Happy Friday to all Oddballs!
Just a quick note that we have published Issue 25 of the Newsletter this afternoon. If you are a subscriber, it should be in your inbox right now.
If not, you can sign up right here.
Looking for value in the overlooked margins of the market.
Small Companies (like Small Banks) As "Jobs Programs"
In Part I of this series, "What is an Oddball Stock?", we mentioned that the pattern of Oddball opportunity over the market cycle goes from just cheap to cheap assuming activism or a "one day" type of liquidity event. Recently there have been quite a few of the one-days happening: Paradise, Inc., Vulcan International Corp, Stonecutter Mills Corp, Randall Bearings, and so forth.
Unfortunately, a lot of the remaining Oddballs that have not had their "one day" are continuing along earning low returns on equity, cheap relative to the liquidation value of their assets - but that asset value has to be discounted because they function as jobs programs for insiders.
What do we mean by "jobs program"? Well, we would describe those as companies that are earning low returns on equity for shareholders but paying quite a high percentage of assets or shareholder equity as salaries.
In a recent Issue of the Newsletter we wrote about a small rural bank: Southern Community Bancshares, Inc. (OTC: SCBS), the holding company of First Community Bank of Cullman. That is a small town of about 15,000 people located 50 miles north of Birmingham, Alabama that was ranked among Businessweek's "50 Best Places to Raise Your Kids" in 2012. This is one of the dwindling number of small banks still trading at substantial discounts to tangible book value. The current offer for the stock is $8.55 (bid is $8.30), and with the 505,592 shares outstanding that makes for a market capitalization of $4.3 million. Meanwhile, the stockholders' equity is $10 million, up from $9.7 million the previous year, for a price-to-book ratio of 0.43x.
There are no intangible assets on the balance sheet, nor is there goodwill. There are a surprisingly small amount of investment securities (U.S. government agency, municipal, corporate, and mortgage backed): only $6.3 million of which $5 million is maturing within five years. The bank had huge loan growth over the past year, from $58 million to $90 million (a 55% increase!). This was funded by a $20 million increase in interest bearing deposits and a $7.5 million increase in borrowings from the FHLB.
Interest income grew 52% and interest expense almost tripled, so net interest income after providing for loan losses only increased by 34%. But the amazing thing is that net income was actually down year over year, falling from $398k to $374k – a sub-4% ROE both years. The reason was a big increase in non-interest expense, primarily salaries and employee benefits. Possibly, someone made (and perhaps deserved) a big commission on the $22 million in new loans (which if so would be a one-time expense).
However, the other gotcha if an investor is looking at this from a P/B perspective (and since ROE is so low how else is there to look at it?) is that there is over $5 million of property and equipment on the balance sheet, which feels like quite a bit for a bank with only $10 million of equity. Looking at the footnotes, this is mostly land and buildings/improvements, so we are guessing that we must be seeing the balance sheet effect of the building depicted below:
Another cupola! Perhaps we need to start a Bank of Utica Small-Town Bank Headquarters Hall of
Fame? Having half of the bank's equity tied up in premises makes the 57% discount to book value feel much
less generous.
According to the Form FR Y-6 filed by the holding company in 2017, there is an employee stock ownership plan that owned 25% of SCBS. Other insiders are reported owning significant stakes as well (the company does not provide ownership figures in the notice of annual meeting). So the insiders have significant skin in the game. They must be really bullish on rural northern Alabama real estate to have spent half their equity on this building. We will have to stop and see the town next time we are in the area. (One other odd thing is that they still have $326k of "occupancy expenses" despite owning $5 million of real estate and apparently having only one branch.)
But it underlines the absurd business model of small banks, which we have been harping on for the past year. Imagine if you were going to take $10 million in equity to start a fixed income closed end fund – or maybe a business development company. What if someone foolishly offered to guarantee your liabilities so you could borrow really cheaply and lever up ten times. Wouldn't you hope to earn more than four percent on the equity after all that? And would you spend half the equity on a headquarters?
Like many small banks, maintaining this as a going concern seems to be of dubious value to shareholders, compared to the immediate return (and opportunity to redeploy capital) that they would get if the bank were sold. Instead, its purpose as a company might perhaps be better understood either as a jobs program ($1.65 million of salaries) or as civic monument with a copper cupola.
One could look at the non-interest expenses is as percentage of assets or as a percentage of equity (which is obviously multiplied by the leverage of the bank). So, the $3.1 million of total non-interest expense for 2018 was 2.7% of the year-end total assets.
If the bank can maintain its net interest margin (which may be tricky with short term rates higher than what they paid on deposits last year), this situation might continue indefinitely, even though it may not be the most efficient use of shareholders' capital or the most efficient way for society to provide deposit and lending services to rural northern Alabamans.
Unfortunately, a lot of the remaining Oddballs that have not had their "one day" are continuing along earning low returns on equity, cheap relative to the liquidation value of their assets - but that asset value has to be discounted because they function as jobs programs for insiders.
What do we mean by "jobs program"? Well, we would describe those as companies that are earning low returns on equity for shareholders but paying quite a high percentage of assets or shareholder equity as salaries.
In a recent Issue of the Newsletter we wrote about a small rural bank: Southern Community Bancshares, Inc. (OTC: SCBS), the holding company of First Community Bank of Cullman. That is a small town of about 15,000 people located 50 miles north of Birmingham, Alabama that was ranked among Businessweek's "50 Best Places to Raise Your Kids" in 2012. This is one of the dwindling number of small banks still trading at substantial discounts to tangible book value. The current offer for the stock is $8.55 (bid is $8.30), and with the 505,592 shares outstanding that makes for a market capitalization of $4.3 million. Meanwhile, the stockholders' equity is $10 million, up from $9.7 million the previous year, for a price-to-book ratio of 0.43x.
There are no intangible assets on the balance sheet, nor is there goodwill. There are a surprisingly small amount of investment securities (U.S. government agency, municipal, corporate, and mortgage backed): only $6.3 million of which $5 million is maturing within five years. The bank had huge loan growth over the past year, from $58 million to $90 million (a 55% increase!). This was funded by a $20 million increase in interest bearing deposits and a $7.5 million increase in borrowings from the FHLB.
Interest income grew 52% and interest expense almost tripled, so net interest income after providing for loan losses only increased by 34%. But the amazing thing is that net income was actually down year over year, falling from $398k to $374k – a sub-4% ROE both years. The reason was a big increase in non-interest expense, primarily salaries and employee benefits. Possibly, someone made (and perhaps deserved) a big commission on the $22 million in new loans (which if so would be a one-time expense).
However, the other gotcha if an investor is looking at this from a P/B perspective (and since ROE is so low how else is there to look at it?) is that there is over $5 million of property and equipment on the balance sheet, which feels like quite a bit for a bank with only $10 million of equity. Looking at the footnotes, this is mostly land and buildings/improvements, so we are guessing that we must be seeing the balance sheet effect of the building depicted below:
According to the Form FR Y-6 filed by the holding company in 2017, there is an employee stock ownership plan that owned 25% of SCBS. Other insiders are reported owning significant stakes as well (the company does not provide ownership figures in the notice of annual meeting). So the insiders have significant skin in the game. They must be really bullish on rural northern Alabama real estate to have spent half their equity on this building. We will have to stop and see the town next time we are in the area. (One other odd thing is that they still have $326k of "occupancy expenses" despite owning $5 million of real estate and apparently having only one branch.)
But it underlines the absurd business model of small banks, which we have been harping on for the past year. Imagine if you were going to take $10 million in equity to start a fixed income closed end fund – or maybe a business development company. What if someone foolishly offered to guarantee your liabilities so you could borrow really cheaply and lever up ten times. Wouldn't you hope to earn more than four percent on the equity after all that? And would you spend half the equity on a headquarters?
Like many small banks, maintaining this as a going concern seems to be of dubious value to shareholders, compared to the immediate return (and opportunity to redeploy capital) that they would get if the bank were sold. Instead, its purpose as a company might perhaps be better understood either as a jobs program ($1.65 million of salaries) or as civic monument with a copper cupola.
One could look at the non-interest expenses is as percentage of assets or as a percentage of equity (which is obviously multiplied by the leverage of the bank). So, the $3.1 million of total non-interest expense for 2018 was 2.7% of the year-end total assets.
If the bank can maintain its net interest margin (which may be tricky with short term rates higher than what they paid on deposits last year), this situation might continue indefinitely, even though it may not be the most efficient use of shareholders' capital or the most efficient way for society to provide deposit and lending services to rural northern Alabamans.
Oddball Stocks Newsletter - Also Available à La Carte
Just a quick note that there are two different ways to become a true Oddball: subscribe to the Oddball Stocks Newsletter, or purchase one of the limited number of back Issues that we have published à la carte.
You can see a full list of à la carte Issues, but they are Issues 19, 20, 21, 22, and 23.
The June 2019 Issue (#25) of Oddball Stocks Newsletter covering the 2019 annual report season will be published shortly, and the only way to get it is to be a subscriber.
Some comments from happy subscribers:
You can see a full list of à la carte Issues, but they are Issues 19, 20, 21, 22, and 23.
The June 2019 Issue (#25) of Oddball Stocks Newsletter covering the 2019 annual report season will be published shortly, and the only way to get it is to be a subscriber.
Some comments from happy subscribers:
- "You need to raise the price!"
- " I think you guys are selling yourself short on your company visits. Saying that you are visiting or reporting from a company in your marketing, doesn’t give justice to the insight and analysis you are providing."
- "The quality of the writing (even including your new contributors) is really top-drawer."
- "Great newsletter! - you guys are either providing too much info or not charging enough..."
“What is an Oddball Stock?”
The philosophical subject of “What is an Oddball Stock?” frequently comes up and we thought that we should share our thoughts on the question.
Oddballs are small companies. From time to time we talk about companies with larger market capitalizations or balance sheets (most always dark, OTC-listed ones) but an Oddball is much more likely to be a $1 million company than a $1 billion one.
Oddballs are opaque. We are always disappointed if we find a company's financial statements readily available because that means the company is much less likely to be inefficiently priced. So the opacity comes from being OTC traded and therefore not SEC-reporting. Oddballs have all different letters of shareholder friendliness and communication, from the detailed presentations of Pardee all the way down to a company like Vulcan International. Besides the paucity of information provided to shareholders by management, the Oddballs do not generate news. Time goes by with not a peep heard from them or about them.
Of course, that paucity of information is why the Oddball Stocks Newsletter serves such a valuable function for subscribers. Even though we make no "recommendations," we help investors in this space figure out what is going on. By the way, the dearth of information that the owners of Oddball companies have about them reminds us of something in the book Panic by Andy Redleaf:
Oddballs are older companies. You have probably noticed a number of companies that we have written about that are in the “Century Club,” having been around for a hundred years. And related to this, the Oddball companies are in simple and prosaic businesses. We hear a lot these days about “disruption,” but we think there is something interesting about companies that have been around for a century; especially if they are trading for less than 10x earnings. Also, because the Oddball businesses are older, they tend to be asset intensive. That is, they employ tangible assets that show up on the balance sheet, not intangibles or human capital. And because of this we are often discussing their valuations in terms of book value metrics.
The factors above tend to lead to inefficiency and underpricing of Oddballs because many investors systematically avoid these factors in their investing. Meanwhile, we have noticed that Oddball investors tend to prefer different subsets of investment theses. For example, some like the “cashbox” or negative enterprise value. Some like a very low EV/FCF ratio along with buybacks, so that the company can take itself private quickly if price stays the same. Most Oddball investors seem to prefer overcapitalization and shun debt. Also, Oddball managements seem to want their companies to be overcapitalized, which drives return on equity lower and therefore price-to-book lower.
The pattern of Oddball opportunity over the market cycle goes from just cheap to cheap assuming activism or a "one day" type of liquidity event. Recently there have been quite a few of the one days happening: Paradise, Inc., Vulcan International Corp, Stonecutter Mills Corp, Randall Bearings, and so forth.
Unfortunately, a lot of the remaining Oddballs that have not had their "one day" and continue along earning low returns on equity, cheap relative to the liquidation value of their assets, but which asset value has to be reasonably discounted because they function as jobs programs for insiders. More about that principal-agent problem in Part Two...
Oddballs are small companies. From time to time we talk about companies with larger market capitalizations or balance sheets (most always dark, OTC-listed ones) but an Oddball is much more likely to be a $1 million company than a $1 billion one.
Oddballs are opaque. We are always disappointed if we find a company's financial statements readily available because that means the company is much less likely to be inefficiently priced. So the opacity comes from being OTC traded and therefore not SEC-reporting. Oddballs have all different letters of shareholder friendliness and communication, from the detailed presentations of Pardee all the way down to a company like Vulcan International. Besides the paucity of information provided to shareholders by management, the Oddballs do not generate news. Time goes by with not a peep heard from them or about them.
Of course, that paucity of information is why the Oddball Stocks Newsletter serves such a valuable function for subscribers. Even though we make no "recommendations," we help investors in this space figure out what is going on. By the way, the dearth of information that the owners of Oddball companies have about them reminds us of something in the book Panic by Andy Redleaf:
What modern capital markets do very well is raise large amounts of capital from a broad base of investors who are persuaded to give their money to perfect strangers with precious little idea of what these fortunate recipients are going to do with it. In order to keep the money coming in under such admittedly odd circumstances, liquidity and the universal, instantaneous "price discovery" that financial markets offer with a glance at a computer screen are essential. The public investor, knowing so little about what he is buying, must be able to tell himself he can get that money back (or what's left of it) pretty much whenever he likes. [...] Public securities markets, and especially equity and derivative markets, are bad markets because their knowledge base is thin (at least compared to the sum of what could be known about the underlying companies if shareholders were allowed to know it, or inclined to learn it).Compared to bigger public companies, most Oddballs are illiquid. This comes from being small and also from having a small float. Many of the most interesting Oddballs are heavily insider-owned or at least owned by investors with a long time horizon who do not “trade” their stock. So, as small as the market capitalizations are, this makes the effective investible size of the companies even smaller.
Oddballs are older companies. You have probably noticed a number of companies that we have written about that are in the “Century Club,” having been around for a hundred years. And related to this, the Oddball companies are in simple and prosaic businesses. We hear a lot these days about “disruption,” but we think there is something interesting about companies that have been around for a century; especially if they are trading for less than 10x earnings. Also, because the Oddball businesses are older, they tend to be asset intensive. That is, they employ tangible assets that show up on the balance sheet, not intangibles or human capital. And because of this we are often discussing their valuations in terms of book value metrics.
The factors above tend to lead to inefficiency and underpricing of Oddballs because many investors systematically avoid these factors in their investing. Meanwhile, we have noticed that Oddball investors tend to prefer different subsets of investment theses. For example, some like the “cashbox” or negative enterprise value. Some like a very low EV/FCF ratio along with buybacks, so that the company can take itself private quickly if price stays the same. Most Oddball investors seem to prefer overcapitalization and shun debt. Also, Oddball managements seem to want their companies to be overcapitalized, which drives return on equity lower and therefore price-to-book lower.
The pattern of Oddball opportunity over the market cycle goes from just cheap to cheap assuming activism or a "one day" type of liquidity event. Recently there have been quite a few of the one days happening: Paradise, Inc., Vulcan International Corp, Stonecutter Mills Corp, Randall Bearings, and so forth.
Unfortunately, a lot of the remaining Oddballs that have not had their "one day" and continue along earning low returns on equity, cheap relative to the liquidation value of their assets, but which asset value has to be reasonably discounted because they function as jobs programs for insiders. More about that principal-agent problem in Part Two...
Another Oddball Stock Retrospective
We did a retrospective the other day on PC Connection, finding that it compounded at 24% (counting dividends) from the time it was mentioned in September 2010.
Another early Oddball Stocks post was Ingram Micro in September 2011. (In addition to the Oddball blog writeup, it was also presented at the Value Investing Congress in 2011.)
This is another boring business - not consumer facing and not a "compounder" - but let's see how it did over time. First, here was Nate's thesis on the blog back in 2011:
It is often hard to find charts of stocks that have stopped trading, but Barchart.com has one for IM up until it was acquired.
Another early Oddball Stocks post was Ingram Micro in September 2011. (In addition to the Oddball blog writeup, it was also presented at the Value Investing Congress in 2011.)
This is another boring business - not consumer facing and not a "compounder" - but let's see how it did over time. First, here was Nate's thesis on the blog back in 2011:
ValuationWhat ended up happening is that in February 2016, Ingram Micro announced that it would be acquired by a Chinese company for $38.90 per share, cash. The deal ultimately closed in December of that year. Counting a couple of small dividends that were received in 2015, that was a compounded IRR of 16.3%.
Here are a few quick valuation stats:
-P/E of 9.69
-EV/EBIT 3.08
-EV/FCF 5.52
So on a few simple metrics the company is coming up cheap. What might be an appropriate valuation for Ingram Micro? The industry average P/E is 10.5, which if IM traded at that level they would be at $19.11, not much upside.
A P/E of 10.5 plus cash results in a price of $27.75 per share.
If the company traded at an EV/EBIT of 8 the price would be $32.34 which is quite a bit higher than $17.66.
Conclusion
Ingram Micro is trading at a very cheap discount to net assets, and the business is trading cheaply as well. Even with both of those factors I don't have a good feeling about Ingram Micro. The company has a decent amount of debt and operating leases, and earnings are extremely lumpy. I also don't know how much valuation expansion exists. Clearly the company is cheap, but how much cheaper than peers. And for an industry that has bad margins maybe a P/E of 10 is warranted. If the market values based on P/E they are already close to full value. This is going into my consider further, and re-consider if it drops bin.
It is often hard to find charts of stocks that have stopped trading, but Barchart.com has one for IM up until it was acquired.
Paradise, Inc. Is Liquidating! ($PARF)
Well, it looks like another "one-day" stock has had its day:
Regarding the acquisition, one Tweeter commented, "Seneca Foods is buying Paradise inc. candied fruits business for $9.4 mln, ~0.6x last year's sales and somewhat over 3x operating earnings. That's a nice buy for Seneca and a shitty sale for Paradise investors, a perennial OTC asset play."
In fairness, the proxy statement describes a very long lasting marketing process by Paradise's bankers, and apparently this was the highest offer. It would be interesting to know the real reason that nobody stepped up willing to pay more for this segment.
Another Tweeter observed that Paradise "announced in Feb18 it was exploring strategic alternatives. Didn't disclose until 12/7/18 that it had entered into a retention agreement effective 10/31/17 with CFO with $75K bonus paid when company sold."
The proxy statement is well worth reading. The negotiations with the eventual buyer lasted from March 2018 until April 2019. One thing that is a little ominous is that the buyer wanted the fruit business but not the plastics and especially not the real estate. See this little tidbit:
Here is the detail from the proxy statement on the estimated proceeds after the asset sale of the fruit business:
One wonders what the real estate is going to bring... It seems like management should have elaborated a bit on the problems revealed by the Phase 2 environmental study. Is it a Superfund site or what?
Dear Fellow Shareholders:That is from a proxy statement that was filed with the SEC. It goes on to give an estimate of the liquidation value:
We are pleased to inform you that on April 15, 2019, Paradise, Inc. (“Paradise” or the “Company”) entered into an Asset Purchase Agreement (the “Purchase Agreement”), with Gray & Company (the “Buyer”) and Seneca Foods Corporation (the “Parent”). Subject to the closing conditions included in the Purchase Agreement, including most importantly approval by you as our shareholders, the Company will sell to the Buyer the assets of its glacé fruit product business (the “Fruit Business”). If approved and closed in accordance with its terms, the sale of the Fruit Business (the “Asset Sale”) would be for an aggregate purchase price of approximately $10.9 million, consisting of cash consideration of approximately $9.4 million and assumed liabilities of approximately $1.5 million. Approximately $0.9 million of the purchase price would be held in escrow for six months after the sale to satisfy indemnification obligations of the Company. We ask for your approval of the Asset Sale as described in further detail in the accompanying proxy statement.
In addition, our Board of Directors has determined that the best course of action following the Asset Sale is the orderly sale of our remaining assets, including our molded and thermoformed plastics business (the “Plastics Business”) and the real property on which we operate our businesses (the “Real Estate”), as part of a Plan of Complete Liquidation and Dissolution (the “Liquidation Plan”). As a result, we are also asking in the proxy statement for the approval by our shareholders of the Liquidation Plan.
Assuming shareholder approval and closing of the Asset Sale, the Board estimates that the aggregate amount of distributions to shareholders as a result of the Asset Sale and Liquidation Plan will be between approximately $18.0 million and $25.0 million, or approximately $35 to $48 per share based on 519,600 shares outstanding...Paradise was a net-net idea that Nate posted way back in July 2012 - so seven years ago. At that point, shares were trading at about $18. Commenters actually gave the idea a bit of a hard time, for example:
Your investment in a business like PARF has costs -- the returns that you could have earned in treasuries, bonds, ETFs, or some other stock.Over the years the company paid a paltry $0.92 of dividends, but with the liquidation announcement there is now a $38.52 bid for the shares. That represents an IRR of a little over 12%. If the liquidation were to result in $45 in proceeds a year from now, the IRR might end up being 13% compounded for eight years. (It should be noted that this is about the same as the total return of the S&P 500 over the same seven year time period.)
If one invests $100 in PARF's assets, one can expect 6% back per year; if one invests the same amount in the S&P or some other index, one can expect ~9% back a year. Every year one holds PARF, one loses 3% of the value of one's investment via opportunity cost.
That's why the business has negative economic value for the investor. Everyone else, -- employees, suppliers, customers, tax authorities -- are quite happy with PARF.As for the private investor,given that PARF's under-performance is built into the business (tremendous amount of working capital required to generate very little in terms of profit), why would a rational person -- private buyer or Mr. Market -- want to pay full price?
I don't think they would: the'd pay 2/3 of the price of the assets, just in order to break even.
And that missing 1/3, the proxy for value destruction, has a value of ~$5-$6 million, which, not coincidentally, is the value of the excess cash.
Regarding the acquisition, one Tweeter commented, "Seneca Foods is buying Paradise inc. candied fruits business for $9.4 mln, ~0.6x last year's sales and somewhat over 3x operating earnings. That's a nice buy for Seneca and a shitty sale for Paradise investors, a perennial OTC asset play."
In fairness, the proxy statement describes a very long lasting marketing process by Paradise's bankers, and apparently this was the highest offer. It would be interesting to know the real reason that nobody stepped up willing to pay more for this segment.
Another Tweeter observed that Paradise "announced in Feb18 it was exploring strategic alternatives. Didn't disclose until 12/7/18 that it had entered into a retention agreement effective 10/31/17 with CFO with $75K bonus paid when company sold."
The proxy statement is well worth reading. The negotiations with the eventual buyer lasted from March 2018 until April 2019. One thing that is a little ominous is that the buyer wanted the fruit business but not the plastics and especially not the real estate. See this little tidbit:
On January 3, 2019, the Parent terminated negotiations with the Company regarding a merger but communicated its willingness to purchase only the Fruit Business of the Company under an asset purchase. The Parent did not give any reason for this termination at this time, but later told the Company that it did not want to acquire the stock of the Company based on the preliminary results of the Phase 2 study.Apparently the buyer was emphatic that they did not want "to be in the 'chain of ownership' for the Company’s real estate property"! The way that this was resolved is that Paradise is doing an asset sale of just the fruit business; not a merger or sale of the whole company.
Here is the detail from the proxy statement on the estimated proceeds after the asset sale of the fruit business:
After execution of the Purchase Agreement, the Company will have an estimated remaining asset value net of liabilities of approximately $14.0 million (with the Plastics Business and Real Estate being valued at net book value). Given that, estimated future proceeds to shareholders are calculated as (1) the cash consideration from the Asset Sale; plus (2) the net tangible value of remaining assets less liabilities; less (3) transaction-related fees/expenses and severance ($4.2 million); plus/minus (4) operating profits/losses between the date of closing of the Asset Sale and the date of full liquidation of the Company (assumed to be break-even) — totaling $19.2 million of estimated proceeds.Payments of severance and a special bonus are going to be an eye-popping $3.2 million -that is over $6 per share.
One wonders what the real estate is going to bring... It seems like management should have elaborated a bit on the problems revealed by the Phase 2 environmental study. Is it a Superfund site or what?
Activism Story: Texas Pacific Land Trust ($TPL)
An Oddball correspondent wrote in about the ongoing proxy fight at Texas Pacific Land Trust (TPL), which, while too big to be a true "Oddball" is certainly Odd, unique, very old, and interesting:
While we are not involved in the TPL flight, we believe that good corporate governance consists of real owners (not professional board members) sitting in the board room making decisions (with skin in the game) about their property. (See this example of an older Oddball post on activism.)
There is litigation between the Trust and the activist investors, and the countersuit by the dissident nominee is very interesting:
The Eric Oliver dissident nominee is the Chairman of AMEN Properties which is a micro cap and kind of an Oddball. He and his fund have a $31 million stake in TPL! Oliver was also involved in a company that maps oil and gas activity in the Permian.
We'll have more on these topics - activism, share cannibalization, capital allocation, resource investments like Pardee Resources - in the upcoming June Issue of the Oddball Stocks Newsletter. If you've read this far into this post, you should really think about subscribing. Maybe try an à la carte back Issue, like Issue 19 or Issue 20 from last year.
Here's a 55 minute video that allows you to experience the drama (from the special shareholders meeting on May 22). The man in front speaking is Eric Oliver, a "dissident" candidate who handily won the open trustee spot, although this is hotly contested in federal court. He is frequently interrupted by the attorney for the two existing sitting trustees. There's also a blog that has frequent updates.Texas Pacific Land Trust has been around since 1888 and is a favorite of the Horizon Kinetics fund managers. From the Wikipedia history of the trust:
TPL was created in February 1888 in the wake of the Texas and Pacific Railway bankruptcy, as a means to dispose of the T&P's vast land holdings. TPL received over 3.5 million acres, and certain T&P bondholders were allowed to exchange their (now worthless) bonds for trust certificates. The certificates were later divided into "sub-share" certificates (3,000 sub-share certificates is the equivalent of one trust certificate), and the sub-share certificates have been traded on the NYSE since January 1927.See the map of TPL's west Texas acreage. One of the things that investors have liked about TPL is that it is a "cannibal" - allocating income to significant share repurchases:
Over 100 years later, even having sold 75 percent of its original landholdings, TPL is still among the largest private landowners in the State of Texas. As of December 31, 2008, TPL owned 963,248.33 acres of land in 20 West Texas counties, of which around 70 percent is located in Culberson (315,640.09 acres), Reeves (194,750.28 acres), and Hudspeth (160,467.44 acres) counties. In addition, TPL owns a 1/128 nonparticipating perpetual royalty interest in 85,413.60 acres (over half of which is in Ector and Midland counties), and a 1/16 nonparticipating perpetual royalty interest in 386,987.70 acres (over 60 percent of which is in Culberson and Reeves counties).
TPL has a long-standing policy to repurchase sub-shares with excess cash. As noted in the 2015 annual report, "As provided in Article Seventh of the Declaration of Trust, dated February 1, 1888, establishing the Trust, it will continue to be the practice of the Trustees to purchase and cancel outstanding certificates and sub-shares. These purchases are generally made in the open market and there is no arrangement, contractual or otherwise, with any person for any such purchase."Of course, it helps that TPL's land was on top of the Permian oil bounty! Yet, historically, TPL's almost "autopilot" policy of self-repurchasing has proven to be a great capital allocation strategy, avoiding the all-too-common resource producer patterns of buying overpriced land (often at cyclical commodity peaks) just to grow production, or boondoggles from straying afield (something that Pardee investors are currently grappling with).
In 2015, the Trust purchased and retired 204,335 sub-shares at a cost of $28,771,073, representing an average cost of $140.80 per sub-share. The number of sub-shares purchased and retired in 2015 amounted to 2.5% of the total number of sub-shares outstanding as of December 31, 2014.
The policy of buy backs has reduced the sub-share count by 26% between 2004 and 2015 (from 10,971,375 at the end of 2004 to 8,118,064 at the end of 2015.)
While we are not involved in the TPL flight, we believe that good corporate governance consists of real owners (not professional board members) sitting in the board room making decisions (with skin in the game) about their property. (See this example of an older Oddball post on activism.)
There is litigation between the Trust and the activist investors, and the countersuit by the dissident nominee is very interesting:
On information and belief, the incumbent trustees have caused TPL to spend upwards of $5 million of shareholder capital on this proxy contest to date. But nowhere in the Declaration of Trust are trustees vested with the authority to wage proxy contests against shareholders, or in any way utilize trust property to impose on shareholders the nominee of the incumbent trustees. The trustees do not enjoy the same broad set of powers and wide field of discretion as the directors of a modern corporation. Nothing gives the incumbent trustees the power to take actions outside of managing the trust's property as strictly outlined in the trust documents. Because the incumbent trustees have exceeded their authority under the Declaration of Trust, they are personally liable to the trust for all the expenses they have incurred without proper authority.Check out how many copies of their proxy card the incumbents sent - all with the Trust beneficiaries' money!
The Eric Oliver dissident nominee is the Chairman of AMEN Properties which is a micro cap and kind of an Oddball. He and his fund have a $31 million stake in TPL! Oliver was also involved in a company that maps oil and gas activity in the Permian.
We'll have more on these topics - activism, share cannibalization, capital allocation, resource investments like Pardee Resources - in the upcoming June Issue of the Oddball Stocks Newsletter. If you've read this far into this post, you should really think about subscribing. Maybe try an à la carte back Issue, like Issue 19 or Issue 20 from last year.
Goodheart-Willcox Company (GWOX) Tender Offer Results Are In!
Back in March we posted about the tender offer by the Goodheart-Willcox Company Employees' Profit Sharing and Stock Ownership Plan and Trust of $150 per share for up to 124,000 shares (which is 27.8% of the outstanding stock) of GWOX.
The company has announced the results of the tender offer:
We will have a discussion of this - and many, many other developments from Oddball annual report season - in the upcoming June Issue of the Oddball Stocks Newsletter, due to drop later this month.
Also, make sure you see Nate's post on the failure of Enloe State Bank in Texas. Watch how he uses CompleteBankData tools to delve into what was going on at that bank.
The company has announced the results of the tender offer:
52,557 shares of The Goodheart-Willcox Company, Inc. common stock were tendered by shareholders at the price of $150.00 per share, for a total transaction amounting to $7,883,550 and representing 11.7834% of the total outstanding shares of the Company’s outstanding stock.So the tender offer was "undersubscribed" - they did not receive as many tenders as they had been willing to buy. The last trade of GWOX was for $150 per share at the end of April. This has always been pretty illiquid and now will probably be even more so.
The shares were redeemed by The Goodheart-Willcox Company, Inc. Employees’ Profit Sharing and Stock Ownership Plan and Trust. By having the benefit plan acquire the shares, it allowed tendering shareholders to take advantage of certain provisions of the tax code called Section 1042 which allowed them to reinvest in U.S. qualified securities without incurring capital gains taxes.
The President of Goodheart-Willcox stated the optional tender offer provided two advantages to the shareholders ---liquidity for their shares as well as tax advantages for reinvesting the proceeds.
The shares added to the Employees’ Profit Sharing and Stock Ownership Plan and Trust will be used to attract and retain talent in order to grow the Company into the future.
We will have a discussion of this - and many, many other developments from Oddball annual report season - in the upcoming June Issue of the Oddball Stocks Newsletter, due to drop later this month.
Also, make sure you see Nate's post on the failure of Enloe State Bank in Texas. Watch how he uses CompleteBankData tools to delve into what was going on at that bank.
Why did Enloe State Bank fail?
It's been a few years since a bank failed. Which has been excellent for industry observers, at one point during the crisis it seemed like a half dozen failed each weekend. In typical fashion the FDIC drops a press release late on Friday when they close a bank.
Banks fail for a myriad of reasons from bad loans to being caught in a liquidity crisis. Usually it's a combination of both. A portion of the bank's loan book turns south requiring additional capital at the same time that the bank doesn't have access to capital, or capital is walking out the door. These confluence of events eventually lead to FDIC receivership.
When a bank fails the FDIC negotiates an agreement with another local bank. The local bank acquires some or all of the failed bank's deposits along with the choice loans. Any "bad" loans are either handed over as part of the sale and guaranteed by the FDIC, or handled by the FDIC themselves.
As long time readers know this isn't a bank tracker blog, and I rarely write about failures. So why this one?
The failure of Enloe State Bank is fascinating, and after a little digging I'm convinced there's a lot more here than meets the eye.
First off in the FDIC's press release they note that the bank had assets of $36m and deposits of $31m. So then why did Legend Bank (the acquiring bank) only take $5.2m in assets and why did this little bank incur a $27m hit to the FDIC's insurance fund? Secondly if you Googled the bank news articles from two weeks ago appeared saying that the ATF was investigating a suspicious fire at the bank. Someone was seen burning papers inside. Suddenly this is starting to sound like a movie plot and merited further investigation.
I did what any curious person would do, I started to dig into the numbers and wow... something is very off here.
First let me provide a little background. At CompleteBankData we are building one of the most advanced market analysis, full-stack bank marketing and bank prospecting tools. We collect data from a variety of sources daily and build out a mosaic showing the current lending market place and opportunity set. We pull things like deeds, property assessments, mortgage originations, UCC filings, agricultural subsidies and farm information along with credit details and business profiles (revenue, fleet size, number of employees etc).
While the previous paragraph might just seem like a plug for my business, and in a small way it is, I provided it as background for what I found. Because without knowing what we do you'll be scratching your head wondering how I researched this post.
In general if we pull up a bank with $285m in loans we will be able to find a number very close to that in our database. There are usually differences due to rounding or other factors, but it's usually very close. So image my surprise when I started to dig into Enloe State bank and only found a shadow of the number of loans they report.
The bank had $36m in assets, but in the last five years only originated $5.8m in loans. Prior to that they'd only originated another $3m or so in loans in the prior ten years.
This was head turning at first, but it could make sense. In Q1 they noted about $5.9m in first lien mortgages, that's right near our $5.8m number. They also have $3.2m secured by farmland and another $10m in loans to finance agricultural production. It's the ag loans where things start to get a little fishy.
The bank is classified as an agriculturally focused bank, yet the majority of their loans are for an acre or less. I found a few on properties that were over 10 acres, which would be considered a very small farm. A second aspect was that these "farmer" loans were small. For example one couple on 50 acres borrowed $96k. Digging into the loan details it appears that the $96k was to finance a residence on the property, not the farm land itself.
Which means I just can't find their $3.2m in farm loans. Our property data only dates back to 2003, so it's possible the $3.2m in land loans all pre-date this century. But let me let that hang for a second and let's talk about ag production lending.
If a bank is lending against production there are usually a few ways to identify the activity, primarily though UCC filings. For example, a bank that is lending for seeds and operating costs they will also secure equipment such as tractors and spreaders.
When I looked at Enloe State Bank's secured financing history back to the 1980s they had a pattern of lending to farmers at least a dozen times a year if not more. This persisted right up to 2011 and then just dropped off. There were a few random loans since, but not much of note.
The weird UCC financing pattern might have an explanation, or it might not. A second factor that turns my head a little is $2.3m in in unsecured loans to individuals.
Let me see if I can piece this together for you. Legend Bank decided to acquire $5.7m in assets, so loans and possibly Enloe's $2m in held to maturity securities. Meaning that the only "good" loans were potentially their $5.8m in residential loans that I found, although the number could be potentially less.
So what about all of the farm loans? This is pure speculation, but I think this might be why someone was burning papers in the bank. I think it's possible that the bank was lending on "production" that either didn't exist, or was highly inflated. I know this is speculation, but it's somewhat founded speculation. I took a list of their borrowers that I knew about with the largest land holding and attempted to cross correlate with farm subsidies or farm income. It turns out that their largest farmers don't have any identifiable farm income to note. They've never requested a federal subsidy, and they don't appear in any other sources of farmer income.
And then there's that $2.3m loan. Was it for a farmer who fell behind? Maybe they had a few bad years? Or was it something else?
The malicious explanation is that the $2.3m in unsecured and production lending were fraudulent and a way to extract money from the bank. The innocent explanation is that they were lending to a poor quality set of farmers who couldn't farm well. Except if it was a bunch of lousy farmers I would have thought they would have requested a little something from Ol' Uncle Sam. Maybe they were so lousy that never even crossed their mind!
A few years ago or former bank examiner mentioned a story that is worth mentioning here. He said he was assigned a sleepy little bank in a small town. During his initial research he discovered the entire board consisted of the owner and employees all related to the same family and same car dealership. Unsurprisingly the bank was only making loans to the dealership and family related to it. Consider it a little captive nepotistic financing arm that flaunted a number of regulations. This former examiner said he immediately called his boss and within a week the bank had been shut down. Their credit quality wasn't quality, and a number of loans were questionable.
As I read about Enloe State Bank discovered some of the oddities posted above this same story came to mind. If an innocent explanation doesn't exist here then I think it's possible something like this former examiner story could be plausible. Someone from a regulatory agency started to dig deep and realized that a few things didn't quite add up. Suddenly the bank is caught on their heels and by the time the FDIC realizes how bad things are it is easiest to just shut things down.
I want to end with this caveat. I don't know any of this for sure, but there are a number of red flags here, the biggest being the FDIC's $27m expected loss, and a $27m hole in loan data.
I will be watching this one with interest for a detailed FDIC post mortem.
Banks fail for a myriad of reasons from bad loans to being caught in a liquidity crisis. Usually it's a combination of both. A portion of the bank's loan book turns south requiring additional capital at the same time that the bank doesn't have access to capital, or capital is walking out the door. These confluence of events eventually lead to FDIC receivership.
When a bank fails the FDIC negotiates an agreement with another local bank. The local bank acquires some or all of the failed bank's deposits along with the choice loans. Any "bad" loans are either handed over as part of the sale and guaranteed by the FDIC, or handled by the FDIC themselves.
As long time readers know this isn't a bank tracker blog, and I rarely write about failures. So why this one?
The failure of Enloe State Bank is fascinating, and after a little digging I'm convinced there's a lot more here than meets the eye.
First off in the FDIC's press release they note that the bank had assets of $36m and deposits of $31m. So then why did Legend Bank (the acquiring bank) only take $5.2m in assets and why did this little bank incur a $27m hit to the FDIC's insurance fund? Secondly if you Googled the bank news articles from two weeks ago appeared saying that the ATF was investigating a suspicious fire at the bank. Someone was seen burning papers inside. Suddenly this is starting to sound like a movie plot and merited further investigation.
I did what any curious person would do, I started to dig into the numbers and wow... something is very off here.
First let me provide a little background. At CompleteBankData we are building one of the most advanced market analysis, full-stack bank marketing and bank prospecting tools. We collect data from a variety of sources daily and build out a mosaic showing the current lending market place and opportunity set. We pull things like deeds, property assessments, mortgage originations, UCC filings, agricultural subsidies and farm information along with credit details and business profiles (revenue, fleet size, number of employees etc).
While the previous paragraph might just seem like a plug for my business, and in a small way it is, I provided it as background for what I found. Because without knowing what we do you'll be scratching your head wondering how I researched this post.
In general if we pull up a bank with $285m in loans we will be able to find a number very close to that in our database. There are usually differences due to rounding or other factors, but it's usually very close. So image my surprise when I started to dig into Enloe State bank and only found a shadow of the number of loans they report.
The bank had $36m in assets, but in the last five years only originated $5.8m in loans. Prior to that they'd only originated another $3m or so in loans in the prior ten years.
This was head turning at first, but it could make sense. In Q1 they noted about $5.9m in first lien mortgages, that's right near our $5.8m number. They also have $3.2m secured by farmland and another $10m in loans to finance agricultural production. It's the ag loans where things start to get a little fishy.
The bank is classified as an agriculturally focused bank, yet the majority of their loans are for an acre or less. I found a few on properties that were over 10 acres, which would be considered a very small farm. A second aspect was that these "farmer" loans were small. For example one couple on 50 acres borrowed $96k. Digging into the loan details it appears that the $96k was to finance a residence on the property, not the farm land itself.
Which means I just can't find their $3.2m in farm loans. Our property data only dates back to 2003, so it's possible the $3.2m in land loans all pre-date this century. But let me let that hang for a second and let's talk about ag production lending.
If a bank is lending against production there are usually a few ways to identify the activity, primarily though UCC filings. For example, a bank that is lending for seeds and operating costs they will also secure equipment such as tractors and spreaders.
When I looked at Enloe State Bank's secured financing history back to the 1980s they had a pattern of lending to farmers at least a dozen times a year if not more. This persisted right up to 2011 and then just dropped off. There were a few random loans since, but not much of note.
The weird UCC financing pattern might have an explanation, or it might not. A second factor that turns my head a little is $2.3m in in unsecured loans to individuals.
Let me see if I can piece this together for you. Legend Bank decided to acquire $5.7m in assets, so loans and possibly Enloe's $2m in held to maturity securities. Meaning that the only "good" loans were potentially their $5.8m in residential loans that I found, although the number could be potentially less.
So what about all of the farm loans? This is pure speculation, but I think this might be why someone was burning papers in the bank. I think it's possible that the bank was lending on "production" that either didn't exist, or was highly inflated. I know this is speculation, but it's somewhat founded speculation. I took a list of their borrowers that I knew about with the largest land holding and attempted to cross correlate with farm subsidies or farm income. It turns out that their largest farmers don't have any identifiable farm income to note. They've never requested a federal subsidy, and they don't appear in any other sources of farmer income.
And then there's that $2.3m loan. Was it for a farmer who fell behind? Maybe they had a few bad years? Or was it something else?
The malicious explanation is that the $2.3m in unsecured and production lending were fraudulent and a way to extract money from the bank. The innocent explanation is that they were lending to a poor quality set of farmers who couldn't farm well. Except if it was a bunch of lousy farmers I would have thought they would have requested a little something from Ol' Uncle Sam. Maybe they were so lousy that never even crossed their mind!
A few years ago or former bank examiner mentioned a story that is worth mentioning here. He said he was assigned a sleepy little bank in a small town. During his initial research he discovered the entire board consisted of the owner and employees all related to the same family and same car dealership. Unsurprisingly the bank was only making loans to the dealership and family related to it. Consider it a little captive nepotistic financing arm that flaunted a number of regulations. This former examiner said he immediately called his boss and within a week the bank had been shut down. Their credit quality wasn't quality, and a number of loans were questionable.
As I read about Enloe State Bank discovered some of the oddities posted above this same story came to mind. If an innocent explanation doesn't exist here then I think it's possible something like this former examiner story could be plausible. Someone from a regulatory agency started to dig deep and realized that a few things didn't quite add up. Suddenly the bank is caught on their heels and by the time the FDIC realizes how bad things are it is easiest to just shut things down.
I want to end with this caveat. I don't know any of this for sure, but there are a number of red flags here, the biggest being the FDIC's $27m expected loss, and a $27m hole in loan data.
I will be watching this one with interest for a detailed FDIC post mortem.