with companies with accumulated deficits? I've seen you buy a few of them. I see that and I just get scared. I may be missing some good ideas this way though. But this brings me to my next question - have you ever sat down and done an analysis of your past investments, and figured out which strategies seem to be the safest, and what attributes your losers had in common? Obviously there's an infinite number of attributes you could rank them by- strong businessses, owner operators, cash boxes, good managements, weak businesses with poor management that are just so cheap that it doesn't matter, etc. For example, I am wondering if a policy of generally avoiding shareholder deficit companies would improve the batting average or not. Sorry if that sounds like a sarcastic question; it's not intended to be. I also wonder things like, for insider ownership, is it better to have some but not too much? Anyway, if you ever do decide to do a review of that sort I think it would make for wonderful reading.
ReplyDeleteMatt,
DeleteAbout two years ago I sat down and calculated my hit rate at the time. I should really sit down and do it again, it would be very instructive.
I went over my brokerage statements for the last seven years ago this winter. Just looking through past holdings was interesting. Of all the net-nets I've purchased I've only lost money in two, both were biotechs with high cash burn rates. Every other net-net I've ever purchased I've sold out with a gain amazingly.
While I've done well with net-nets I have never made spectacular returns, less than 100% usually. I have done better with low book value companies and cash boxes where the company has some growth.
It would be really interesting to see how some of these things have done on different factors, such as insider ownership etc as you mention. If I get a block of time, maybe a week or so I should do this, it would be instructive for sure.
I've also wanted to go back and see how stocks I've written about on the blog have performed and see if anything can be pulled from that.
Nate
Wish I could say the same. I have lost money on some net nets, and the times I have it's been a pretty simple reason, namely, they were !@#$ businesses with no niche or competitive advantage, and the mktcap to ncav gap was closed by operating losses that reduced the equity. So it seems maybe the thing to do is to avoid these. The only problem is, most net nets are not very good businesses. Maybe there is something different about the ones that failed, maybe it is just dumb luck.
DeleteAnyway, I think what I really would like to see is an analysis of your losers. If you could do something where you went through each one and gave a brief explanation of what happened, and then see if it could have been foreseen or not, I think I could learn a lot from that. I learn a lot anyway when you give the reasons why you passed on an investment, and this would be sort of the same thing. Again just a suggestion, either way it's a great blog and I'm always glad when i see it pop up in my reader
Excellent post Nate!
ReplyDeleteI've read my share of those deep research reports. It is often an eye-opener to meet the author. I've experienced quite a few situations, where it has become clear that the author excels in writing reports, but not really in investing. Sometimes they don't invest at all themselves in equity.
It sounds like a fact that 1 dollar cash is worth 1 dollar, but you forget that that dollar is not in your pocket. I'll give you an example:
- Somebody owes you 10 000 dollars
- He:
a) pays 20% interest and can easily pay the loan back
b) is nowhere to be found and has very likely moved to some unknown location
It is pretty obvious that 10 000 USD is not worth the same in cases a) and b). If you believe there is no difference, I'll sell you case b) for 10 000 dollars.
When you own equity, your claim is weaker than in the example.
What you are actually saying, is that you believe that Mr Market will eventually grant 1 dollar market value to each dollar owned by the company.
Just as in the receipt of FCF from operations should be discounted so should the balance sheet cash and salable assets etc.
ReplyDeleteI love looking at NAV but the entire market is mostly looking at cash flow or earnings or lines on a chart or the alignment of planets. Opportunity cost can be very high is basically the problem because eventually you need the market to agree with you.
So I look for catalysts in some form or another.
One way is, in my opinion, to focus on the higher quality businesses that grow intrinsic value that are trading at a discount to their current NAV. LMCA has been my favorite company on this front for a while... haven't done the calculations recently though. (the valuation of LMCA is pretty fun...answering questions like what are the Atlanta Braves worth? is pretty awesome) There are a ton of other companies with similar characteristics that like the obvious BRKA. Whitman's Modern Security Analysis has a lot to say on this subject.
Using -EV as a tool for stocks that are grossly undervalued on a going concern basis as opposed to looking for a liquidation. The market implies that the business is worth -200M or something like that and when the market is way off that's when I'm interested. HCI is the best example I have ever seen of this. It has a tremendous competitive advantage for insurance in the state of Florida as many large insurance companies have been pulling out of the state. FCF was (is?) greater than the EV (because it was negative) of company and the company was growing at a fast rate while increasing their dividend. I could have bought at around $6-7 now its at $30-35 and its still cheap!
Likewise with companies with hidden assets that they are likely to monetize. CBB has a 69% ownership of CONE. For CBB, who has a massive debt problem, if they are able to unload some of the debt they carry from sale of CONE at the market rate they will likely reap around a billion in value but when they pay off their debt the interest payable will decrease by $100m annually. Putting a 15x multiple (slightly more than half of AT&T ttm P/E) on that debt savings we have a value of 1.5 billion on a 700 million dollar company. ( I should note that this is a very low quality company currently).
HCI -- hmmm... You do know insurance companies aren't valued like a "normal" operating biz, right? I.e. the cash and mkt. securities on the B/S aren't really all "their" cash. It's mostly float... claims that have yet to be paid out.
DeleteYou also realize you're literally taking "hurricane risk", right? There's a reason why other insurers have pulled out of the state... To quote Munger, "Why, God, has this bargain found me and no one else?"