If you hang around small caps long enough you'll eventually hear the complaint from companies that "it costs too much to be public." Sometimes this statement is true. For very small and unprofitable companies being public is costly and a financial burden. But these are rare cases, usually the cost of being public is an excuse management likes to tout to justify deregistering their securities from the SEC and "going dark" allowing them to operate in obcurity..
A company I've owned and followed for years, Opt-Sciences (OPST) filed their Form 15 on November 4th. The Form 15 is a document that notifies the SEC that a company intends to terminate their security registration. A company can do this if they have less than 300 shareholders of record. A shareholder of record is a shareholder who has possession of a physical stock certificate. If you own shares of a company in a brokerage account your name will never appear on the company's shareholder register. Rather the aggregated owner, Cede & Co, will appear on the shareholder register. Small companies like to go dark through this loophole. They might have thousands of shareholders with brokerage holdings, but these brokerage holdings only count as one registered owner. Most small companies have less than 300 shareholders with physical certificates.
Small companies will readily pay dividends and mail reports to shareholders who own shares in street name but when it comes time to determine if a company has enough shareholders to remain public or not companies will claim that street holders are not real shareholders. I know this is patently false as I've talked to CFO's of companies I own in street name, and they can see the number of shares I own and the name associated with my street holdings.
Opt-Sciences is a familiar name for small cap value investors. The company manufacturers anti-glare coating for aircraft instrument displays. The company has traded below book value since the financial crisis. The last time they traded for more than book for an extended period of time was in the mid to late 1990s. They are profitable and their balance sheet is loaded with cash and marketable securities. If one backs out their excess cash and securities the company has some eye-popping returns on equity and an extremely low P/E.
The company has a book value of $20.54 and earned $1.40 for the first nine months of 2015. Management expects the fourth quarter to generate about $.30 in earnings, for $1.70 in earnings for the full year. If you back out 75% of their cash and securities, which is $11.93 per share the company trades for 4.4x earnings. Ex-cash the company earns above 20% on their equity, although this could be misleading depending on how old their facilities are. It's possible they've depreciated all of their plant resulting in an artificially high ROE.
With the market at elevated levels it isn't often an investor finds a company at 4.4x earnings and trading for less than book value.
The reason that the stock is cheap is also the reason that going dark is a bad idea for the company. Opt-Sciences is cheap because management controls 66% of the company through a trust and another 6% directly for a 72% insider ownership stake. The Chairman is the head of the trust, while his son-in-law is the CEO. The beneficiaries of the trust are the CEO's wife and her brother, who is also on the board. The board consists of three members, the Chairman (trustee), CEO and his brother-in-law (trust beneficiary). The proxy claims the CEO has no control over the shares held in the trust, but these three family members appear to be on good terms, and it's laughable to say that the CEO's comments about the company wouldn't influence his wife's decisions or that the family wouldn't talk about the company at family gatherings.
Shareholders seem to have lost hope that value will ever be realized at the company and have been unwilling to trade shares for more than book. I don't blame any shareholders for giving up hope, there isn't much reason to hope with Opt-Sciences. While the company is generating good returns management is keeping the rewards to themselves. They don't buyback shares, and don't pay a dividend.
The company's Form 15 filing was terse. It contained no information as to why the company was going dark and didn't provide any details for the owners of the other 28% of the company who aren't insiders. The lack of communication speaks volumes as to how management thinks of the company. They act as if this is a small private company with a few nuisance shareholders hanging on.
As of January 2015 the company had 316 registered shareholders, 16 more than is required to go dark. Since then the company hasn't repurchased any shares, or announced any reverse splits to reduce their shareholder count under 300. It's possible the company is going to go dark illegally with more than 300 shareholders and hope the SEC just doesn't care.
I hope that Opt-Sciences will continue to publish financial reports for shareholders, but I'm skeptical. I've seen this pattern in the past where companies with large cash holdings go dark. Going dark can be a precursor to management sticking their hands in the cookie jar and looting the cash pile. When a company files with the SEC salaries and compensation and insider trades must be disclosed. In the world of dark stocks companies fly fast and loose without rules. Allegations of insider trading are rampant as well as managements with less than 100% ownership interest stealing 100% of the company's economic interest for themselves through high salaries and undisclosed perks.
It's possible that Opt-Sciences will be a good mannered dark company, but it's just as likely they'll fall off the face of the earth and shareholders will wonder what happened to their investment as management pillages the plunder.
The company is cheap but I'd wait to see how the going dark transaction plays out. Will the company continue to provide updates to shareholders? Or will shareholders be forced into suing the company for an annual report that they're legally entitled to have? A huge red flag is that they're proceeding to go dark with what appears to be more than 300 shareholders without any communication or plan to reduce that number. It could be a sign that the company believes they can do what they want.
My messages is "buyer beware" to investors interested in this company. It appears cheap at first glance, but the lack of meaningful communication with investors as well as the blank going dark filing leave me leery. This has all the markings of a company about to enter the value graveyard.
Disclosure: No position
Looking for value in the overlooked margins of the market.
