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.
Is it possible that current shareholders couch alert the SEC spurring them to action to prevent the deregistration?
ReplyDeleteThis company kind of reminds me of RSKIA (cash box) except they pay a dividend.
ReplyDeleteNate, I have seen references in various places that the JOBS act of 2012 contained wording that allowed smaller companies to no longer be obligated to file SEC reports if they had less than 1200 shareholders (registered I assumed). My understanding was that was to encourage or promote small businesses under Obama's plan. That might provide a means of going private with >300 registered shareholders. Have you heard/seen this as well, or do I misunderstand this reference to the JOBS act in other articles.
ReplyDeleteHi Nate,
ReplyDeleteDid the JOBS Act of 2012 allow small companies to go dark if they had less than 1200 shareholders (registered, I assumed)? If so, this might be the means for OPST's actions. Have you heard of this new ruling? I have seen it referenced several times in articles.
I think the 1200 threshold is for banks and bank holding companies. Regular companies still have the 300 limitation. Opt could have gone under 300 shareholders of record without doing a repurchase by encouraging current employees, directors, and past employees to submit their certificate shares into a brokerage account.
ReplyDeleteAnonymous - Unless there is proof that Opt misrepresented the actual number of shareholders of record the SEC will not care.
Just curious . . . why doesn't anyone (or everyone) within the sound of my voice by ~ 10 shares to distribute to your family and maybe close friends?
ReplyDeleteThe trick is buying the shares, AND THEN ASKING/TELLING your broker that you want to REGISTER the shares in YOUR name, and NOT have them held in Street Name.
Once you get the certificate for the 10 or 20 shares, type up a Letter of Instruction detailing how you want your REGISTERED shares split up:
E.g.,:
1 to your spouse (or S.O.)
1 to your child, registered under UTMA/UGMA (if under 18 or 21 depending on your state's laws)
1 to next child
1 to mom
1 dad
1 to grandchild (same UTMA/UGMA)
with the remainder to yourself (in this example, starting with 10 shares, 5 were used to welcome 5 new shareholders to the company, and there were 5 left over for yourself, as the 6th new shareholder).
Wash/Rinse/Repeat
They are claiming to be pretty dams close to 300 according to the Form 15 that was filed). All that they really need is about 25 to 30 new shareholders before the end of the year and that way, they don't need to worry about suspending their duties to report under the SEC Act of 1934.
See, you help the company out while helping 5 other people "invest in America."
Has anyone had a dialogue with the company about ways to increase shareholder value? Management seems to be unaware of the potential for a nasty assessment from the IRS under the Accumulated Earnings Tax. The lack of distributions, intended as a way for the Kania family to avoid taxes on their investments, would likely have exactly the opposite effect if the company were audited. From the IRS's article on this topic (https://www.irs.gov/irm/part4/irm_04-010-013.html), it appears the tax would apply in this situation, and would more than outweigh the tax benefits to the Kania family of not making distributions, as is its intent.
ReplyDeleteSomeone who either has a dialogue with the Kania family, a more meaningful position in the company, or more knowledge of tax law needs to raise this issue with management. Perhaps they can be persuaded to buy back stock and make a distribution.
I contacted the company recently requesting their annual report. They asked for proof of ownership. I sent a brokerage statement and promptly received the report. They also said they would continue to respond to qualitative questions from shareholders about the business, but won't publish the reports - you'll need to request them. I'd also refer you to this writeup by anton at Value Investors Club (https://www.valueinvestorsclub.com/idea/OPT-SCIENCES_CORP/137261) from late last year. He has good things to say and is very credible having owned shares for a decade. There are definitely risks here, but it is cheap on both pillars (earnings and assets) and I think it has a place as a small position in a diversified microcap value portfolio. I am kind of surprised by your position here, Nate. I've been going through all your posts and I think a few years ago you may have been more bullish in a situation like this. They will probably save at least $100-200k by deregistering, which is non-trivial on $1.8mm of op income and $1.5mm of FCF. Also, McCabe takes a $200k salary which seems very reasonable to me considering he is the salesforce and the only executive officer.
ReplyDelete