Gotham Partners Case Study

“We are primarily value investors” - Gotham Partners Investment Treatise

Back before Pershing Square was formed in 2004, Bill Ackman had started an investment partnership called Gotham Partners with his fellow business school grad, David Berkowitz.

The catalyst for forming Gotham was Seth Klarman’s “Margin of Safety” book. It wasn’t the typical current Pershing mantra of “predictable, cash flow generative, high quality businesses” but more deep value with a catalyst.

One of those deep value investments was Circa Pharmaceuticals that helped them get out of an initial drawdown.

Gotham Partners

Gotham opened it’s doors March 1, 1993 with only $3 million in AUM right out of Harvard Business School. One year later they would have 10x that amount as a result of being up 21% in their first 10 months. Initially both partners tried working full time jobs during the day and investing at night but that wasn’t going to cut it as they viewed this way as the riskier approach by not going all in.

They got their initial launch capital by cold-calling more than 100 members of the Forbes 400 list with only four ending up investing. They also created a 17-page “investment treatise” that was sent to potential investors. The document outlined everything:

• their investment approach

• the current state of the equity markets

• how they view risk

• their target partner

The first month of launching their fund got off to a bit of a rocky start:

One investment that helped them turn the fund around in the early days was Circa Pharmaceuticals.

The Hatch-Waxman Act

A little history of the generic pharma industry is needed first.

Before the early 1980’s, getting a generic drug to market proved to be too slow of a process because generic pharmaceutical companies had to:

• Wait until the patent on a pharmaceutical expired before running tests. Any time prior to this would be patent infringement.

• Once the patent expired and a company could run tests, the generic had to under go the same testing as if it was a brand new drug, running a full NDA (New Drug Application). Running an NDA is extremely costly and takes years.

• The FDA had no fast track process or bioequivalence testing (what is now ANDAs) i.e., the generic had to run all the same tests the patented product did to prove it was bioequivalent.

Not only would a patented product get their usual exclusivity period, but they would also get the period from when the patent expired to when a generic was approved many years later.

The Hatch-Waxman Act was a piece of legislation passed in 1984 that fixed these problems by establishing the ANDA (Abbreviated New Drug Application) process and allowing bioequivlaence testing (meaning no new clinical trials typical of NDAs were needed). Because of this piece of legislation, generics went from 19% of the US prescription market back then to now 90%.

Incidentally the 1984 verdict in the court case of Circa Pharmaceuticals (formerly called Bolar Pharmaceuticals) is what caused a huge uproar in the US Congress that led to the Hatch-Waxman Act. I won’t bore you with the details but you can read about it here.

Circa Pharmaceuticals Scandal

Circa (formerly Bolar) was the largest generics drug manufacturer in the US, but once the Hatch-Waxman Act was passed, they decided to try to skirt around this new law as did many other generic companies.

In 1990, the FDA accused Circa of submitting false data in order to get approval for their generic drugs, primarly a hypertension drug called Dyazide. Dyazide was the generic industry’s top selling drug and from 1987 to 1990 it did $142 million in sales. By “submitting false data”, the FDA meant that Circa was literally taking the already approved patented pharmaceutical’s powder, putting them in Circa capsules and submitting it for bioequivalence. Then hiding, falsifying and destroying the records of doing so!

What came next were formal charges and indictments on most of the top level executives of Circa, including the CEO. Followed by a bunch of lawsuits, fines and jail time.

February 1991, UPI article

The FDA made Circa withdraw all of their current selling generic drugs from the market and they were prohibited from manufacturing or selling generics until the FDA deemed their manufacturing facility was in compliance. This affected 180 of Circa’s products. The FDA essentially froze their business for the time being.

To top it off, the CEO also admitted to price fixing this drug with their competitor, Vitarine Pharmaceuticals, to stifle competition.

The stock went from $50 to $4 between 1990 to 1993 as headline after headline kept the company in the spotlight and the large legal overhang weighed on the stock.

Summer 1993

Circa was the classic left-for-dead stock.

• The CEO and other executives thrown in jail.

• $78 million paid in fines over the past few years

• The FDA in April just gave notice that it can manufacture and submit trials for new products again

The only real remaining legal issue outstanding was the price fixing scheme.

Gotham, after being down 3% in their first month of March 1993, started buying and paid as low as $4.12 and up to $6.25 for an average price of $5.18. They entered the investment some time in-between March 1993 and July 1993. I could only find a balance sheet for December 31, 1993 but it would have been approximately the same during the time of their purchase as the few million dollars paid in fines in November 1993 were offset by some shares forfeited back to the company by prior executives. Here’s a general overview of what Circa’s capitalization would have been:

And if you looked at the most recent March 1993 10Q or the past 3 years annual reports (1992-1990) it didn’t paint a pretty picture. The income statement was a mess, with fines, sales decreasing due to the FDA freeze and losses piling up.

In 1992, the company did $89,015 in total sales. Down 99% from two years prior.

But if you had dug a bit deeper, you would have seen there was value to be had.

Circa Valuation

Circa had an extremely strong balance sheet to make up for its lack of operations.

Cash and marketable securities totalled $51 million. They owned their own 161,500 square foot manufacturing facility in Copiague, New York that was worth roughly $25 million. They had a 50% JV interest with Mylan in Somerset Pharmaceuticals which produced a drug called Eldepryl that treated Parkinsons. Somerset was doing about $40 million a year in earnings and they were sending roughly $20 million of that in dividends to Circa. While the Eldepryl drug exclusivity expired in a few years, they were going to turn it into a patch to extend its life. Putting a 7x multiple on the potential extended earnings stream would value it at around $140 million.

They had some off balance sheet assets like a $71 million NOL. Tax affecting this at 35% would value it at $25 million. And they also had approximately 38 drugs in the pipeline that they could bring to market due to the FDA’s recent restriction lift.

On the liability side, they had legal reserves taken that were backed by securities held in a trust. Their only real form of debt was a JV liability (different from the Somerset JV above) of $15 million that was to be paid down based on the royalties now being earned on the drug in that specific JV. Summing it all up and this is what the underlying value was:

$10.18 was double the average purchase price Gotham bought it for. What gave investors pause was the uncertainty with regards to how much Circa would have to pay to settle their price fixing lawsuit. But there was a large margin of safety as anything less than a $100 million fine, based on my math, and investors would have come out ahead.

Outcome

Over the summer and into the fall of 1993, the price of Circa started rising as the market realized that the legal overhang was almost over as they were able to settle their price fixing lawsuit for just over a million dollars. In about October 1993 Gotham sold their shares for $9.47 getting an average return of 83%. Not bad for a few month holding period but based on what happened after they should have held on.

In 1994 Circa started getting some drug approvals and filing some ANDA’s and NDA’s while making other investments. The company's earnings increased substantially in 1994, reporting $17 million in net income or $0.80/share. So Gotham paid essentially 3x EV/FCF.

In 1995, Watson Pharmaceuticals bid $600 million, or $32/share. Had Gotham held they would have earned 6x their money in 2 years.

Even though they didn’t capture most of the price appreciation, they were able to claw back their initial 3% drawdown right out of the gate and finish the year up 21%.

Gotham Windown

Gotham would eventually have to liquidate their fund in the early 2000’s as a result of taking more illiquid bets while at the same time facing investor redemptions from the negative headlines of the MBIA Eliot Spitzer investigation.

They reached a peak AUM of $568 million in 2000 but then received $108 million in redemptions that year.

One of the more well known moments for Gotham was their 1995 plan to recap the Rockefeller Center Properties due to excessive debt via a rights offering vs the Sam Zell/Disney/GE group proposal with Goldman ultimately winning the bid for the property.

If you want a better understanding of why they were forced to wind down Gotham, there is a great article by Gretchen Morgenson from 2003 that I’ll include here that does it better than I could.

Update on Some Smaller Positions

I wrote a summary of some of the smaller positions in the portfolio in the recent Q3 2025 letter but thought I’d expand on some of them in a bit more detail here.

Citizens Bancshares Corp. (CZBS)

I originally wrote this up at the beginning of the year and it’s slightly down since that time period. Just to refresh, it has an $84 million market cap currently. For that price you get 1) $93 million in cash at the bank holding company:

and 2) a bank subsidiary that should spit out $10 - $15 million in earnings this year. It is one of the most overcapitalized banks in the US banking system, in my opinion, with all capital ratios in excess of 10%. Just a couple of key items from their annual report and Q1 earnings release:

• In 2024 they repurchased $459,000 worth of shares compared to $7 million the prior year.

• Their preferred dividends increased significantly, although off an extremely low base, to $1.27 million. Without this dividend they would have cleared EPS of $7, which puts the stock at around 7x adjusted trailing earnings. Instead they did EPS $6.5 in EPS in 2024.

• BVPS is $36/share when you factor in the ECIP preferred. But if you value this preferred at where other banks have valued it in mergers at 28% of par value, adjusted BVPS comes in at $85/share vs a $47 stock price.

• The company still has a large deposit cost advantage over many banks with the increase in rates the past couple of years. As recently as Q1 their deposit cost was 0.94% vs the average rate for smaller banks at1.81%. And many of the key banking ratios suggest that Citizens is an above average bank: Pre-tax return on assets greater than 2%, efficiency ratio of 57% and ROE, when eliminating preferred dividends and marking the preferred at market, of 13%.

• They just announced a $4m share buyback (5% of shares) this year and increased their dividend by 10% to $1.10/share. Management is doing all the right things from a capital allocation perspective since they got the ECIP money 3 years ago. The problem with the stock is the extremely low liquidity in the shares that makes it nearly impossible to do a large buyback unless they do a tender offer. I still believe they’ll eventually do an acquisition but the management team needs to find the right deal which could take time.

I’m more than happy to continue owning this as it trades for about 7x earnings, a significant discount to adjusted book value and private market value (would most likely go for greater than 1x book value if sold) and a huge cash pile at the holding entity.

Tetragon Financial Group (TFG.AS, TFG.LN)

Not a huge update as the thesis remains the same but Tetragon has been hitting all time highs recently on the announcement of further Ripple buybacks and as the market somewhat awakens to Tetragon’s ownership in the company.

Ripple’s latest buy back is taking place at a $40 billion dollar valuation which means $250/share. In the private market place it’s marked at $137/share and Tetragon right now is marking their stake at $94/share. It’s currently their second largest holding.

As the price of Ripple has gone up and become a larger percentage of NAV, the stock price has had to follow it to maintain the roughly 50% - 55% historical discount to NAV. The new NAV is just over $40/share and TFG is at $19/share. If (hopefully when) Ripple IPO’s at a large valuation, Tetragon’s share price should follow it upwards. I continue to think the management team has a huge opportunity to buy in greatly discounted stock to increase the NAV that would accrue to themselves before that happens.

In the mean time the CEO of TFG Asset Management, Stephen Prince, has picked up over $5m in shares this summer. It’s a pretty large buy from an insider and I don’t need to remind everyone that insiders sell for many reasons but they usually buy for one.

Leons (LNF.TO)

Leon’s announced a great Q2 but still hasn’t given a specific timeline for their real estate IPO. A few Q2 highlights:

• Adjusted earnings per share, when netting out the $7.6 million USD forward contract loss, was $0.57 for the quarter. This is a 30% YoY increase which was contributed by two main items: overall sales were up 4% to $644 million and gross margins expanded nearly 100 basis points from 43.9% to 44.82%.

• The company continues to return profits to shareholders in the form of dividends and share buybacks. Their quarterly dividend was raised 20% from $0.2/share to $0.24/share and they’re in the process of buying back 5% of the company on the open market from March 2025 to March 2026. The buybacks so far have been negligible as they’ve only bought back 12,800 shares out of a possible 3,403,405 shares.

• They still have a really strong balance sheet with net cash of $50 million after netting out debt and customer deposits as well as real estate marked at cost of $681 million on balance sheet vs ~$1.5 billion market value.

The key to the stock increasing from here, in my opinion, is a timeline of the IPO and then obviously the actual IPO. The TSX IPO market has been nonexistent these past few years. It’s had one IPO this year that was a New York luxury apartment REIT called GO Residential. The deal was oversubscribed and raised US$410 million and I’m hoping this opens up a path for Leon’s to consider taking their REIT to market.

Until there is more clarity on the IPO the stock may be range bound for a bit. One thing I am watching is for when they submit their Secondary Plan with the City of Toronto which is required to change the land use of their corporate headquarters and actually redevelop it. You can check at this link if they submitted and unless I missed it I still don’t see it there yet. The submission was to be done by 2H 2025 so we are a bit past that timeline now.

EDU Holdings Limited (EDU.AX)

I’ve never written EDU up but it had/has a lot of the hallmarks of a special situation I look for when I took a position:

• Corporate change via a management buyout. Management wanted to buyout shareholders and delist the company because of burdensome listing fees, regulatory uncertainty and low liquidity.

• Large insider purchases and buybacks leading up to the buyout

• Earnings inflecting in their underlying business

At the time of the MBO offer in May, they also announced a 50% buyback of the shares (75m of 150m). The buyout was announced at $0.165/share or a $24m market cap and was subsequently dropped as shareholders pushed back on the timing and price of the buyout as you’ll see below.

EDU is an Australian for-profit education provider that provides it’s students certificates, diplomas and degrees and operates two divisions. They’ve suffered some losses the past few years due to COVID but earned record revenues and profits in 2024. Revenues were up nearly 100% to $42 million, operating income turned positive to $4.2 million and net income inflected positively as well to just under $3 million.

In 2022, Australia’s Skilled Priority List had 1) early childhood teachers, 2) child carers and 3) age and disability carers as 3 of the top 10 professions in critical shortage. At the same time, EDU decided to start a product development plan with course offerings going from 22 to 29 course offerings in 2024 targeting these professions.

It’s IKON division provides Higher Education (like Bachelor and Masters of Early Childhood Education amongst others) to both domestic students and international students. The increase in the international students in this division has been what’s driving the inflection as you can see from their 2024 annual report.

While domestic students has remained somewhat steady, the international student enrolments have gone gangbusters and has the majority of Ikon’s overall $28 million in revenue in 2024 as seen below. Ikon delivers longer student durations (2-4 years) due to the type of program offered and at higher tuition costs of approx. $19,000 - $48,000 making it more durable and predictable vs a certificate course lasting less than a year compared to EDU’s ALG division.

It’s ALG segment offers diplomas and certificates to international students in Mental Health, Counselling and other Vocational Education and while it grew revenues 43% from 23’ to 24’ ($9.3 million to $14.2 million), it finally flipped to profitably as of the June 30, 2025 1H results of $0.5 million. While it seems that this division will now add to profitability going forward, it’s a smaller part of the overall business.

The nature of EDU’s business has large operating leverage as it rents rooms in some of Australia’s major cities (or via online) and must pay the teachers no matter how many students are enrolled. If you have one student in the entire program, you still have to pay the fixed costs of the campus, student administrative costs and the business will operate at a loss. But if you have many students, the costs of the business stay relatively the same for each new incremental student that enrols and falls right to the bottom line. This leads to huge incremental margins as you’ll see below.

Since the attempted $0.16/share MBO was dropped the stock’s been on a tear up to just under $0.76/share as the CEO and other insiders have made large purchases, EDU has repurchased over 6 million shares (on top of the 9% of the shares repurchased in 2024) and enrolments and the underlying business have continued their torrid pace of growth.

In June they released that Ikon’s T2 25’ enrolments were up 118% to 3,725 students and YTD 2025 enrolments were up 132% to 6,967 student enrolments vs YTD 2024 2,996 enrolments.

And their first half results highlighted why management wanted to take it private. 1H 2025 revenues jumped over 100% to $36 million while the company netted a total $6.3 million with incremental EBITDA margins of 45%. The company completely transformed their balance sheet, adding $16 million in cash from both operations just in the first half of this year. Right now they are sitting on net cash of $21.2 million.

Based on just the first half results, insiders wanted to buy the company for 1x annualized EBITDA or 2x earnings. It was clearly worth a lot more and the stock has reacted as such when the bid was dropped, going up over 4 times the bid price.

Coming up with a valuation for a company where earnings have inflected and is growing very rapidly can be a bit of a challenge, not to mention the regulatory risk (see below) that is always lurking. But there is some comfort in the large net cash balance sheet and current business model where students in IKON are signed up for 3-4 year degrees allowing revenue to be more predictable.

With a share price of $0.78 and shares outstanding of 152.5 million (accounting for the share repurchases to date) puts the market cap at $119 million. Netting the $21.2 million in cash brings the enterprise value to $97.8 million. Management has stated that the 2nd half of 2025 will look like the first half so just annualizing this and adding $6 million in 2H net income to cash at year end would bring the enterprise value down to $91.8 million.

Meaning this would put EDU at 4x 2025 EV/EBITDA and 7x 2025 earnings. Because IKON makes up a larger part of the overall business and their degrees are 3 - 4 years long, their current run rate for 2026, without taking into account newly enrolled students, should be roughly the same as 2025. Based off of 2026 numbers and cash build up during the year would put EDU at 6x earnings and 4x EV/EBITDA. If you add in an expected growth rate of between 10% - 20% for new enrolments, it’s trading at 5x 2026 earnings and 3x 2026 EV/EBITDA. Clearly way too cheap for a company that just grew more than 100%, will have sustainable earnings going forward, a net cash balance sheet that is only growing and a company in the open market buying back stock aggressively.

This investment and business is not without its risks. There has been a push to bring down migration into Australia as the number of international students in Australia has gone from 474,493 in 2022 to more than 800,000 as of the end of 2024. The theory is that all of these international students have caused a housing affordability crisis with rents and house pricing in Australia ranked as the one of the most unaffordable place to live currently. By making it harder for students to obtain entry, the theory is it would free up homes and bring rents and pricing down to help abate the situation.

One way that’s been implemented is by increasing the nonrefundable VISA application fees from $710 to $2,000 and tightening entry conditions. Another way the Australian government proposed in 2024 was by capping the number of international student commencements at universities (essentially onshore student visa holders) with each school only getting certain allocations of the total cap.

This student capping legislation was scrapped but there’s still some uncertainty around the international student space and what the government will ultimately do. One of the reasons it was most likely scrapped is that not only does Australia have the second highest share of International students globally, but it contributed $51.5 billion to the economy last year, meaning it’s Australia’s 4th largest industry and the “biggest export we don’t dig out of the ground” according to Education Minister Jason Clare. Blowing this industry up would likely cause an Australian recession.

There is currently a target for 2025 of 270,000 commencements and it was raised to 295,000 for 2026 with the 2025 numbers looking like they’ll just be met. The Department of Education in Australia puts out monthly data on enrolments and commencements that allow you to track how each educational sector (VET, HE, etc.) is performing at this link. This regulatory risk is the biggest risk to the stock but the government seems to have turned the dial down on severe restrictions for now.

I came across this idea from Jeremy Raper (@puppyeh on twitter) and credit goes to him for being one of the first ones on the name.

Western Capital Resources Inc. (WRCS)

Not much has really changed since I wrote WRCS this summer (see here). It is highly illiquid and trades on the expert market so the vast majority of investors don’t have access to a broker to buy it or can’t look at something with such a low float. It trades at $14.50/share right now, a slight discount to where the company tendered in April at $15/share.

So far in 2025 WRCS has bought two arenas for a total of $10.3m with little cash down and a large percentage of the purchase price using favourable seller financing so their debt is up a bit but they still have $15m in net cash as of 2Q 2025. These purchases were disclosed in their annual report occurring after the December 31, 2024 financial period and their 1Q 2025 and 2Q 2025 don’t disclose if anything else was purchased, it’s just a set of financial statements.

I believe both purchases were from Black Bear Sports Group, which if you recall is owned by Murry Gunty, who is WRCS largest shareholder through a maze of LLCs. There seems to be a grey line between Black Bear and WRCS as not only is WCRS purchasing the arenas from Black Bear but Black Bear, at least for the April 1, 2025 purchase of the Chelsea, Michigan rink, even announced a press release on their own site in August about a sponsorship name change when they no longer owned the arena:

I’m not sure exactly what the ultimate outcome here is as the company keeps doing tender offers AND buying businesses within the holding company. One outcome could be more tenders until there is a potential merger squeeze out of minority shareholders. Another outcome could be to merge the two companies (WRCS and Black Bear). While another scenario could just be to continue as is: trade on the expert market, repurchase LLC interests over time and add ice rinks and other businesses to the holding corp. structure.

With a stock price of $14.5 and adjusted shares outstanding at 5.3m, the market cap is $77m. Subtracting net cash of $15.5m and adding NCI of $1.7m gives an enterprise value of $63 million. While I am not exactly sure how the losses and turnaround of their purchase of Northern Brewer is going currently, just annualizing their YTD numbers puts the business at 5x - 6x EV/EBIT. If there are still some losses at Northern Brewer, that could be weighing earnings down a bit as it lost $2.2 million in 2024. Raising that to zero or even to the point of profitability would eliminate the drag on earnings and value the overall business at between 3x - 4x EV/EBIT. I’ll have to wait for full year 2025 numbers to be sure and in the mean time I’ll be watching for further tender offers or nuggets of information I can find.

Idea Brunch With Edwin Dorsey

I was interviewed by Edwin Dorsey on his Sunday Morning Idea Brunch this past week. We talked a bit about my background and a couple of stocks I like at the moment.

You can read about it here but I think some of it might be behind a paywall. If you want the full PDF send me an email or I’ll see if I can attach a free PDF here later. Enjoy!

Edit: Here’s the full PDF

Case Study: Warwick Valley Telephone Company

I came across this article from 2006 about Larry Goldstein (of Santa Monica Partners, or SMP) and his investment in Warwick Valley Telephone. I made some notes that I thought I’d share in the form of a case study at what made Warwick an interesting set up but ultimately not a successful investment. I like reading old writeups or articles to see what information was available at the time of an investment to see what the investor was seeing and think if I would have made the investment as well. It’s also a good way to screen for future investments based on the setups of the past and certain pattern recognition to look for.

I believe SMP owned this a few years prior to filing their first 13D but I’ll start with when the first 13D was filed at the end of 2003. From what I read the total size of the position for SMP was 1.7% (based on $160m fund size and $2.65m investment). Not huge, but I think he set a record for the number of 13D letters sent to a company.

Valuation

Warwick was a rural local exchange carrier (RLEC) in a few small towns in New York and New Jersey that was muddling along with a few million in profits. The stock had been owned by families in the Goshen, New York area and passed down generation to generation. Apparently the largest shareholder was an elderly lady who lived in Warwick too.

At first glance it doesn’t seem that appealing. On the surface it appeared expensive and more than fairly valued.

Equity Income > Operating Income

But if you look closely at the financials you’ll see they generated more money from their equity investments than their main RLEC business.

Flipping to the balance sheet, those equity investments that generated $8.3m in 2003 were carried at only $5.3m.

And going to the back of the annual report to Note 9, you’d see a breakdown of what these investments were.

The O-P Partnership was a 7.5% joint venture in a Limited Partnership called Orange County-Poughkeepsie Limited Partnership (“OCP”) with Verizon that sold wireless minutes to larger telecoms that was hidden from the consolidated financials. Verizon owned a majority 85% of the partnership as a GP. How did a partnership investment carried at $3.7m throw off so much equity income?

Well when you read the disclosure of how the partnership was doing, this was what you would have seen:

For a better visualization, this would be the past few 5 years (excluding 04 and 05 at the time).

The partnership owned what seemed like one of the best businesses in the world: fast growth, huge margins and it barely needed any capital to operate or grow. Because the investment was accounted for using the equity method, you couldn’t see the valuable partnership investment unless you looked in the notes. Yes you could see some income from equity method affiliates, but you had to dig a bit further to grasp exactly what you were looking at. Anyone running a screen back then probably wouldn’t have picked up on this.

The OCP partnership even paid out the vast majority of their income to partners. The millions that were distributed to Warwick were essentially propping up the muddling RLEC business.

So they had an investment on the balance sheet marked at $3.7m that was likely worth many multiples of that and paying out millions of distributions. Yet SMP didn’t think it was being fully reflected in the stock price.

SMP First 13D

Santa Monica Partners filed their first 13D (the first of many) in late 2003 when the share price was $25.5 vs where they thought it should be at $39. They gave a list of 5 unique options that Warwick could do to highlight the underlying partnership value:

Here’s the full 13D filing. My favourite financial engineering option here is #1 because it’s pretty unique. I don’t think I’ve ever seen a company do that. Issuing a debt instrument backed by the distributions of the partnership stake to create over $100m in value.

The management team didn’t seem to think it was worth that much though as they had a valuation done the prior year. Their advisors only came up with $22.5m.

However, it would be the spinoff that SMP would argue for as detailed in a follow-up letter. By doing the spinoff, the new company would get the original Warwick RLEC business and the existing company would keep all the investments so it could pay out all of it’s income as dividends.

Management and the board refused to engage with SMP and discuss any of their ideas. They continued taking the partnership distributions and plowing them back into the RLEC, which continued it’s decline.

With an unwilling board SMP tried a different tactic.

Verizon Ploy

Remember Verizon owned 85% of the partnership. At the time, Verizon had $53B in debt and was looking at selling assets to pay some of that down. So SMP sent a letter to Verizon’s CEO outlining what they thought OCP could fetch in an IPO.

Based on their estimate, on the high end it could go for $3.8 billion and on the low end $1.5 billion. Verizon’s 75% proceeds would be $1.8B - $3.26 billion. SMP even asked for an investment banking finders fee if they proceeded with their plan.

I’m not sure if they did or didn’t hear back from Verizon but I’m going to say not because nothing came of the letter. Verizon continued owning their 85% of OCP.

With this tactic not working, SMP tried another one.

Letter to Shareholders

A year passes and in May 2005 the shares are now down to $21.

With still no real response from Warwick’s management or board, SMP obtained the shareholder registry and decided to write what they thought the stock was worth to all the shareholders.

They believed Warwick’s 7.5% ownership stake in the OCP partnership was worth $28.5/share - $40/share.

And the RLEC business was worth another $11/share.

This was about 100% upside from where it was trading. And STILL management refused to engage as their stock had fallen the past couple of years. The value was clearly there waiting to be unlocked but management kept putting the distributions from the fast growing wireless partnership into the declining RLEC business. Not doing anything to increase the value of the company’s stock.

There were then numerous 13D’s filed by SMP trying to embarrass the board and management. From failing to budget for Sarbanes-Oxley costs to incessant questions about how the business was going to be run for shareholders. None if it working to get management to do what they wanted

SMP tried another tactic now.

Investment Company Act

It’s now December 2005 and the stock sits at $19.

The SEC just sued National Presto for not registering as an Investment Company and won during this time because they had investment securities that represented 61% - 92% of their total assets.

National Presto now couldn’t engage in any interstate commerce or sell any securities until they registered as an Investment Company. And there could have been personal liability had the executives continued to defy the law as they were currently evading regulations when not registered properly.

I’m not an Investment Company Act expert, but from my understanding the two big tests of being an Investment Company under the Investment Company Act are:

1. At least 40% of the company’s assets are in securities or investments

2. More than 90% of the overall income is derived from the investments

Because OCP’s fair value was much greater than the value of the original RLEC business and the fact that pretty much all the pre-tax income of the entire business was generated from this investment, Warwick was potentially an Investment Company.

They even disclosed as much in their 10-K stating they might have to register and restructure as an Investment Company. It starts to make a bit more sense now why Warwick’s advisors only valued the OCP at $22.5m vs $91m for the main operating business. So they wouldn’t have to restructure.

SMP picked up on this and in 2005 filed a proxy wanting either a spin, sale, or to register Warwick as an investment company. By registering as an investment company, Warwick would have to restructure into two different companies and the investment company that’s holding the limited partnership would operate as a pass-through entity and pay out all of it’s income. This would be a huge win for SMP as they had been angling for a huge dividend increase as well.

You can apply for relief under Section 3(b)(2) of the Investment Company Act to the SEC and state you aren’t an IC but the SEC doesn’t have to necessarily grant you that relief. Warwick applied for relief and withdrew their application before the SEC even ruled.

Again, nothing ended up happening with this tactic as the SEC never made them register and SMP couldn’t get them to register themselves.

Proxy Fight

It’s April 2006 and the stock has drifted lower still to around $18. SMP finally decides to file a proxy and nominate themselves to the board as well as increase the dividend substantially. They faced an uphill battle as many shareholders were local and didn’t seem to want any change.

The partnership investment still kept growing for the most part as you can see below. But the main RLEC business was now burning cash and decreasing in value each year that passed along.

Even with the stock down more than 30% since the first 13D was filed, the other shareholders still chose to not vote for SMP’s proposals.

The Following Years

The stock continued to drift lower over time. In November 2009 it sat at $12.68 and this was the last 13D filed by SMP. They introduced a potential buyer to the company but management didn’t want to sell. Kind of unbelievable.

In 2011, Warwick purchased Alteva and changed its name.

And in 2015 it was finally bought out for $28.7m. I’m not sure if SMP still owned shares or not but it was a far cry from what they thought it should have been worth 10 years prior.

What Went Wrong

This seemed like the ideal Good Co./Bad Co. An extraordinary business that was hidden in the financial statements of a slowly dying business. There were a few problems that made this a poor investment:

• Poor capital allocation - The value was clearly there, but the growing cash flows from the partnership were being reinvested into the slowly declining RLEC business. They were throwing great money after bad.

• Staggered board - Only 3 directors were allowed to be elected each year. It would take a few years to at least control the board and exert some type of control.

• Disengaged management and board - Because SMP only owned 2.5%, the executives and board didn’t really have to do anything they said because they didn’t control or have that large of a position. They had no urgency to increase shareholder value as they didn’t own much stock and didn’t feel threatened about potential executive turnover.

• Lack of other shareholder pressure - You would think with a declining stock price that other investors would hold management accountable. But other shareholders weren’t fans of SMP and decided to vote against SMP’s ideas.

Knowing what happened after the fact, it’s easy to think I’d pass on making this investment. I’m almost certain I would’ve jumped at the chance to own such a unique asset that seemed undervalued in the market. That’s what makes investing so tough. The set up from a valuation and business stand point was extremely compelling but the capital allocation/management angle wasn’t. You typically need both to make for a great investment.

SMP summarized what happened here perfectly:

A Left For Dead OTC Stock at Less Than 1x EV/FCF

Summary

Pacific Health Care Organzaiton (PFHO) is a California workers’ compensation cost containment company that:

• Trades at 0.26x 2025E EV/EBIT and 0.37x 2025E EV/FCF

• In the first 6 months of 2025 they did $618K in EBIT vs an enterprise value of $929K.

• No capex is required to run the business and ROIC last year was over 100%

• Revenues and margins have recently started inflecting as they’ve expanded into new States

• Cash makes up 93% of the market cap with no debt giving strong downside protection

• Profitable since 2010
  

Anytime you’re offered a company at less than 1x FCF with nearly the entire market cap in cash you need to ask yourself:

Why am I so lucky?

In this instance I don’t think it’s hard to find why.

• The stock has been left for dead for a number of years on the OTC market

• Liquidity is abysmal at 20,000 shares in 3-month ADV, although that’s recently increased.

• They’ve grown their cash balance over the past decade without doing much with it

• 4 large customers have left in the past 10 years

Here’s the capital structure of the company today:

What’s a Cost Containment Business?

Here’s how the business works.

All employers in California, whether it be a small company with 5 employees or the City of Los Angeles with thousands, has a work force of employees. The employer has to obtain workers compensation insurance for their employees BY LAW from either an insurance company, the state insurance fund which is kind of a last resort, they can self-insure if they are a large company or partner with a Professional Employer Organization (PEO). Once an employer decides which one, they can contact PFHO to enroll their employees and use some of PFHO’s services to help reduce their workers compensation expenses if an employee gets hurt.

Here are some of PFHO’s current clients:

A lot of their clients are not-for-profits, municipalities or corporations who typically won’t look to bring what they do in-house. There’s been some insurance clients in the past that have dropped PFHO because they wanted to bring the within their own company.

The business isn’t the greatest with zero switching costs, no real locked in contracts and no product differentiation. But there are certain elements that make it attractive like very little capex or working capital, high returns on invested capital and it’s easy to scale when on-boarding new clients. It’s comparable to a legal or accounting firm. Each year or month you bill the client for your work without having any real contract in place that they’ll come back. If a current customer wants to switch out of using PFHO, sure it’s a bit of a hassle . But if they prefer another company’s service and price they can just notify PFHO that they will be discontinuing their services.

The 5 main ways that PHCO makes money are:

HCO (Health Care Organizations - 20.5% of 2024 revs.)

PFHO offers employers the option to enroll in their HCO’s, which is a state approved managed-care system. PFHO owns 2 of the 3 licenses in California and the other one is held by Promesa Health Inc. An employer might choose to use a HCO because it allows them to control the medical treatment for first the180 days after the initial injury and thereby having some control over the cost. After this time period the employee can look else where outside the organization to help rehabilitate. HCOs differ from MPNs because they are chosen by the California Division of Workers’ Compensation, rather than by employers and their insurance providers.

MPN (Medical Provider Networks - 10.3% of revs.)

PFHO administers 22 of the 2,518 MPN’s issued by California. MPNs are usually a group of either doctors, physios or other medical/healthcare providers that accept a lower billing rate in exchange to get more volume referrals from the insurance company if it joins the MPN. The MPN is used for the life of the workers’ comp. claim. Healthcare providers in an MPN don’t need to have the necessary medical expertise when it comes to treating injuries in the workplace. Customers will choose MPNs because there are fewer costs associated with this program mainly in the form of no annual enrollment fees and less administrative costs and burden vs. enrolling in the HCO. The employer directs which provider the injured employee will see for the first visit and after that the employee can use someone else after within the network if they’d like.

HCO + MPN Hybrid

They also offer a combination of the two if an employer enrolls in the HCO and then just prior to the 180 day expiration, the employer enrolls the employee into the MPN to keep control of the medical care. Medex is the only entity in California that offers this hybrid.

Medical Bill Review (6.8% of 2024 revs.)

Someone from PFHO reviews the medical bills that are invoiced to ensure that bills are reasonable and compliant and nothing nefarious is taking place. PFHO receives a fee for each medical bill that’s reviewed and a percentage of savings off the hospital bill.

Utilization Review (33% of 2024 revs.)

UR is required by law for workers compensation claims. Someone, a nurse or medical director, will compare the treatment plan against the medical guidelines for the injury. It helps avoid potential excessive costs that a medical provider might include.

Medical Case Management (25.7% of 2024 revs.)

Essentially someone that oversees the entire injury process and ensures everything runs smoothly. Each medical case manager (i.e. nurse) coordinates between the employee, medical practioners, claims adjuster, etc to ensure the injured employee returns to work as soon as possible and is on track to healing and closing the claim.

Industry/Competitive Dynamics

The reason the workers cost containment industry exists is because there are potentially two sides of fraud that can occur when dealing with workers’ compensation claims: from the employees on one side and from medical professionals/lawyers on the other. Employees may embellish or lie about their injuries to get more money or not have to work while collecting workers’ compensation. Doctors or lawyers can collude with the worker to exaggerate a claim, over treat or over prescribe. This would cause increased costs for the the claim and the entire system. Just in 2024 alone potential fraud loss that was detected and saved was $157m, so clearly the industry is needed.

Getting industry data for the industry in California has been tricky but here’s what I’ve been able to find:

• Two of the largest cost drivers for dealing with workers’ compensation claims are claims frequency and treatment duration.

• California has the longest workers comp. claims open after 60 months when compared with other states. More than 3x the states median according to the Workers’ Compensation Insurance Rating Bureau of California (WCIRB) 2025 State of the System. Longer claims open leads to higher costs as you’d expect.

• In 2024, insurers collected $15.5B in workers’ comp. premiums earned and paid in total losses and medical expenses $16.7B. Within that $16.7B, $459m went to medical cost containment costs paid and the total cost amount has been pretty stable the past few years. If you want more of a breakdown of these costs you can read it here.

• The national occupational injury count in the US according to the BLS for 2023 was 2.37m compared to 2.34m in 2022. In 2023 this resulted in 946,500 cases “days away from work” (DAFW). California recorded 472,500 total recordable cases of nonfatal occupational injuries and illnesses with 297,000 of that being DAFW in 2023. And in 2022 California had 566,000 total cases with 388,600 DAWF.

There is always going to be demand for reducing workers’ compensation expenses as employees continuously get injured and make claims. The problem is that it’s an extremely competitive industry that’s highly fragmented with no real differentiation in my opinion. You can see the number of companies here that have MPN licenses in the state of California. There’s a lot.

Fortunately, you don’t need much to go right here for the stock to work. There’s a price for everything.

Financials

For losing some large customers about a decade ago, their revenues have been pretty stable, hovering between $5m - $7m. You have to go back to 2010 to see the last time they lost money. There is very little capex spent in the business (last year was 0.15% of revenues), and when money is spent on capital expenditures it’s to replace laptops or other devices. There is no building or equipment maintenance that needs to be refreshed.

They convert EBITDA into free cash flow at a high percentage as well. 2024 EBITDA was $886,719. With capex of $9,131, no interest costs and normalizing their tax rate to 28% to include California’s state tax, normalized FCF would have been $629,307. Or about a 71% conversion rate. And because the business is service-oriented and asset light, ROIC excluding cash (EBIT/NWC + PP&E) was over 100%.

Cash has piled up on the balance sheet over the past 10 years. They did a small special dividend and repurchase years ago but nothing really to move the needle. Their most recent special dividend was for $0.10/share in 2023 which shows they do pay SOME excess cash out. They’ve almost mentioned in the 10-K that they’re looking for acquisitions but they haven’t found one yet.

As of Q2 2025 the net cash over total liabilities is even greater at $11.2m compared to $10.36m at the end of the fiscal year.

Inflecting Margins & Growth

The company has stated that they are expanding into 6 other states outside of California in their medical case management (MCM) services and the evidence has started to show up. Not only are Q1 2025 and Q2 2025 margins up over 40% to ~17ish% from the prior year quarters, but MCM revenues are up 54% and 67% as well. It is a small base to start from but there is clearly progress being made. The QoQ revenue from the most recent quarter is up 20% too. This business line should be easy to scale and also display operating leverage as it’s just onboarding a case manager who coordinates the entire process for multiple cases.

With the inflecting margins and newfound growth, PFHO just earned in the first 6 months $618,000 in EBIT, or half of it’s enterprise value!

Valuation

It’s tough to find precedent transactions in the space because it’s not that large. MedRisk bought Conduent’s Casualty Claims business in 2024 for $240m. It’s a larger workers comp. claim business with more customers, scale and an auto claims portion attached to it. Conduent didn’t break out revenue or EBIT for their Casualty business in their 2024 10-K as they moved the total revenue line item into “Divestitures” on their income statement and since they sold another business that is included in there for the total $180m revenue, it’s tough to discern the full 2024 revenue that would make up this business.

But if you look at their 2024 Q3 10-Q, the Casualty Claim’s business did $100m in revenue and $6m in pre-tax profit in the first 9 months. Annualizing these for the full 2024 would be $133m revenue and $8m pre-tax profit. Roughly 30x pre-tax. Obviously there should be an increase in margin potential and if we assume 15% EBIT margins (about where PFHO is) the multiple goes to 12x EBIT.

PFHO’s best comparable in the space is the publicly traded CorVel Corporation. Although they are larger, operate in many more states, have more customers and more lines of business than PFHO (auto, general liability, PPO management) some of their business offerings overlap. CorVel is a $4.6B market cap company that has been growing nicely the last few years and returns capital to shareholders through share repurchases. Assuming some decent growth again in 2026, they’re trading at 30x 2026 EV/EBIT and 24x 2026 EV/EBITDA. Clearly trading at multiples significantly greater than PFHO.

Where does that leave PFHO?

Right now if we just annualize what they did in 1H 2025 without taking into account further growth or margin expansion and assuming their net income approximates free cash flow, I have PFHO at 0.26x EV/EBIT and 0.37x EV/EBIT. This is netting out total cash and investments. A ridiculously cheap price.

Clearly if the company was put up for sale they would fetch more than these multiples. How much more is obviously the question. I’ve thought about what would happen if they dividend out their entire treasury portfolio. After the dividend, would the stock really trade down to a few hundred thousand dollars? Or would it be valued more on the underlying business? Your downside is completely protected by the total cash balance right now.

The market isn’t giving them any credit for their huge cash balance or potential for more growth. I use an 8x EBIT multiple to value their core business. It’s a large discount from where CorVel trades at or where Conduent’s segment sold for. It’s an asset lite business with high returns on capital that is growing by expanding into new states. I don’t believe 8x is over the top.

Using 8x EBIT and adding up the estimated net cash at the end of the year, the potential upside is 75% on conservative assumptions.

I mentioned PFHO is comparable to professional accounting or legal firms and these are typically valued based on billings or projected billings between 1x - 1.5x. Even if you valued PFHO that way the value of the core business would be roughly the same.

Management/Shareholders

The CEO, Tom Kubota, is 85 and has been the head of the company for 25 years. He has an ownership stake of 65% but effectively controls near 100% of the company due to some preferred voting shares. He hired a bank to help explore M&A a few years back but nothing has come to fruition yet. As I said above he’s attempted a little capital allocation with the special dividend in 2023. His salary is nothing egregious for the size of the company at $200K.

One interesting thing to note is that both of his daughters had been working for the company and sat on the Board of Directors for the past decade up until recently. Kristina, one of the daughters, was the CFO from 2021 to 2024 and just resigned from the Board this month. Lauren, the other daughter, had been with PFHO for 10 years and in the same 8-K filing as Kristina’s resignation also resigned from the board and her position as Secretary of the company. Both left to pursue other professional endeavors. At age 85 and no family members in the business, it would be an opportune time for Tom to get his estate in order and possibly sell the business.

The daughters’ board seats were replaced with Bruce Everakes, who owns a 5.5% stake, and Scott Allen, who is the company’s controller. Their legal counsel, Donald Balzano, owns 6.9% of the company as well so there is huge insider alignment.

Catalysts

• Something finally happens with the cash. Special dividend? Acquisition? Buyback? The company doesn’t need a lot of working capital to operate and the entire treasury portfolio should be sold and paid as a special dividend to shareholders which would be $0.76 cents a share. Almost the total share price.

• Potential sale of business. The CEO is 85 years old and both daughters just exited the business. If there was ever a good time to cement a legacy, it should be within the next year or two to sell.

• Continued expansion. Growth by expanding into other States as they have been doing.

• Multiple expansion. Underlying business gets some type of multiple put on it. It used to trade at a higher multiple a decade ago when it was growing but since then it’s suffered multiple compression. The recent growth might get rewarded with any kind of multiple.

• Acquisition. The company finally makes an acquisition.

Risks

• Customer concentration. They have 3 customers that make up 43% of sales and in the past they have had large customers leave with Walmart being the most recent. However, most of these customers left because they either brought the business back in-house as a result of being insurers themselves or just stopped using certain services PHCO provides all together. Most of the current customers represent corporations, non-for-profits or cities that are unlikely to bring what PFHO does internally. Even losing customers over time they have still remained profitable. But there is a risk that you wake up one morning and lose a large customer.

• Business Quality. The business competes on price and quality. I don’t believe there is a real “moat” but they’ve been profitable for a long time even when they lost large customers. If someone offers a better price or service, they may lose the customer. Depending on the size of the client and number of employees, it could be a bit annoying to move everyone over to a new provider.

• Majority shareholder risk. The CEO owns 65.7% of the common stock but essentially 100% of the voting control of the company through the preferred. There are 16K preferred that are convertible on 1-1 basis of the common but each share of the preferred has 20K/share of votes. While not a risk “per se”, he has total control of the outcome here.

The outcome I’d like to see is the for the treasury portfolio to be sold off an dividend off to shareholders. Followed by a sale of the business. It’s a fragmented market and I am sure there would be many bidders for this. WIll it happen? Who knows. Your downside is protected with the huge cash + investment portfolio and you have upside in the event some type of multiple is placed on the underlying inflecting business.

Disclosure: Long PFHO

Buffett Book Thoughts; Italian Markets (Buongiorno)

I finally got around to reading Buffett’s Early Investments by Brett Gardner. I really enjoyed it and the amount of research that went into the book was incredible. The book highlighted some of the investments made during the Buffett Partnership years and pre-partnership years that aren’t often talked about (excluding AMEX & Disney).

I made some notes and just thought I’d share some takeways from the book regarding some continuous themes of the investments Buffett made.

Balance Sheet Focused

Obviously this won’t come as a surprise to anyone but each company profiled had a strong balance sheet. Even the Disney investment at the time had a net cash balance sheet with other assets like the film library, Florida land and Disneyland rides. All of the companies had next to little amounts of debt.

These types of investments with strong asset backing and little debt helps explain why he hasn’t really lost much money over the span of his 70+ year investing career. This makes sense as he recently stated at the Berkshire AGM that he focuses first on the balance sheet over an 8 or 10 year span before even looking at the income statement. A company can’t really be zeroed if it doesn’t have debt. The balance sheet focus provides downside protection should the business falter, and some of them did as they weren’t great businesses.

Cheap Entry Price

All of the companies in the book had extremely cheap entry multiples whether it be from a P/NCAV, P/TBV or on an earnings basis. I put together all the multiples paid (excluding British Columbia Power because that was an arbitrage):

• Marshall-Wells: Bought at 0.46x P/TB, 0.60x P/NCAV, 1.93x EV/EBIT, 5.5x P/E. Didnt make anything on it though and sold at a 1% loss.

• The Greif Bros.: Bought at 1.52x EV/EBIT, 3.74x P/E, large discount to TBV. The company was buying back lots of stock and it was a decent winner at 20% CAGR for his holding period.

• Cleveland Worsted Mills: Bought at EV/EBIT of 1.91x, P/E of 5x. Dividend cut so Buffett lost money (but it liquidated after and it would have made money had he held. See below)

• Union Street Railway: Market cap of $643K and EV of -$327K. You could buy it at a significant discount to the net cash on it’s balance sheet (stock price of $30-$35 a share vs $48.13 of net cash) and it had barely any debt. Although not profitable at the time, it was repurchasing a large amount of its stock and had a return of capital distribution multiples of the stock price due to a strong balance sheet. He earned a 30% IRR.

• Philadelphia & Reading: Stock price was $13.38 with NCAV of $9.16. It had a hidden culm bank inventory value which put adjusted NCAV at $17/share and TBV at $31.33. Because of the strong asset value of the balance sheet, Micky Newman (the son of Jerome Newman of Graham-Newman) completely changed the direction of the company by liquidating excess inventory and purchased profitable businesses unrelated to the coal operations. This allowed P&R to use up the valuable operating losses and shield taxes. The change in capital allocation in using cash to acquire profitable businesses one at a time is what really made the stock go from $10 to $200 in 14 years.

• American Express: 2.5x EV/EBIT 3 years out from time of purchase

• Studebaker: 1.39x TBV, 6.43x P/E

• Hochschild, Kohn & Co.: 0.77x P/TB, 5.73x EV/EBIT, 10x P/E, 9.7% after-tax FCF yield. Was technically a “loser” for Buffett and Munger.

• Disney: 3.51x EV/EBIT, 7.11x P/E

The vast majority of these investments worked out really well but for 2. And even the two that didn’t work out, the loss was mitigated or would have worked had he held on a bit longer (see below).

Hidden Assets

In some of the investments there were some off-balance sheet assets that weren’t reflected in the numbers.

• Philadelphia and Reading traded around a $18.8m market cap, or $13.38/share, with a NCAV just below that but because it had what are known as culm banks that weren’t visible on the balance sheet, the value was hidden. Culm banks are a waste material from anthracite mining which can be used as an alternative fuel source. This asset would have fetched approximately $17/share based on Buffett’s estimate. More than the market cap of the company. It also had valuable operating losses from mine abandonments.

• Studebaker had 10 segments and they didn’t disclose numbers for the segments. The fast growing STP segment would only later be revealed when Studebaker IPO’d STP. It grew revenues from $13m in 1964 to $44m in 1968. It also had $30m of large tax loss carryforwards that only would have showed up in the notes to the financials, not the actual balance sheet figures.

• Hochschild, Kohn & Co had assets that the balance sheet didn’t account for: 1) the LIFO reserve meant that if the company used FIFO, inventory would be 5% higher and 2) the real estate carrying value was greater than what it was marked at on the balance sheet for.

• When Buffett bought Disney, it had a market cap of $80m. The total film library cost was $205m but just $9m of it was on the balance sheet due to being amortized over time. One of the films was Mary Poppins which had just done $30m in sales and Cinderella did $2.5m in rentals. Plus you got over hundreds of short films, 21 animated features and other film and TV shows for that $9m on balance sheet. And every few years you could recycle these movies to generate income because a new generation of children would watch them. Clearly worth more than the $9m it was marked at.

• The Greif Bros. Cooperage balance sheet had understated it’s inventory as well because it used LIFO accounting in a rising price environment.

• Union Street Railway operated buses and sold tickets in advance. Every sold ticket that went unused was a liability on the balance sheet as deferred revenue. Not only did the company get access to this “float” from unused ticket purchases, but because the liability barely changed year over year, it was highly likely that the tickets wouldn’t be used and therefore the liability could be written down to zero, adding some extra asset value to the business.

Scuttlebutt

• When the salad oil scandal occurred, Buffett compiled “a foot-high worth of material” on the company that came from bank tellers, bank officers, restaurants, hotels and credit card holders that all showed the scandal didn’t affect the underlying business. He even went to restaurants in Omaha to be sure customers were still using their Amex cards. It was still growing at a tremendous clip during this period and allowed Buffett to purchase the business at 2.5x EV/EBIT a few years out from when he bought it. A crazy cheap price for AMEX’s franchise quality.

• There’s a story of Buffett going to a Kansas City railroad yard for a month to count tank cars in the yard in order to gauge how fast Studebaker’s STP segment was growing.

• Even when he went to Disneyland, he was trying to calculate the profitability of the rides and park.

The Losers

• Cleveland Worsted Mills - I wouldn’t even say this was a real “loser” but for Buffett it was. He bought just prior to the company cutting the dividend because it was a declining business and sold just after that. But they ended up just liquidating a year or two after he sold and if you bought after that you would have made 21% - 50% annual returns due to the liquidation distributions. The cheap earnings multiples weren’t actually as cheap because the business deteriorated but he had protection through the balance sheet.

• Hochschild, Kohn & Co. - Buffett’s purchase of this Baltimore department store seems like a bit of a head scratcher to me. Not only is retail an extremely tough business to be in and predict the future of, but the price paid didn’t seem that attractive as well. You can look up all the multiples in the above section but 10x earnings for a low growth, low ROIC business doesn’t compare to the earnings multiples paid on the other investments profiled. Buffett and Munger would end up selling the business for $11m vs a $12m purchase price but because they received $3.5m in dividends, it technically wasn’t a loss.

Overall Takeaway

• Buffett is more value agnostic than people associate him with. He’s known for “buying wonderful companies at fair prices” but even back in the early days, it seems like he was just looking for mispriced bets. Whether it was from net-nets, companies on the proverbial “operating table” or arbitrages, if his downside was protected and the price paid made sense, it could be a potential investment.

• A test I noticed that Buffett likes to use is the private market test. What would the company go for in a private transaction? He did it with Disney and said it was worth multiples of what he bought it for. He’s also quoted saying something similar with his Washington Post investment.

• Extremely strong balance sheets, with none/small amounts of debt and low entry multiples are what has protected his downside in the event that his analysis of the business was wrong.

• Having earnings stability and some kind of capital allocation taking place (whether it be agitating for a change in capital allocation through his control positions or someone who knows how to allocate capital) is where he made a lot of money.

Borso Italiana

I’ve looked at some stocks on the Italian exchange before but with Italy being one of the top tourist destinations in the world I thought I’d go through and take a look at each one. There are some unique companies as usual. Like Avio SpA that could be a play on the potential increase in European defense spend or SOL Spa that seems like it could be the Air Products of Italy.

The Italian Borso has three segments to their market:

• The MTA (which stands for Mercato Telematico Azionario) is where their large and mid cap stocks trade.

• The Euronext Growth segment is for medium to small companies

• The Euronext STAR segment is for small companies

All in there is about 353 publicly traded stocks. I’m sure I missed some and there are others I have highlighted on my excel document that I’m watching but for now I figured I’d write a few up that are interesting.

Cairo Communications –  CAI.MI. They operate several divisions that produce periodicals/books, an advertising arm for their print division, and they own the TV network La7, which is one of the top 10 TV channels in Italy. On top of that, they have a 60% stake in RCS Media. This stake can make the underlying accounting a bit confusing as Cairo consolidates RCS onto their financials. They recently just tendered for 18% of their shares, and only 11% was subscribed, which leads me to think that management sees their stock as undervalued. The owner, Urbano Cairo, owns a tad over 50% of Cairo, and 100% of the Serie A team Torino FC, although that doesn’t come with the company unfortunately.

Health Italia - HI.MI. Undergoing a mandatory takeover bid currently with a premium at 157% to the unaffected price. With the stock at €280/share and the bid to come in at €300, there is a nice little spread if arbitrage is your thing.

F.I.L.A. - FILA.MI. You can read my Q2 Letter to get my thoughts on it. It remains deeply undervalued and might be the cheapest stock in Italy.

Lindbergh - LDB.MI. Providing MRO parts has historically been a great business and that’s the line Lindbergh is in. They provide ordered parts to technicians overnight (while they’re sleeping) and other ancillary services. Lindbergh is also looking to roll up the Thermodydraulic service market, which is highly fragmented with 5K companies. It is mandated that Italians must perform yearly maintenance on their heating systems and Lindbergh has started to acquire some small companies that have technicians that services these homes. There is a really good VIC writeup from last year too that covers this well!

Caltagirone Editore - CED.MI. This ones an interesting one. It owns several leading local papers in Naples, Rome, Venice, etc. and a top 5 national one called Il Messaggero. It’s owned and controlled by Francesco Caltagirone’s holding company at 61%. The good news is that with a market cap of €760m, it’s backed by 51% of net cash and investments for an enterprise value of €373m. The bad news is is that the papers don’t make money and are subsidized by the income earned from the investments. It will be interesting to see how long this will go on for! Oh, it also has €51m in tax losses and what is most likely undervalued land carried at €60m.

Brunello Cucinelli - BC.MI. Apparently there are people who like to spend thousands of dollars on a t-shirt or a pair of shoes. The value investor in me could never. Up 900% since going public 13 years ago and trading at 49x earnings and 19x EV/EBITDA, there was a recent article in the FT about the founder Brunello Cucinelli that was interesting. What started in 1978 with €550 is now worth €7B.

RCS MediaGroup - RCS.MI. If you owned FIAT a decade ago you would have received shares of RCS that FIAT owned and were spun off to shareholders (not an actual spinoff, just FIAT’s stake). They own the #1 and #2 Italian and Spanish newspaper, Corriere della Sera and El Mundo. And in sports they own the largest Italian and Spanish newspapers, La Gazzetta dello Sport and Marca. They also put together large sporting events like Giro d’Italia. Their Newspaper segment is their most profitable and just did €50m in EBIT out of the overall company’s EBIT of €93m, which is quite impressive as most paper companies operate at a loss. Now, RCS itself announced at the end of 2024 that they will be doing their own spinoff and separating their Sports and Events division. I’ll be watching to see if shareholders vote for the spinoff and potential spin dynamics at play.

NewPrinces - NWL.MI. The original company was a small milk business in Salerno that has grown to a large €2.8B European food behemoth. They are an acquisitive company and have done about 15 acquisitions in the past 20 years to grow their business. Their brands include Ragu (pasta sauces), Matese (dairy), Pezzullo (pastas) amongst many others in similar categories. They also just announced a few weeks ago that they are buying Carrefour’s Italy business for €1B and might be listing their manufacturing assets on the London exchange. The stock is up almost 100% YTD as investors are excited about integrating these acquisitions as well as future ones.

Racing Force - RFG.MI. Last year I rented a car and drove from Rapallo to Stressa. Little did I know I would have driven right past this company. If you’ve seen the new F1 movie with Brad Pitt, you would’ve saw their brands in the movie. Their OMP segment produces racing equipment that the racers wear (suits, boots, gloves) as well as safety equipment in the vehicle like the seat or seat belts. Their Bell Helmets are worn by 70% of F1 racecar drivers, which seems like a pretty good niche moat to own. They’ve grown sales at a 12% CAGR since 2021 and 14% the last 10 years to €65M last year and earn a decent profit of just under €6m. It will be interesting to watch their growth drivers in the future like their Skier’s Eye application in the defense industry.

As I said I’m sure I missed some so if you can think of any interesting ones just let me know.

An Expert Market Security at 3x FCF Buying Back Tons of Stock

Note: this is an extremely illiquid security and doesn’t trade a lot on the OTC expert market. If interested, I wouldn’t rush into purchasing as small amounts of volume can move the stock. I still haven’t received 2024 financials but used the tendering document that disclosed unaudited 2024 financials and used 2023 financials for some segment data. Once I receive the audited 2024 financials I will update this. This is not investment advice.

Western Capital Resources Inc. (WCRS) is a bit of a quirky security. It trades at:

• 3x EV/FCF

• It’s net cash makes up 50% of it’s market cap

• They’ve repurchased 42% of it’s shares in the past 2 years

• It has a variety of small niche businesses that spit off cash.

If you go online to crack open the most recent annual report you won’t find it. Because with some OTC stocks that go dark this company no longer files with the SEC as of July 2022. You have to be a shareholder to obtain their financial info.

If you dig a little online you can read that they recently did a tender offer and inside that tender offer document they list how many shares they were offering to buy, but it also had their financial statements included the past few years that have only been available to shareholders. Reading this document sent me down a bit of a rabbit hole.

There’s an accounting quirk in their financial statements that skews their true outstanding share count and when taking this number into account you’ll see that what’s on the reported financial statements as shares outstanding is “technically” not true.

Capitalization

They’re current capitalization seems pretty straightforward. I’ve got it at roughly 5x trailing EV/EBITDA and 7x trailing FCF before making any adjustments. It’s cheap but not egregiously cheap from an initial look. Using 8.1m shares outstanding and a $13 stock price, the market cap is $105m today. Adding $13m in debt, a small noncontrolling interest of $1.4m and netting out the $48m in cash, the total enterprise value is $72m.

What’s the Company Do?

Western Capital was spun off in 2006 from Multiband Corporation as a Minnessota incorporated company but was called URON back then. Not until 2008 did they change their name to the current one. In 2012, Blackstreet Capital Management became the majority shareholder using various partnerships (like WCR LLC) and are still the largest shareholder to this day. Blackstreet is a holding company that owns various businesses either in distress, underperforming or are in out of favour industries. It was formed by Murry Gunty in 2002 who is also the CEO of Black Bear Sports Group, which owns 42 ice rinks in some eastern States. The few LLCs that own Western Capital are just cash and Western Capital stock.

In 2016 Western Capital redomiciled to become a Delaware corporation. They went dark in the summer of 2022 to “reduce or eliminate significant compliance costs associated with the Company’s public reporting status”.

This company is a cash flowing machine with a few odds and ends businesses. They operate cellular retail stores, pay day loan centres, ice rinks and some other segments. I wouldn’t say these businesses are great but they are niche, stable and cash flowing. They are focused on making acquisitions of strong cash flow generating businesses or buying assets that need a bit of fixing.

Over the past 5 years the’ve grown revenues from $130m to $189m and have produced free cash flow each year, even during covid. Since I haven’t received the 2024 financials that disclose each segment numbers, I’m basing the size of the overall segment on 2023 ending numbers. They operate the following segments:

Segment #1 - Cellular Retail Segment

This is their largest and most profitable segment and represented 62% 2023 revenue and 57% of 2023 net income. They operate authorized Cricket Wireless dealers which means they can only sell and operate customers on the Cricket network. They’ve bought dealer stores over the years and currently have approximately 259 cellular retail stores (119 100% owned and 140 less than 100% owned, which is what the minority interest distributions go to on the income statement). They charge customers based on a no-contract basis which is a pay as you go phone plan vs signing up customers to long-term phone contracts and collecting monthly fees. They also sell cell phones and accessories in the store. Profits have grown as they’ve acquired stores. Cricket is owned by AT&T and they have just over 4,000 locations in total across the US so Western owns about 6% of the total stores.

Segment # 2 - Direct to Consumer

This segment sells a variety of garden products under different brands like Jackson & Perkins which is 150 years old, Park Seed or Wayside Gardens. It’s their second largest segment and did $43m of 2023 revenues (25%) and $4.1m in net income (32%). You can go to their website and order plants, seeds, gardening supplies and home restoration furniture. Because there is no retail footprint, the costs of running this business are lower than the typical B&M businesses. It’s usually seasonal as most garden companies have little sales occurring in the summer months.

Northern Brewer was purchased in July 2024 for $6.2m and was added to this segment. Northern is another online retailer that sells home-brewing beer and wine-making kits and equipment. The results for all of Western in 2024 were weighed down by Northern as they reported a $2.2m loss. They recently moved the distribution operations from Minnesota to South Carolina as this reddit post notes. I would assume moving the facilities to combine it with the plant operations would help save money as they’ll save on duplicative fulfillment costs going forward.

Segment #3 - Consumer Finance

Their third largest segment operates 19 payday loan centers and 3 pawn store locations. It did $7.1m of revenue in 2023 (4% total) and only $846K of net income (less than 1% overall). These stores provide high interest “payday loans” and other short term forms of financing to weak credit borrowers. The loan size is typically a few hundred dollars and lasts up to a month.

While not my favourite business given the highly regulated nature (there is always the threat of Congress waving their pen and abolishing or dismantling the entire industry) and low barriers to actually opening up a payday loan business, it does serve some need as there are consumers that are shut out of the traditional banking system because of their credit scores and need some place for quick cash.

It doesn’t tie up a ton of capital as the payback period on the loans are very fast which leads to lower loans receivable balances outstanding. However, there will always be a problem with collecting 100% of the amount lent out.

There largest geographic exporsure in this segment is North Dakota, Iowa, Kansas and Wyoming. Nebraska used to be in the top 4 but they ceased writing new loans in 2020 because the people of Nebraska passed an initiative that limits the annual interest rate on payday lenders to 36%. There are now 20 states (plus DC) that have capped rates payday lenders can charge consumers, up from 16 states 10 years ago. That’ll always be a risk to this line of business as more and more states have voted to cap the rates.

Segment # 4 - Manufacturing

This division was added in 2021 when they purchased Swisher for about $3.5m. It had revenue of $10.4m in 2023 (6%) and barely any net income. The Swisher brand manufactures an assortment of outdoor products like mowers, log splitters and other timber items, safety shelters and other products. A big competitor in the space as you’d imagine is Deere.

Segment #5 - Ice Rinks

After going dark, they entered into a new segment and purchased 6 ice rinks (including the real estate) in the state of Michigan and New York. Murry was on a podcast last year and gives a good background on how he got into purchasing arenas for Black Bear and the business behind them and I imagine it’s why Western has started buying them. He makes an interesting point that the ice rink arena business model has a different customer and consumer where the customer is the parent and the consumer is the child. Both have to have a good experience for the arena to be successful.

If your buying an ice rink, you can make money a few ways: renting the ice out at a certain rate to the general public, running hockey leagues and the concession. From what I could find online there are about 2,600 ice rinks in the US: 2,100 indoor and 500 outdoor. If a municipality runs the rink it usually does at a loss which has given the private sector a chance to come in and take over some arenas.

There’s actually a publicly traded company in Canada, Canlan Ice Sports Corp., that runs 15 arena facilities mainly in Canada and some in Illinois as well that would be a decent comp. In 2024 it did $94m in revenue and $3m in earnings which shows that these arenas can be run at a decent profit.

Those are the 5 lines of businesses that Western is currently in. But the thing that really interested me was located in the cash flow statement.

Cash Flow Statement Quirk

Below is Western’s 2021 financing section of it’s cash flow statement. Looks pretty normal.

Compare it to their 2023/2022 cash flow statement after going dark.

That “Purchases of contra equity” jumps right out. What does that mean? Reading a bit further down after these financials, you somewhat get your answer.

“Purchases of contra equity”. Other wise known as treasury stock, which is a contra equity account. By buying back your own shares, you are reducing your equity balance (which should be in a credit balance if the company has retained earnings i.e. contra equity is a debit that reduces equity). But Western Capital isn’t exactly buying back their own stock. They are buying the LLC’s interests that have stakes in the company. So they are indirectly buying back the shares. And they plan on cancelling these shares as well.

So technically on the tender document they can say their current shares outstanding is 8.8m as of March 20, 2025. But if you consider all the contra equity purchases and actual stock buybacks since going dark, they’ve bought back 3.8m shares. Meaning they’ve bought back 42% of their shares over the past 3 years!

Right now the stock is even trading below their most recent tender of $15/share too that was just done in April.

Why’s it Cheap?

I’m sure you can come up with a few reasons why it’s so cheap but I’ll go ahead and state some of them.

• It trades on the OTC Expert Market because they don’t report their numbers with the SEC as of 2022. You have to be a shareholder to actually get their financials.

• Because of the SEC rule change a few years ago, most investment brokers don’t let investors purchase certain OTC stocks, they only allow you to sell them if you had them in your account. So it can be tough to buy these. Anytime it’s difficult to buy a security, the probability of it being mispriced increases.

• This stock barely trades. You’d be lucky on a good day if it has any volume.

• It also has an extremely large shareholder that owns its stake through various LLCs.

Normalizing 2024

At first glance, 2024’s numbers don’t look as good as in prior years. But there are certain adjustments that should be made to come to a normalized earnings figure. With the purchase of Northern Brewer last year, their loss of $2.2m dollars was included. They took a $0.7m goodwill charge and there was also a transaction/integration charge related to this acquisition of $1m. Adding back these one offs and the FCF for 2024 comes to just over 12m. If they can turn a profit at Northern Brewer, these numbers would increase.

Valuing Western Capital

Right now, without making any number adjustments, Western’s trading at 7x trailing FCF. But if you make the one time expense adjustments and assume they can cut the small loss at Northern Brewer (without actually adding anything into profits), it’s trading at 3x EV/FCF. The business’ cash flows are pretty stable so I’m comfortable forecasting the same amount of FCF for 2025. What’s the right multiple on these diverse stream of cash flows? I don’t know exactly but 3x feels way too low. If we use the current face multiple of 7x that it’s trading at and add the net cash, upside is about $23. Using some higher multiples will obviously increase the price some more. My range of fair value is anywhere from $23 - $30 for upside of 77% - 131%. These numbers would increase if they continue to buy back their own shares at their current rate.

I didn’t do a segment multiple analysis on each business line as the price today is crazy cheap. Once/if the stock price increases, then I’ll try to get a bit more granular but the margin of safety here is already quite large and with net cash making up 50% of market cap and the company turning into a share cannibal, the downside to me seems limited here.

Risks

With all OTC stocks, each one comes with more than your standard risk. One major one here is that Black Street, the largest investor, sold Northern Brewer to Western which is obviously a non-arms length transaction. This could give the impression that Black Street wanted to offload this loss making business to cash out and used Western to do so. But there was a fairness opinion done and I believe there is strategic business sense for Western to own that asset as opposed to Black Street.

Another risk, which ties into the first one, is that Black Street owns a majority stake in Western. While I don’t have updated figures as of today, their last 13D before they went dark showed they owned 75% of the shares. The buybacks since have been for some of those shares and if they didn’t sell into the tender or any buybacks that occurred last year, I peg them still at 75%. If they did sell some into the tender, I’ll find out once I receive some of their most recent documents. So what Black Street says essentially goes here. Being domiciled in Delaware certainly helps protect shareholders if some type of bad governance were to occur. But buying back extremely undervalued stock is the exact opposite of bad governance. If Black Street or anyone else tried to buyout the remaining shareholders for way less than fair value, being incorporated in Delaware should help protect minority shareholders.

If Congress were to eliminate high APR’s that payloan centres can charge, it would affect Western’s Consumer Finance segment. Because this segment doesn’t contribute that much to profits (<1%), the effect would be muted and isn’t that large of a risk to worry about in my opinion.

Summary

This is an illiquid, undervalued OTC expert market security that trades at 3x EV/FCF, has repurchased 42% of its shares in the past few years that offers an estimated 77%-131% upside to fair value.

Disclosure: Long WCSR

A Few Idea Updates (MHI.AX, PAC.AX, TFG.AS)

I haven’t done an update on any of the stocks I’ve written up so thought it’d be a good time to do so. Of the three I am updating below, only Tetragon made it into the Halvio Capital portfolio and for the purposes of full disclosure, I personally own some Fannie/Freddie common and a small amount of Merchant House International Limited.

Merchant House International Limited (MHI.AX)

If you remember they announced they were going to be liquidating their remaining assets and distributing the proceeds to shareholders upon the sale of their property and equipment (prior write up here). The remaining property was just a textile factory in Virginia, not exactly Class A property. Well, because their only Australian director resigned from the board in February (there was no real point in being on a board anymore for a company liquidating I assume) the ASX suspended trading in the stock. It’s been frozen at $0.15/share since. In that time period the company disposed of their new equipment on their premises for US $4m and have now announced a sale of their factory and land in the past couple of days. This was the company’s balance sheet as of March 31, 2025 with an NAV just under AUD $.24/share.

On April 1, a day after this balance sheet date, they collected the final tranche payment from their sale of the equipment for $US 2m, which would be AUD $3.09m that needs to be added on to the balance sheet.

The proceeds from the sale of land and building are for AUD $12.3m for a gain of AUD $3.61m. I’m not an expert in Australian taxes but my understanding is that for companies with less than $50m in sales the rate is 25%. Taxing that gain at the Australian capital gains rate of 25%, their net proceeds should be AUD $11.4m. The company also owned a condo that it sold at a profit that would net about AUD $132K.

This is now my updated model with a vast amount of the assets in the bank account. I believe I am being conservative in the costs as they’re are currently no operations and so the only expenses would be listing, audit and board fees.

What’s next is a TBD shareholder vote to distribute the proceeds and a timeline for payout which should be relatively quick as it is essentially just cash sitting in a bank now.

Pacific Current Group Ltd. (PAC.AX)

This one didn’t quite work the way I envisioned. But because the downside was quite limited due to the hard asset values, it was a relatively small loss. Here was the write up. They weren’t able to repurchase as many shares as I would have liked and the stock drifted a little lower. My whole thesis was that it would move up with the buyback as the NAV would now be higher but it hasn’t responded like that. There is now a short report out on one of their large holdings I’ve read. The stock still might work but I’ve found better uses of the capital that I will get into in my Q2 letter with larger upsides I decided to put it toward.

Tetragon Financial Group (TFG.ASX, initial writeup)

Just a refresh. The main thesis was and is asset sales to repurchase stock at a huge discount to NAV as 1) management owns a large percent outstanding now and can make more from the stock going up than milking fees from the company and 2) buyback a ton of shares to benefit insiders more before Ripple IPOs.

TFG put out a press release on April 30th stating that they didn’t expect a transaction regarding Equitix would occur in the immediate term. You can read the part of the release about Equitix below.

In my opinion, they left the door open for not only Equitix but also other asset sales as well. And sure enough on June 16th, a month and a half later, they sold 14.6% of their stake to Hunter Point Capital.

I’m not sure what occurred in the time frame from no ”..immediate transaction” to a partial sale. It could be that TFG executives saw the Circle IPO on June 6th rip from their IPO price of $31/share to $69/share on the first day, which is now sitting at $240/share, and thought they should start selling assets to buyback TFG shares to get ahead of the Ripple IPO so they’d own more. Or the fact that Ripple itself is buying back shares at $175/share, which now implies a $25B valuation of Ripple and is a huge premium to where it traded in the private markets just a couple months ago. The only question I have to all of that is then why wouldn’t they just sell their whole stake? Why just a smaller portion? Maybe TFG got cold feet from the all the fees they currently earn on NAV? I’m not sure of the answer and would welcome anyone reading this their opinion as well.

Now to the updated NAV. The sale of their 14.6% stake in Equitix will bring in gross proceeds of $256m. Not to mention that now their is a mark on their remaining 66.9% Equitix stake at $1.177B, $184m greater than their carrying value of $993. The total change in value of $440m (proceeds + remaining stake over carrying value), needs to take a 25% management fee into account so call it a $330m uplift, or $3.7/share just from this monetization.

With Ripple at an implied $25B valuation, TFG’s approximately 2% stake would be $500m vs where they have it marked at $239.5 so it should be adjusted upwards of over $200m. Take 25% management fee off the increased mark and it would net $195m or $2.2/share. Adding these new values, TFG’s adjusted NAV should be about $41/share now.

Since the stock has historically traded at a 60% discount to NAV, the price today should be $16.5 today vs $15.75 of where it currently sits. So TFG is now trading at a larger discount prior to any Equitix monetization or Ripple increased valuation, which doesn’t really make sense. We still need to see what TFG does with these proceeds too as they have about $400m in leverage they could pay down or split the proceeds between tender and pay down. One other interesting point regarding Ripple is that WHEN or IF Ripple files for an IPO, I would imagine XRP would rally. And because Ripple owns a ton of XRP, it would create a reflexive loop making Ripple even more valuable as a result.

As alluded in the press release, there is still the potential for a further full sale of Equitix and other assets that can be monetized. As a reader astutely pointed out to me, they have a put option on their BTO asset next year that allows TFG to monetize that asset as well which is 8% of their NAV. How this plays out still remains to be seen but your downside is well protected by the even larger NAV discount it is trading at now and you have a potentially explosive upside should management conduct any type of tender(s) prior to a Ripple IPO.

An Open Letter to The Keihin Co., Ltd (9312.T)

English version

Japanese version

A Profitable Japanese Logistics Company at 0.52x Book Value and 3x EV/EBIT With Real Estate Greater Than The Market Cap; and a Position Sizing Thought

While going through the Tokyo Stock Exchange listings, the sheer amount of undervalued securities can sometimes leave you feeling overwhelmed. Because there are so many cheap stocks, I’ve taken a basket approach and want to share one today. This Japanese stock isn’t like a few in the portfolio with negative enterprise values or huge amounts of excess cash (although it does have some of that). It’s a strong, durable business that’s been around for almost 80 years trading at half of book value with a lot of M&A activity in the sector.

Then I talk about a position sizing thought I’ve come to appreciate.

Summary

Keihin (9312) is a ¥15.8B (CAD $152m) small cap Japanese logistics company trading at 0.52x book value, 0.43x adjusted book value, 3x EV/EBIT and 2x EV/EBITDA. It has almost half of it’s ¥15.8B market cap covered by net cash at ¥6.6B. As well as land and warehousing facilities with a fair market value approaching ¥30B, double the market cap and providing for significant downside protection. In a sector where buyouts are occurring regularly, Keihin makes for an interesting acquisition target as it’s operations have been extremely durable and profitable, with only one unprofitable year in the past 20 during the GFC. Management has even acknowledged that one of their priorities is to close the PBR discount in recent filings.

Extremely Durable Revenues & Profits

The company was started way back in 1947 with just ¥3 million yen to open a Yokohama port and today has a market value of ¥15.8 billion. The business of today consists of a domestic and international logistics business and operates through the whole logistics chain: warehousing facilities, port transportation, land transportation and ocean and air transportation. It is heavily influenced by how the global economy is performing and sales within Japan make up 90% of total sales. This is the revenue and profit breakdown of both segments for their fiscal 2025 year ending March 31:

Looking at the past 20 years of financial data, Keihin’s only loss was in 2009 during the GFC, which speaks to the durabilbity and consistency of the business. Over the past 10 years revenues have averaged ¥48.7B per year with EBIT ¥2.2B and EBITDA ¥4.2B.

On top of the predictable nature of the operations, there has been no share dilution with the share count steady at 6.53 million shares. With Japanese companies earning low ROEs due to their asset side of the balance sheet stuffed with cash and investments, Keihin has earned a respectable 10 year 7.6% ROE. This number would greatly improve if they didn’t hold half their current market cap in cash and investments.

The balance sheet is also in a strong position today as the past decade Keihin has used its free cash flow to pay down debt. It has gone from a net debt to a net cash position when including investment securities.

Cheap On Book, Even Cheaper Using Real Estate FMV

Overall land prices in Japan having been increasing in value the past 4 years since the end of the panedemic with commercial values increasing a bit faster than residential (see here, here and here). Land values in Tokyo’s 23 wards grew 11.8% last year. This should benefit Keihin Co. as they own ¥18,164 billion in buildings and land marked at cost, some located in the Tokyo port areas and others in the major ports of Japan. Some of this real estate has been on the books for decades. To get a current value of what the real estate could be worth, we can look at current prices per square meter of what the land is going for now. If you want to see the exact location and profiles of the buildings/land you can go to their corporate website where it lists each one. But keep in mind they lease some of these and you’ll have to use their Annual Report to get the total square meters owned.

The first piece of real estate is their head office. Located in Minato, a ward of Tokyo, right by the Tokyo Port, the size totals 2,097m². According to e-housing (a Tokyo real estate platform), the average commercial land price in Tokyo’s 23 wards is ¥3,590,800/m². Using the Hokushin pricing for the Minato ward in 2023 it is ¥2,149,700/m². To be conservative, I used the lower number from Hokushin which derives a value of ¥4.5 billion for the head office. About 4.5 times the amount it sits on the balance sheet for. Keep in mind this is using 2023 numbers and not adjusting for the increase in values that 2024 experienced.

The next piece of real estate they own is 18,979m² of land and warehousing facilities in the Koto ward of Tokyo, right on the Port of Tokyo. Using the the 2023 Hokushin pricing of ¥510,200m², these assets could potentially fetch ¥9.6B vs their book value of ¥3.6B.

Moving a bit down south to the Yokohama Port, one of the top 5 Japanese ports, Keihin owns 68,606m² of logistics facilities there. The value of these assets are carried at about ¥10B on the balance sheet. According to the city of Yokohama’s website, industrial land per square meter goes for ¥211,200m². This would put the value of Keihin’s Yokohama industrial assets at ¥14.4B.

The last piece of real estate Keihin owns is in Kobe City at the Port of Kobe. The industrial assets comprise of 21,105m² and have a book value of ¥3,466B. Trying to find industrial land value for these assets was a bit more of a challenge. Using the Utinokati website for land value in the Hyogo Prefecture, the land value would be about ¥1.3m² but I’m sure that includes residential and office/commercial value as well. Statista gives a value of ¥170,700m² which is what I used to be conservative. Using this amount values the Kobe Port assets at ¥3.6B.

If we then sum up all the real estate value, you get ¥32B. Almost double what it is carried at on the balance sheet and twice as much as the market cap of ¥15.8B!

Another way to look at their land value is to take some recent logistics/warehouse buyouts or the cost of building warehouse facilities and derive a value that way. Hong-Kong based PAG bought two warehouses near the Port of Nagoya in 2024 for ¥65.5B that totalled about 243,000m², which equates to ¥269,547/m². The Port of Nagoya is the busiest and largest port in Japan in terms of annual cargo volumes. Although Keihin doesn’t have assets right in this port, if I just assume a 10% discount to the other ports it gives a land value of ¥242,592/m²

At the beginning of 2025 Brookfield also purchased a stake in a Tokyo luxury hotel that came with a large 93,000m² plot of land on the outskirts of Nagoya that they are going to develop into a warehouse. The size of the warehouse is going to be 223,000m² and they’ll be investing ¥42.7B (US$300 million) to develop it which works out to ¥191,480/m². I would imagine this land, being away from the port, is a bit less valuable as evidenced by the PAG buyout numbers above right in the port. Applying a 20% bump to this number for by-the-port assets would come to ¥229,776/m².

Singapore’s sovereign wealth fund, GIC, purchased a logistics facility in August 2024 in Yokohama for ¥57B (US$400 million) that covered 126,000m² which works out to ¥452,380/m². And Nippon Life Insurance bought 3 logistics facilities in Osaka for ¥257,732/m² (¥50B / 194,000m²). Using these transactions and applying it to Keihin’s land size values it at ¥27.4B, not far from the ¥32B real estate value calculated above.

If we take the midpoint of these two values, ¥27.4B and ¥32.2B, and plug them into an adjusted net asset value calculation, Keihin is trading at 0.43x adjusted book value. Too cheap for a consistently profitable business with strategic assets in the major ports of Japan.

Takeout Multiples Lead to 100% Upside

The Japanese logistics industry has been an extremely fertile ground for takeovers and it doesn’t seem like it’s going to stop. Brookfield even said as much when they made their investment a few months ago. This is what one of their East Asian partners said after that deal happened:

Logisteed Ltd. (a subsidiary of KKR) also purchased Alps Logistics Co. last year and SG Holdings Co. (parent of Sagawa Express Co.) tendered for Chilled & Frozen Logistics.

One acquisition that jumps out was the most recent buyout of Nissin Corp. (9066) by Bain Capital just this month. Nissin is a larger, more profitable logistics company that operates on a global scale. Bain bought them out for ¥120B. Here are some of the buyout statistics I’ve compiled using their most recent financial statements and proxy filing:

I’m sure Bain got a pretty good deal and the land and buildings that Nissin owned are most likely extremely undervalued as well. After all, Nissin has been around for 80 years. There are probably costs that will be taken out of that business that would bring these multiples down too. Because Nissin is more profitable and operates on a global scale, when comparing to Keihin I discount the multiples by 20%. Even at the discounted multiples, Keihin could still offer 100% upside using different different valuation methodologies.

I don’t think it is a stretch that a company with a strong net cash balance sheet, significant real estate value that produces extremely durable profits could go for these kinds of multiples.

Management Acknowledges Low Stock Price

The company seems somewhat shareholder friendly so far as they have paid dividends, which were recently raised from ¥70/share to ¥80/share. On the current stock price this yields about 3%. They have also acknowledged in their most recent earnings forecast that returning profits to shareholders is important to them.

May 12, 2025 Earnings Forecast

On top of that, they stated in their 2024 Annual Report that their stock price is undervalued as well and one of their priorities is improving their PBR (price-to-book ratio) and ROE.

March 31, 2024 Annual Report

One way to obviously do this is to start using some of their excess cash and investments and buy back their stock. Buying at such a discount to book value would be extremely accretive to the remaining shareholders and would signal to the market that the company takes the new TSE guidelines and capital allocation seriously. I would be extremely supportive if Keihin goes this route, as I’m sure most investors would.

No Controlling Shareholder

There is also an opportunity for an activist to come in and make a bit of noise as no major shareholder owns over 10%. Some of these corporate shareholders might be friendly with one another and could vote for management friendly policies, but the whole point of the TSE guidelines is to get away from non-shareholder friendly corporate behaviour and to narrow the PBR discount.

Could This Be Another Perpetual Japanese Value Trap?

While historically Japanese stocks have been value traps, the Exchange’s guidelines are encouraging companies to take action to increase their share price and trade to at least 1x book. With Keihin, we have a company that pays out some profits to shareholders and just increased their dividend, a management team on record stating that improving the PBR is one of their priorities, and an industry that has been getting bought out left and right. Not to mention that the hard asset value provides strong downside protection.

Could the stock go no where and drift into value trap land? Yes, it’s possible. But I’ve learned that good things happen to cheap stocks over time.

Disclosure: long The Keihin Co., Ltd (9312)

Position Sizing Thought

The cream rises to the top.

That’s how I’ve been thinking about sizing positions recently. What I mean by that is letting the companies in your portfolio earn the right to be larger positions (h/t to Ian Cassel).

Don’t take a full sized position right away. Take a half sized position and see how the business plays out or if management does what they say they were going to do. If the stock goes up for good reasons, it deserves to be a larger part of your portfolio. It might be more beneficial to start adding then as clearly your thesis would be playing out.

If you buy a 5% position and it grows into a 20% position, I’d say that that company has absolutely earned the right to be a large part of your portfolio. While I get investors have different position limits they can take or risk tolerances, I would be perfectly fine not trimming that 20% position, provided if I could see more upside. Now if that position gets to 50% or more, that’s another story.

While I believe in concentrating in your best ideas, sometimes as investors (myself included), we tend to purchase a full sized position right away and look to add more as it goes down in value to keep the same allocation, hoping and believing that we’re right and the markets wrong. All the while, we might be better off purchasing a half sized position and watching it to see if the management team is executing like they said or if the business is performing like you anticipated. And then adding on the way up.

The counter to this is that if the stock has increased and you only made it a half sized position, you missed out on extra profits by not purchasing a full sized amount. But that seems like a good problem to have!

Of course if something ticks all of your boxes for your ideal investment you should load the boat. But coming across something like that doesn’t occur on a weekly or monthly basis and most investments probably deserve half sized positions at first. At least we shouldn’t be in such a rush to make everything so large a position right away.

Just a thought!

Leons: A Real Estate Co. Masquerading as a Furniture Retailer

Leon’s Furniture Ltd. (LNF.TO) is a dominant Canadian furniture retailer with leading market share that appears reasonably priced on the surface at 10x earnings. However, when taking into account their hidden real estate value that will eventually be IPO’d into a REIT, the stock appears deeply mispriced. With stable margins, consistent profits, a net cash balance sheet and other excess land value, I estimate nearly 100% upside to the stock price and limited downside due to the hard real estate assets that are more valuable than the retail business.

Capital Structure

Business background

Leon’s is the largest furniture retailer in Canada operating in every province under their main brands Leon’s Furniture (52 stores), The Brick (118 stores) and other smaller brands. They are ranked #1 in furniture and appliances and #2 in mattresses at roughly 20% market share of the total overall market. On top of the stores they corporately own and manage, they also franchise 35 Leon stores and 66 Brick stores which generated $33 million of revenues in 2024 out of a total $2.4 billion. The business has been around for over 100 years and was started in 1909 in the small town of Welland, Ontario. It was, and still is, a family-owned and run business and went public in 1969, which was followed by introducing the “big box” concept to Canada a few years later.

As the largest furniture retailer in Canada, Leon’s has an enormous scale over competitors in terms of sourcing inventory, advertising/marketing dollars spent and a wider selection over their large store footprint. When you think about a small mom & pop furniture retailer, they don’t have access to large volume purchasing discounts, they’ll have tiny advertising budgets compared to the big players that can’t be spread across multiple stores and their store spaces are smaller which means there are smaller selections of furniture available. Most retailers compete on price because when you are purchasing a couch, bed or stove you want good quality but you also want to buy at a good price. The brand you are purchasing is not really a factor you think about when shopping which helps Leon’s because they can offer a greater selection at affordable prices. You usually don’t go into a retailer with a particular brand in mind but go into the retailer looking for the best quality at the best price.

For being a furniture retailer that’s tied to 1) a cyclical industry while dealing with 2) high inflation and interest rates the past few years, Leon’s has enjoyed incredibly stable gross margins of 44% while remaining profitable during significant volatile periods over the past decade plus, which speaks to the quality of the operations.

Leon’s has averaged 25% ROIC the past decade with EBIT nearly doubling while compounding revenues at 3.5%. One of the reasons of increased revenues and profitability has been their 2013 purchase of The Brick. Leon’s purchased The Brick for $700m after they underwent a recapitalization a few years prior. They levered their balance sheet to finance the acquisition using $500m of debt and were able to pay it down over 5 years due to the large cash generation of the combined entities. Recently because of COVID, their e-commerce side of the business has grown substantially and now represents 10% of their revenues.

The company obtains all of their supply from 500 different suppliers and is therefore not beholden to any one supplier. They have wholly-owned subsidiaries based in Asia that helps them source their goods. 15% of their inventory comes from the US and with the Trump administration imposing tariffs on Canada, their vendors are potentially going to take the product and produce it offshore to avoid these tariffs or just hold the inventory until more clarity is given.

While I’m not expecting this business to grow revenues and earnings at large rates barring a large acquisition, a nice boost to Leon’s business in the current year could be that a large swath of Canadians are taking pride in purchasing Canadian made products as opposed to US made products as a result of the Trump admins stance on Canada. Q1 2025 results were just released and revenues were up 3%.

Why does this opportunity exist?

There are many reasons why the stock is currently mispriced:

• The Leon family owns about 70% of the shares outstanding. On a market cap of $1.5 billion, that means the total amount of publicly traded stock is really $450 million, hardly enough for large institutions to take a meaningful stake in the company or for any shareholder to gain any control.

• Low trading volumes. The average daily volume is typically 20K shares, and when you factor in a stock price of low 20’s, it results in daily dollar trading volume of just under half a million.

• The company is a furniture retailer. It doesn’t operate in the most exciting industry.

• Real estate has been hidden on the balance sheet. The real estate value has been recorded at the cost on the balance sheet and until the IPO of the REIT occurs, it will continue to be hidden.

• Limited investor outreach. There hasn’t been much outreach to the investment community in the past and the company doesn’t hold quarterly conferences calls.

• It’s been 2 years since announcing the IPO of REIT. May 2023 to today May 2025 marks 2 years of announcing their intention to form a REIT. Some investors could be losing a bit of patience with no given timeline of when it will actually occur.
  

Industry

The furniture industry is extremely competitive with low barriers to entry and high fragmentation. At the end of 2024, there were 3,151 furniture stores in Canada according to Statista with just over half of them in Quebec and Ontario. The total size of the market is about $20 billion with Leon’s at the top at about 20% and IKEA Canada around there as well based on their $2.8 billion in sales for 2024 (although 5% of that is food). Then there are smaller players like Structube (75 stores), Ashley’s Canada (60 stores) and then smaller regional players (BMTC Group - which is also developing its real estate) with a few mom and pop stores.

The past decade has seen many players leave the industry: Target left in 2015, Sears Canada left completely in 2018 and even handed some of their leases to Leon’s in the process, Bad Boy Industry went bankrupt in 2024 and shut down their 50 Canadian locations and Hudson’s Bay recently entered a restructuring process, although they are more a clothing retailer with a small amount of furniture. The result of this is that Leon’s has consolidated market share from ten years ago pre-Brick acquisition from 5%-6% to 20% now. While a couple of years old, as of 2021 81% of purchases in the furniture industry were made in stores which has probably increased a bit since as Leon’s just did $265m of their sales online, up quite a bit pre-COVID. If customers purchasing online continues to grow and make up a larger percentage of total industry volume, it could remove the need for large retail stores to do business and just operate distribution centers to deliver the products. However, currently most customers will look up online what they like, go in store to test it out, and then purchase.

Management

I view the board and management as extremely shareholder friendly. The current CEO who started in 2021, Mike Walsh, is the first CEO in Leon’s history who’s last name is not Leon. He used to be the President of Leon’s Furniture and then the COO prior to becoming the CEO and is very familiar with the business and industry. He also used to work for Canadian Tire when they were undergoing their REIT transaction. The Leon family clearly trusts him because not only is he the CEO who is an “outsider” to the family, but right after being hired he authorized a Substantial Issuer Bid and bought back $200m worth of shares at about where the shares trade today.

Leon’s also authorizes normal course issuer bids to buy back their stock and currently has one outstanding to repurchase 5% of their shares. On top of the buybacks, they also pay a regular dividend that yields 3.5%. The Leon family also owns 70% of the shares aligning our interest with theirs.

History Rhymes: The Canadian Tire/Loblaws Blueprint

The current path that Leon’s is following has been done before in the Canadian markets. 10 years ago Canadian Tire and Loblaws decided to IPO their real estate into a separate REIT, while maintaining a large majority stake. Canadian Tire sold 15% and kept 85% ownership and Loblaws sold 17% and kept 83%. This allowed Canadian Tire and Loblaws to highlight their underlying real estate value while receiving some cash for selling a minority stake. From when Canadian Tire announced in May 2013 to October 2013 IPO, the stock price was up 28% and one year after the announcement was up 78%, not taking the REIT value into account. Loblaws announced their intention to create a REIT in December 2012 when their stock was at $32. In July 2013 when the IPO occurred, their stock was at 42 for a 31% gain. Two years after announcing their intention the stock was up 66%, without accounting for the REIT value. One of the reasons Loblaws wanted to highlight their real estate value was so they could get their stock price up to make a bid for Shoppers Drug Mart using their stock as currency, which they did in the summer of 2013.

One worry about when companies sell their real estate or engage in some type of sale lease back transaction is that, well now they are going to have to make rent payments which will decrease earnings significantly. While true if you’re selling 100%, but if you are keeping a majority ownership initially, the effect should be minimal as the rental income you receive is offset by the rental expense going out. In their initial REIT presentations, both Canadian Tire and Loblaws showed the projected impact of a pro forma REIT on their financials (Canadian Tire presentation and Loblaws presentation)

Because they kept a large initial stake, there was a minimal effect on the EPS, while not only getting access to cash from selling a small percentage but also putting a mark on the real estate that was hidden in the balance sheet. By forming a REIT, it puts in team a place with experience running real estate and developing properties as Leon’s executives have experience in running retail operations, not developing real estate.

Valuing the REIT

On Leon’s balance sheet, there is $268 million in land and buildings recorded at historical cost sitting on the books that is worth multiples of that which will be transferred into the REIT. Right now Leon’s owns 50 owned properties that consists of 5.5 million square feet on 430 acres of land.

Their plan is to transfer the income producing properties into the REIT, IPO a stake while keeping a majority of the shares, and develop some of the land that they have that can be vended in over time. Based on just the 5.5m square feet, we can try to derive some type of value for the income producing portion of the real estate. While the value won’t be exact as the industrial and retail properties are located in different provinces that have different retail and industrial rental rates, we can come to a general view of the value. By using 1.2m of industrial square feet, 3.7m of retail square feet and 0.6m of other real estate and looking at rents per square feet for these types of assets, we can calculate a conservative total rental income, net operating income and then total value of the REIT.

Based on my estimates, total rental income would amount to $103m. I looked at CT REIT (Canadian Tire’s REIT) to give me a guide as to what additional expenses the REIT will incur. Assuming 21% of total income goes to property expenses and 3% to G&A for being publicly listed and corporate overhead, net operating income would be $78m. Putting a cap rate of 6.5% on that equates to $1.2B of value for the REIT. By selling 15% upon IPO, Leon’s can pocket $180m of cash.

Excess Land Value

In addition to the REIT value, Leon’s also owns excess acreage on their owned properties that they are currently looking to develop now and more potentially in the future. The most immediate development is where their headquarters sits at the intersection of the 401 and 400 highway in Toronto. The plan is to partner with developers who will construct a master planned community consisting of 4,000 residential units and also reconfigure their headquarters.

Valuing this development can be a bit tricky as we don’t know the agreement that will be in place on a potential split with the developers, financing involved, margins or timeline. We do know that the total buildable square footage will be 4.6m for this property. If we use the average 2024 $123 pbsf in the GTA, the total value of the land could be $565m. Using the higher range of sales that occurred in 2024 at $202 pbsf, the value could be $929m. Leon’s in still in the process of getting approvals from the City of Toronto for this piece of land and plan on submitting a Secondary Plan in mid-2025.

Of the 430 acres that Leon’s owns across Canada (mainly in Ontario), Toronto is just 40 acres of that. They also have 32 acres in Burlington that they could redevelop due to the dual zoning structure of the land. As well as their Missisauga location off the 401 amongst many others. Because a lot of their stores are classified as an industrial node, they can take the retail portion of the store and reconstruct it into more of a retail node, determine what the “highest and best use of the land is” other land is, and redevelop it. Management has said that if they go from 22 warehouses to 1 or 2 distribution centers, it could free up a lot of real estate. Only the Toronto master planned community development is factored into my valuation. I would imagine the other portions of the land would be worth millions if not hundreds of millions of dollars.

Retail Value

Predicting the value of the retail division is slightly less difficult than the real estate parts. Because the business has been so durable over the years with consistent margins and profitability, the value should not swing by much year to year. Assuming $2.5 billion in sales with 44% gross margins, SG&A amounting to 37% of revenue and incremental rent expense that needs to flow through the P/L due to the REIT IPO, we can arrive at a net income amount of $139m.

What multiple should this business trade at? Fairfax just bought Sleep Country in 2024 for $1.7B at about 17x earnings or 8-10 times EV/EBITDA according to the Proxy Circular. And Canadian Tire trades at a forward 2025 P/E of 12x today. To be conservative, I’ll use 10x earnings even though Leon’s is a larger company than Sleep Country with more product diversity but smaller than Canadian Tire with Canadian Tire retailing more auto and outdoor goods. Using these numbers gets to $1.3 billion for the retail business.

Putting it All Together

If we sum up the value of 1) the independent retailer, 2) the REIT, 3) the Toronto land, 4) the REIT sale proceeds and 5) the net cash on the balance sheet, the total value is $49/share, about 100% upside. This also doesn’t take into account the other land value that Leon’s could potentially develop, making the company even more valuable.

Catalysts

• Completion of the REIT IPO. While it has been two years since Leon’s announced their intention to complete their REIT transactions, we should be getting closer to when it actually comes to fruition. One thing to watch for is if they get approval to list on the Toronto Stock Exchange.

• Potential acquisitions. Management has mentioned that, due to the strong balance sheet, they have numerous avenues to deploy capital by potentially taking on debt. An acquisition could be one method if the price was right.

• Market share gains. Over the past decade the company has gone from single digit market share to about 20% and if current retailers keep going out of business, Leon’s would more than likely increase their market share.

• Accelerated stock repurchases. The company has shown that they aren’t afraid of repurchasing large blocks of stock in one transaction and if the price languishes in the low 20’s for some time, we might see another SIB.

• Canadian Gen Z FOMO. While this catalyst is a bit tongue in cheek, with the early Canadian generations of today effectively locked out of the real estate market due to rapid price appreciation the past few years, Leon’s stock could offer a way for Gen Z to buy Canadian real estate property at bargain prices and for them to realize that value via the REIT unlock.

Risks

While I believe the stock has minimal downside due to the stability of the retail business and hard real estate value, there are some risks to the idea not working out:

• Delayed or failed IPO. It’s been two years since they announced they were going to IPO the real estate. It took Canadian Tire and Loblaws months to go from announcement to IPO. There is still no given timeline as of there most recent Q1 2025 earnings press release.

• Downturn could delay retail purchases. If the Canadian consumer continues to get squeezed by higher inflation or higher rates, they could delay making furniture purchases until they have more disposable income. The nice thing about Leon’s is that they have survived and maintained profitability in pretty severe economic environments (COVID being one of the main ones).

• Reversal of Canadian immigration boom. Canada has experienced a large population increase in the past decade going from 35m to 40m, which many commentators point to the the large real estate boom. Any reversal of this could potentially lead to a decrease in all items related to housing spend. Recent polls show Canadians would prefer a more sensible immigration policy than has been shown in the past 10 years.

Disclosure: Long LNF.TO

Early Findings in the Tokyo Stock Exchange

Japan has been what is termed a “value trap” for years. The companies listed there had always traded a huge discounts to book/net asset value/ earnings while stock piling cash on their balance sheet. No real activism could take place because a lot of companies in Japan had “cross-shareholdings”, where different Japanese companies owned stakes in other Japanese companies, effectively blocking any potential activist from taking a position and agitating for better corporate governance or capital allocation policies.

However, the Japan of yesteryear is completely different from the Japan of today as the country has undergone a renaissance of corporate change the past few years. In 2022, the Tokyo Stock Exchange reorganized from 4 market sections into 3: the TSE Prime, Standard and Growth. The Prime market is for companies that have large market caps, investable to many institutional investors and good corporate governance with an open dialogue with investors.

You can read about the listing requirements for the other 2 segments here.

Then in 2023, the Tokyo Stock Exchange put out a paper titled “Action to Implement Management that is Conscious of Cost of Capital and Stock Price” for companies in the Prime and Standard markets that pushes the companies to disclose their cost of capital and if they are trading under 1x price-to-book, to discuss the reasons why and plans to get it up to 1x. The Japan Exchange Group has put out Case Studies for the Prime and Standard markets on companies that have disclosed their plans and what effective communication from companies should look like. And they even put out a list of companies that have disclosed or submitted their plans and update it monthly.

So what does this all mean?

It means in Japan there are currently hundred of companies trading at depressed valuations, with overcapitalized balance sheets on low earnings multiples that have the “largest activist” on their back to act as a catalyst to realize full value or near full value for their shares: the TSE and the Japanese government.

Not to mention that out of the top ten activist funds in 2024, a large portion of their activity was focused on Japan:

Strategic Capital, Oasis, Dalton Investments and Murakami Funds all have activist positions exclusively in Japan I believe. The number of Japanese activist engagements is at an all time high in 2024 as well:

You can see that the Tokyo Stock Exchange new guideline implementations and the activists are making real capital allocation changes as Japanese buybacks were at an all time high in 2024:

Management buyouts are also at the highest levels since 2011 and the Tokyo Stock Exchange is looking to change the Corporate Code of Conduct that will require firms to improve disclosures around the assumptions of how management teams arrive at their buyout prices. The companies are also being told to reduce and sell off their cross-shareholdings of other companies as these inter-company “investments” reduce the company’s overall capital efficiency and promote poor corporate governance as these friendly shareholders won’t hold the management team accountable.
I’ve started to do a bit of digging and some of the companies that I’ve looked at so far seem egregiously cheap (no position in any of these yet):

The Kaneshita Construction Co., Ltd. (1897)

The company is engaged in the construction industry and sells asphalt products and other construction materials as well as operates a conveyor belt sushi restaurant business. If I were to show you the balance sheet and income statement and had you guess what they were worth, I bet many would be off by a large percentage. This is the balance sheet:

And then the income statement:

If you just take the total cash of ¥8.8 billion plus the investment securities of ¥8 billion less all liabilities of ¥3 billion, you get ¥13.8 billion in value with out taking into account any other asset or the operations of the business. If you calculate the NCAV (current assets plus LT securities less all liabilities) your value would be about ¥17 billion. If you use true NCAV (CA - CL), the value is ¥9 billion. And just using book value, the value is ¥18.8 billion.

This company currently trades in the market for ¥5.6 billion (¥2,652 x 2.1m shares). Which means it’s trading a 0.3x book value, with that book value made up of mostly cash and securities. And oh ya, the company has been consistently profitable the past few years. At least 11% of the shares are owned by the Kanashita family with the remaining large chunks owned by Japanese financial institutions. The company pays a paltry 50/share dividend and has announced a 3% share buyback which is hugely accretive because the company trades so cheap.

Takahashi Curtain Wall Corporation (1994.T) - Takahashi has the number one market share in the Japanese precast concrete curtain wall industry. It has been profitable the last 5 years with various swings in income levels.

It’s stock is currently ¥470/share and there are are 9.55 million shares outstanding for a market cap of ¥4.48 billion. It has ¥1.028 billion in cash and ¥222 million of securities against total debt of ¥1.326 billion so EV is ¥4.556 billion. The past 6 year average EBIT is ¥790 million for a trailing 5 year average of 5.8x EV/EBIT. However, they have tons of other building, land and investment property value on the balance sheet for a total book value of ¥10.772 billion which means it’s trading at 0.41x book value. ¥98 million of the securities on the balance sheet is Sumitomo Realty Development which is currently being targeted by Elliot. About 30%-40% of the shares are held by the Takahashi family.

The Torigoe Co., Ltd. (2009.T) - Sells flours and other food products in Japan. With a share price of ¥825 and shares outstanding of 26m, the market cap is ¥21.5B. Torigoe has ¥10.3B in cash and ¥13.4 billion in short term & long term securities against total debt of ¥3.2B which implies an enterprise value of ¥1 billion. Meanwhile the company did ¥1B of operating income in each of the last 2 years. Are they overearning? I don’t currently know. But trading at trailing 1x EV/EBIT is absolutely dirt cheap and this doesn’t take into account the 10B in buildings and land. Of course there are some liabilities totalling ¥9 billion but book value is ¥35.9 billion so it’s trading at 60% of book. There doesn’t seem like there is a controlling shareholder as just 5% increments sit in certain Japanese financial institutional hands.

Heian Ceremony Service Co., Ltd (2344.T) - Has 4 different segments: 1) funeral services where it operates about 50 funeral halls and parlors, 2) two wedding facilities in their wedding segment, 3) a mutual aid business and 4) a nursing care business. Stock price is ¥800, shares outstanding of 12.3m for a market cap of ¥9.84 billion. For that price you get ¥7.4B in cash, ¥2.5B in securities with no real true debt (using the most recent 3Q report) so essentially nil or negative enterprise value. They did ¥1.5 billion in operating profit last year. Their total assets of ¥33.7 billion is made up of mainly land of ¥10 billion, cash of ¥7.4 billion and buildings of ¥6.3 billion. Against total liabilities of ¥12.69 billion, book value is ¥21 billion which means it’s trading at 0.47x book. Another ridiculously cheap stock.

What I’m Looking For

I am sure there are hundreds more like these which brings me to the point of what I’m going to look for when I build my basket up of these companies. I’ll be looking to add about 5-15 stocks based on the following factors/rankings:

1) Degree of cheapness/undervaluation

2) History of profitability

3) Open register/activist involvement

4) Liquidity

5) Business quality

6) Low debt levels

For companies that fit all of these criteria, they’ll represent a larger portion of the basket compared to other companies that don’t.

Some other good sources of material

Neuberger Berman 2023 White Paper

Dalton Investments - Price to Book is Back?

Japan’s Orphans

ACGA Open Letter: Strategic Shareholdings in Corporate Japan

Some Stocks Worth Monitoring

Thought I’d quickly share 2 stocks I’m adding to my watch list.

Fab-Form Industries ($FBF.V)

Why am I adding this one? 4 reasons:

• The company’s stock price has gotten cut in half the past year

• They created a niche product that could change the way construction sites pour concrete

• Rock solid balance sheet with no debt and 2/3rds of total assets in cash and short-term investments.

• High levels of insider ownership

Fab-Form was started in 1986 in Vancouver B.C. and became public in 1999. It operates in the construction industry and develops and manufactures certain concrete-forming products. For example, their Fastfoot product is a laid out mesh product that helps builders pour concrete footings in order for the concrete to properly form without using excess lumber to keep it in place. They also make insulated concrete forms (ICF), which uses styrofoam to reinforce the concrete walls. They build and supply these products within the region of Vancouver. They have a new product coming out called Fast-Tube that helps guide the pouring of circular concrete walls which the CEO thinks the TAM could be a billion dollars. It competes directly with Sonotube (made by Sonoco), which uses a cardboard like cyclinder to help the concrete stay in place. Instead of the cardboard cylinder of Sonotube, Fast-Tube is a mesh, which fills up as the concrete is poured and is a much better mouse trap as it is way more efficient from a storage and transportation aspect that Sonotube.

The stock has gotten cut in half in the past year due to the decline in sales and the increased capital expenditures as the company has been investing into new products.

It’s grown from a $2-$3m business pre-Covid to peak revenues of $6.1m in 2022 and has steadily declined since. With the business being in the construction industry, it is cyclical and is affected by local housing starts, the weather (as bad weather delays construction activity) and interest rates. For only having 10 employees, it is a nice little business that is aiming to grow a lot more. The gross margins have averaged mid 30% but the operating expenses have stayed somewhat fixed over the past few years which has given them nice operating leverage which you’ll see in their increased net margins. There has been no real dilution of the shares outstanding and the company has maintained great profitability as evidenced by their ROIC and profit margins.

The company has a cash-rich balance sheet with no debt and doesn’t need much capital to operate. Management has stated that some of that cash they want to use for R&D for new products and potentially use it for marketing dollars to get the word out about these products. It’s clear they don’t need that much capital as total net working capital and PP&E is only a couple hundred thousand a year.

Richard Fearn was the president and CEO from 1986 to 2023 until he stepped aside and now Joey Fearn (his son) runs the business. Joey has been in the business for years and obviously knows the company as well as anyone. Richard owns a stake of 3.8m shares and Joey owns 192K shares as of the most recent proxy. Total insider ownership I believe is about 40% as employees own some stakes as well which creates a tight share structure and limits liquidity.

The proxy itself is a good read as the company highlights that “compensation must be performance-based”, “at least 10% of all employees’ compensation should be at performance risk”, highlighting strong ownership culture with the main focus being on building shareholder value.

On a trailing earnings basis adjusted for cash, it’s trading at about an 8x P/E multiple, 5.3x FCF multiple and 6.5 EV/EBITDA multiple.

While somewhat cheap, it’s not egregisouly cheap and to make me a bit more interested I need to see an outlined plan of what they intend on doing with their excess capital (preferably M&A or tender offer) and a return to growth. The company discloses the sale of each of their products so we can track how their new product Fast-Tube is selling.

Reitmans Limited (RET.V, RET-A.V)

Retail is one of the toughest businesses to be in. There is a lot of operating leverage but it’s also next to impossible to predict fashion trends and guess what people will want to buy. You also have to invest large amounts into inventory to sell throughout the year based on what you think your customers will like and if it doesn’t sell, one or two bad years can potentially put you under. However, there is something to be said for retailers that have been around for almost 100 years (even if this one just went through a restructuring process).

They entered CCAA (which is the Canadian bankruptcy proceedings) in 2020 and emerged in 2022. During the restructuring process, they shut down 2 unprofitable brands and let go a bunch of employees. They went from an unprofitable business to a profitable one:

I’ll admit that one of the brands they own, RW & Co., is probably my favourite clothing place. Little did I know when I came across the stock how cheap it really is:

The company is basically trading at it’s cash balance or a negative EV when not taking the lease liabilities into account. It’s at about 2x EBITDA when we factor them in. It’s also trading at a discount to reported book value of $5.6/share. They own their corporate headquarters and distribution centre in Montreal. Ernst and Young performed a liquidation analysis during the CCAA process and valued the headquarters and distribution centre at $114 million, compared to the current $88 million cost on the balance sheet. If we performed an adjusted NAV calculation and bump the PP&E up to $114 million, the adjusted NAV/share would be $6.3/share. If you were to assume last year’s EBITDA margin of 5% against $780 million in total revenues, it gets you to $39 million (this is not adding back ROU and interest depreciation. The EBITDA in the above Valuation adds it back because leases are added on to the EV). Put any type of low multiple to that, say 5x, you are at $195 million or $3.7/share, without taking into account any of the excess cash or building value.

The problem is that the controlling family, the Reitman’s, don’t seem to want to take shareholder friendly actions regarding capital allocation and corporate governance. Out of the 13.4 million common voting shares, they own 56.5% and 8% of the 38.95 million Class A non-voting shares.

Right now they own three retail brands:

1) Reitmans which is a female retail brand with 223 stores across Canada

2) Penn Penningtons which does mens and womens retail in 86 stores

3) RW & Co. which does mens and womens fashion as well in 81 stores across Canada. It operates on a similar level of Banana Republic quality/price point, just a bit above H&M.

They don’t segment their financials between brands but between retail store sales and ecommerce so there is no real way to gauge how each brand is performing.

Donville Kent sent a letter to the board in 2023 asking to eliminate the dual-class share structure, initiate a stock buyback, uplist the shares back on the TSX and have an investor relations presence by holding conference calls and having better communication to the investment community.

The company has taken some of their recommendations so far by introducing a stock buyback in the summer of 2024 but the amount and pace of the buyback so far has been small. And they also hired an investor relations firm last May as well. These are steps in the right direction but the stock has not gone anywhere still and you can get a sense of shareholders fustration based on their last conference call. The below is from Parma Investments on the call:

I would go even one further than what Donville Kent outlined in their letter and ask the board to form a strategic comittee to see if it makes sense to complete a sale leaseback on either one or both of their owned distribution centre and corporate head office and do a tender offer. They also just hired an outside the family CEO and gave her options with a strike price right around where the stock is trading currently.

For now, I’ll be on the lookout for any type of change to capital allocation i.e. increased speed of buybacks or corporate governance. This stock strikes me as a potential MBO opportunity if the market continues to not value it properly.

Disclosure : Added to Watchlist

A Tetragon of Catalysts

Note: This write up was based on a $15.5 stock price and it is currently sitting at $15.05. Some of the numbers will have changed due to this but the thesis still remains.

Tetragon Financial is a closed-end investment fund that trades on the Euronext and LSE at a significant 57% discount to management’s NAV of 35.43/share with potential catalysts on the horizon to unlock this value. Tetragon has limited downside based on hard NAV and huge upside optionality depending on the event path that can range from 61% - 234%+. This is a low risk, highly uncertain bet, in my opinion, based on the range of options management can take this. Some highlights of the investment are:

• Potential sale of their largest holding, Equitix, that would equate to a $6 per share NAV uplift or $16/share in cash added to the balance sheet vs a current $15.5 stock price.

• Buyback/tender offer from proceeds of sale at significant discount to NAV.

• Ripple Labs IPO, where Tetragon holds a 2% investment and by my calculations, owns an indirect “look through” XRP token value of $23.46/share

• Other potential asset sales and returns of capital

This is one of the more interesting set ups I’ve seen recently. On top of the catalysts, you collect a 3% dividend while you wait.

History

Tetragon invests in different asset classes and IPO’d in 2007 at $10 a share. The stock has pretty much traded sideways at that price since. It has a checkered history starting a couple of years after their IPO. In the early 2010’s hedge fund manager Leon Cooperman sued and released some letters to the board. If you want to read the lawsuit you can here. The gist of it was executive pay was too high, no high water mark on the performance fee calculation, disagreements on capital allocation and the main one: Tetragon founders sold Polygon Management LP, in which they were also founders in, to Tetragon for shares of Tetragon, only to have Tetragon than announce a $150 million buyback the same date. The valuation for the purchase of Polygon wasn’t released, shareholders didn’t get a vote and the whole process was done in the dark with related party conflicts. The lawsuit was eventually thrown out.

There is also the fact that during the GFC, management took down their NAV (as mostly everything was down then) but double dipped on performance fees on their way up as the NAV was written back up as a result of the no high water mark.

Both of these events have left a stain, in my view, on the company which is why it trades at such a large discount to the underlying NAV now and the past decade.

What’s changed vs what hasn’t?

For one, management has actually compounded NAV at a decent clip of about 11% at the same time earning ROEs at the same rate.

When Tetragon first started, the large majority of NAV was made up of a portfolio of CLO’s and bank loans. Today, the bank loan and CLO portion of the portfolio only make up 5%, with ownership of asset management, hedge funds and venture capital comprising over 50% of NAV now. This is a breakdown of their current NAV:

Insider ownership has gone from 11% a decade ago to now sitting at 40%. The lawsuits have all been settled and are now a thing of the past. The hurdle rate to earn their incentive fee is now a larger percentage as in years past it was based on LIBOR + 2.6% where LIBOR was under 1% or equal to it. Now it is based on SOFR + 2.7% but rates are a lot higher today so today the hurdle would be about 7% compared to 3%-3.5% a decade ago.

However, management is still paid a 1.5% of NAV fee and there is still no high water mark. The shares that any shareholder buys are also non-voting shares as in the past too.

Why does this opportunity exists?

If you mention Tetragon to most investors, I am sure they will roll their eyes. Many will remember the lack of a high water mark for the incentive fee or the fact that when you purchase shares, your shares are non-voting. Both are valid reasons and why there is such a large discrepancy between price and NAV. These two reasons are certainly enough to produce an “ick” factor associated with this investment. If you look at the Association of Investment Companies webpage (350 members of the closed-end investment industry in the UK), Tetragon is on the last page when sorted buy price to discount from NAV.

Some secondary reasons creating the opportunity are:

• The company reports in USD, trades on the Euronext and LSE and is Guernsey domiciled.

• Closed-end investment funds should trade at a discount to NAV

• The market doesn’t believe management’s stated asset value

There is a very fatigued shareholder base that has sat on dead money for the past decade and only until the past few months has the stock had a very positive reaction causing the current set up.

Current set up

Thesis #1 - Sale of Equitix

Reuters had a report out in October that Tetragon was in talks to sell Equitix, in which it has a 75% stake in and represents 26% of NAV i.e. their largest holding. The report went on to cite that the value could be 1.5 billion pounds based off of 11 billion pounds of AUM (US $13.8B). Equitix owns some unique infrastructure assets that should be highly coveted by large asset management firms like the contract to operate and maintain the M25, a major highway that surrounds London, or the High Speed 1 30-year contract to operate UK’s high speed rail plus many more.

How likely is the sale? I would give it greater than 50% odds as it was reported by a very creditable source and also confirmed by the company, amongst possibly other potential asset sales. The only reason the company confirms this is to let other bidders know that they are accepting offers or shopping the asset as generally companies don’t comment on press report speculation.

A sale price of 1.5 billion pounds converts into US $1.936 billion. Using a 75% ownership ratio as the 81.48% given in the financials is a little unclear exactly if they receive that full amount, Tetragon would receive US $1.452 billion, which means there would be a value uplift of US$529.6 million to NAV based off of reported NAV for Equitix of US$922.4 million on Dec. 31, 2024. This results in an extra $6/share in NAV uplift or brings on $16/share of cash on the balance sheet, which is just a bit more than where the stock trades today. Even though the company purchased their stake in Equitix for US $208 million, from my understanding of Guernsey tax law there are no capital gains tax and would therefore not have a taxable event.

The infrastructure space has been ripe for deals. BlackRock bought Global Infrastructure Partners for $12.5 billion, which held $100 billion in AUM, for a percentage of 12.5% AUM. CVC Capital Partners just bought infrastructure manager DIF and General Atlantic bought Actis. All these deals could have been a potential trigger for Tetragon to solicit bids and test the market

What could the potential value of Tetragon trade at if they sell Equitix? Based on using 60% price to NAV, it could be worth $25 for upside of 61%. The stock has historically traded at 50% of NAV for the past 10 years but I would argue that a company that’s compounded NAV at 11% since IPO and is willing to sell their largest component of NAV for cash , and maybe return that cash, could see a decrease in the discount from price to NAV. Even if you use 50% there is still a bit of upside.

Thesis #2 - Explore return of capital via tender or special dividend

If/once Equitix is sold, I believe Tetragon could look to make a tender offer using the proceeds at a significant discount to NAV. Management and Tetragon employees own about 40% of the company and would be highly incentivized to see the stock price increase now. What is the use of owning such a large chunk of a significantly undervalued company if you cannot sell your shares for their true fair value? I am assuming the tender occurs at $25 because that’s the value I have if Equitix is sold. It could, if it occurs, happen at levels below $25 which would be even more accretive to NAV. But assuming a tender is done at $25, it could result in 80% upside.

Thesis #3 - Potential IPO of Ripple Labs

This is where the thesis gets really interesting. I’ll preface by saying that I am in no way a crypto expert but I like situations with extreme optionality on the upside, even if there are different event paths that could occur. The late grate Michael Price called this the steak and sizzle approach. Focus on the steak and get the sizzle for free.

In 2019, Tetragon made a Series C preferred equity investment in Ripple Labs for $150 million with the option of Ripple redeeming their investment if it was ruled that XRP was a security on a go-forward basis. The SEC sued Ripple in 2020 stating they had been issuing unregistered securities from the sale of XRP, which led to Tetragon suing Ripple to redeem their investment as a result of the SEC lawsuit. Tetragon’s suit was dimissed and Ripple decided to buyout the Series C preferred back anyways in 2021. Tetragon then purchased Series A and B preferred of Ripple on the secondary market. While they have never disclosed the price paid or terms, there have been reports that they own about 2% of Ripple. Although not a perfect method, triangulating what Ripple is carried at on Tetragon’s balance sheet vs Ripple valuation in 2024 comes to roughly 2%:

What’s interesting about their Ripple investment though is that Ripple in January 2024 owned $25 billion worth of XRP tokens on their balance sheet at a rough price of $0.5/token when they did their tender offer for $11.3 billion last year. This meant they were buying back shares at under a 50% discount to net asset value and I believe they made another tender in 2024. And now one year later, the XRP price has gone vertical:

Sitting at just around $2.3, their XRP tokens are now worth more than $100 billion, thanks to a nearly 5-fold increase in price and the CEO of Ripple thinks the original $11.3 billion valuation of Ripple is “very outdated”. The drastic price increase is as a result of the friendly Trump administration coming into office, the resignation of Gary Gensler who was antagonistic to Ripple, Ripple only having to pay a $125 million dollar fine which was substantially below the $2 billion the SEC wanted from their lawsuit and the SEC recently approving bitcoin ETFs. Not to mention a potential US Strategic Reserve for purchasing cryptocurrencies that could come into affect.

Ripple’s balance sheet isn’t public so we can’t see exactly how many tokens of XRP it holds but its around 46 billion against a total supply of 100 billion according to various news outlets. At today’s price of $2.3, Ripple owns about $105 billion XRP on balance sheet. At Tetragon’s current stock price, the “look through” ownership of their XRP holdings are about $23.46 which means Tetragon’s implicit value less their holdings is negative 720 million. Stated another way, an investment in Tetragon today means you are receiving about 3B of assets for a negative $720 million.

GAM Global Special Situations Fund has noticed the same implicit value in SBI Holdings, which is a Japanese financial services company that owns 8%-9% of Ripple and based on their look-through holdings, is trading at a negative market cap as well. They recently sent a letter to SBI you can read here. They want SBI to publish a daily figure of SBI’s lookthrough XRP holdings and to establish a public XRP coin buying program buy purchasing the coins outright to close the gap to NAV, similar to what Microstrategy has done in the US.

And Ripple itself is essentially doing somewhat of a reverse Microstrategy approach. Microstrategy issues equity at a premium to NAV and buys bitcoin whereas Ripple is just tendering for shares at a severe discount to NAV and could/should possibly sell some on balance sheet XRP and use it to repurchase more shares.

So what is the likelihood of Ripple going public and potentially releasing all of this value? Last January Ripple was looking to go public outside the U.S. because of the hostile SEC and decided to put it on hold. Since then, Gary Gensler is no longer the SEC chairman and the Trump administration has been viewed as extremely favourable to the crypto industry. Trump even issued his own coin days before he entered the white house with the first lady following suit. The CEO of Ripple has stated that going public wasn’t prioritized previously because of the prior SEC administration. With that administration now gone, experts are predicting late 2025 to 2026, potentially once the lawsuit with the SEC is finalized. I have no unique insight into when this could occur but view it as extremely positive for this investment (maybe not for society overall) that the administration is very pro crypto. While Ripple does trade on certain private markets online, coming to a precise valuation is near impossible due to no real business numbers being available. Just using a valuation of $15B, almost a 50% increase from their tender, gets to an overall stock price of Tetragon up 84%.

While the above valuation is just valuing Ripple’s potential business based on a gain from their last tender of $11.3 billion, this investment can get a bit silly on potential upside optionality if/when Ripple comes public and the market chooses to value it based on their on balance sheet XRP holdings. If the market were to value it just at todays XRP value of $105B, the upside can be quite dramatic.

And if Ripple starts trading like how the market values Microstrategy, at a multiple of their bitcoin holdings, Ripple could be worth a multiple of the 105B on balance sheet crypto holdings. The scenario above doesn’t account for the fact that the XRP token price could increase in value, or that Ripple would most likely be a highly coveted IPO by a lot of retail traders and garner a huge valuation.

Thesis #4 - Other asset sales

There is the possibility of other asset sales on top of Equitix. One of the analysts covering Tetragon thinks the BGO asset could be disposed of in the near term. While this would be viewed favourably by the market (of course depending on price and uses of the cash), it is not a main point to the overall thesis but would be most welcomed.

Potential Value Creation

Management and other executives own about 40% of the company, with the two main founders Reade Griffith and Paddy Dear owning 27%. I think they have done a relatively good job of compounding NAV since inception at 11%. One thing that does bother me is management’s aloofness on how to close the discount to NAV. On the most recent call they said “they don’t think there is a clear silver bullet to closing the discount to NAV”. I lay out some options on what I would do to close the discount at the end of this write up but with the persistent discount to NAV ongoing, upper management have the option of collecting their combined $50-$100m incentive fees per year until they retire in 5-10 years, or they have the option of creating a ton of value right up front. Based on my valuations, this could be the potential value they can create for themselves:

Risks

In all potential deals, there is the possibility of the sale falling through. If the Equitix sale doesn’t occur, it is possible this trades back down a bit and is dead money. I don’t think it should trade back down to 10, it might go down to the 11-12 range based on the markets perception that the company is willing to entertain offers for some of its assets and turn at least some of their investment NAV into cash.

What if Equitix might not get as a high a price as reported? Anything at NAV or above and turning their investment into cash is a win in my opinion as they could still use that cash to repurchase at a significant discount to NAV.

Or what if the company chooses to reinvest any proceeds from asset sales into other investments? While a bit of risk, it wouldn’t be a terrible outcome as management has shown they can grow NAV at a decent clip. However, this wouldn’t allow for larger outsized returns as outlined above in my opinion.

There is also the risk that if a down turn occurs, management can write down NAV, write it back up and double dip like they did in the GFC. I give this situation occurring low odds. Back in the GFC, management owned just loans and CLO’s, assets that were heavily affected by the crisis and most likely deserved to be written down then. Now they own a more diverse set of assets. We’ve also seen during the COVID 2020 market that their NAV actually increased, which should dispel most of this risk. The company could also face a barrage of lawsuits from investors, tainting the investment in the stock even more and thereby increasing the price to NAV of where it trades, in which management owns 40% and not giving them a path to realize their holdings at fair value.

What if Ripple doesn’t IPO or the price of XRP drops? While a lot of the upside of the investment could be tied to a Ripple IPO and their significant holdings of XRP on balance sheet, you don’t need the Ripple IPO to occur to earn a decent return in the stock. While it would be nice for Ripple to IPO and be a highly coveted asset by retailer and institutional investors, if they stay private they can still grow their value without going public. And even if their value doesn’t increase, Tetragon the stock, can still earn a good return if management liquidates some assets and repurchases shares.

Event Path If I Were Management

The first step I would take is currently what mangement is doing. Putting one of your largest holdings on the block and trying to crystalize that value. I would also sell another asset as well for further NAV uplift. Once these sales occur, I would announce a larger tender at a significant discount to NAV in order for NAV/share to grow even further, increasing management’s and investors who choose to stick around ownership further.

The next step, however unlikely, would be to convert the non-voting shares into voting. If management doesn’t sell back into the tender, they could go above 50%, thereby making the newly proposed voting shares semantics as they would now control the voting shares and eliminate some of the discount to NAV. At the same time, instill a high water mark which would further erase some of the discount to NAV. Instead of the high water being just NAV, tie it to some type of performance based measurement of shareholder value like stock price. These two steps I would do after the tender to allow a larger price to NAV gap to exist during the buyback.

Once these are done, start highlighting the Ripple investment and the indirect “look through” XRP that Tetragon now holds. This could show the market that one of the ways to play the Ripple IPO would be by owning Tetragon, thereby increasing demand for the stock.

Disclosure: Long TFG.AS, TFG.LN

Investment Idea: Currency Exchange International

Currency Exchange International - Long

Note: this was written up based off a $15.93 stock price and it is now trading at $15.25.

Jerry Jones Outsized Returns; Interesting Reads

I was listening to the Founders podcast episode on Jerry Jones and wanted to jot down some key characteristics of what made some of his investments so great as well as a brief summary of the podcast. I highly recommend listening to it. I wasn’t aware that Jerry’s Cowboys purchase was a deep value turnaround.

Jerry Jones had always wanted to purchase an NFL team. He had told everybody all his life he wanted to. But first he had to make some money to finance it. He made a bit of money when his father sold his insurance company that Jerry helped build and which netted him about $500,000. Since he was extremely hungry to become rich, he then moved to Little Rock, Arkansas and wanted to get into the oil business. His first deal was when he met someone who was shopping an oil deal that everyone had turned down and had said no to. Jerry was the only person who had said yes, while at the time he was selling mobile homes.

The result?

The group hit their first well that was worth more than $4 million dollars. And they kept hitting wells each time they drilled for 15 consecutive times. He ended up selling 1 of his oil production companies in 1976 for $50 million.

What allowed him to make an outsized return on this investment that I think can apply to public markets or any type of investment is 1)When people turn their nose up at it and think it is dumb/crazy, 2) There is an ick factor associated with the investment and 3) Everyone doesn’t want to touch it and says no to it. When any of these characteristics apply to an investment you are being pitched, I believe it would pay to do more work. Or to look for investments that people think are dumb/crazy to invest in to. I don’t mean to go look for huge cash burning non-revenue generating businesses, but real businesses with downside protection that others don’t or can’t touch for whatever reason. A good example wold be General Growth Properties in 2008.

2nd and 3rd Investment

After his first success, in 1980 he decides to drill for natural gas with a partner and they take a shot drilling at 2 wells. One near San Francisco and one in South Eastern Oklahoma. Right away, the production was a disaster as an employee made a half a million-dollar mistake by accidentally dumping cement in the well ruining it at their Oklahoma location. They then invested another $500,000 and moved the drill bit 100 feet and the next day hit a natural gas well worth over $40 million. While this was happening, the San Francisco well was going to be worth $40 million over a two-year period. In total, they made $80 million on their first two natural gas drills.

The last deal he does before buying the Cowboys is extremely interesting. Jerry’s friend was the CEO of Arkansas-Louisiana Gas Company, which is the state regulated utility company. In 1981, Jones forms a new gas drilling company called Arkoma Production Company. He then enters into a deal with Arkansas-Louisana Gas Company (which people say is one of the greatest sweet heart deals of all time) that allows Jones’ company to sell gas to this utility company (which his friend is the CEO of) at a price much higher than what the utility company was currently paying other gas companies for their gas. The deal was for $4.50/thousand cubic feet, which meant Arkoma was getting more than 9x the price that other natural gas producers were selling their product for.

Then in 1985, the natural gas industry was deregulated and the price of natural gas went down significantly. But because of the terms of the agreement between Arkoma and the utility, the utility company had to purchase from Arkoma the most amount of gas it could produce at the maximum legal price. Jones then decides to purchase other natural gas producers that didn’t have this sweetheart deal because he has a guaranteed price he can sell to the utility company compared to what all the other natural gas producers could currently sell at. Thereby buying more supply and selling the gas at the inflated rate. The end result of all of this: the utility company was paying Arkoma $40 million a year for gas it didn’t need. Because this was a terrible deal for the utility company, it decided to purchase Arkoma in 1987 for $175 million. The total value to Jones and his partner based on money taken out of the business and sale price allowed them to pocket over $300 million. These articles here, here and here give a good background of the deal. This leaves Jones with about $90 million in cash at this point in his life.

Cowboys Purchase

The current owner of the Cowboys in 1988 was forced to sell the team because he had a severe cash crisis with all the businesses he owned. The owner was never really interested in owning the team but wanted to own it for the depreciation it threw off to cover his profitable oil business. When he decided to sell, he pitched 75 people who all had said no and financial advisors at the time had said buying the cowboys was “ridiculously overpriced, and financial suicide”. Enter Jerry, who buys the team in 1989 for $140 million. He used all of his $90 million in the bank and borrowed the remaining $50 million at high interest rates.

With that, he got a football team that just recently lost $9 million, couldn’t sell a majority of the luxury suites as only 6 of 188 were sold, attendance dropping 25% from the prior year, and only one home game had sold out.

Within a few years from taking over they were averaging more than $30 million in profits per year and are now doing over a billion in revenue. As of 2024 they were valued at $10.1 billion, earning 112 times his initial $90 million investment.

Here’s how he earned outsized returns on his Cowboys purchase:

• Purchased from a forced seller

• The owner had shopped the team to 75 other parties who all said no before Jones came into the picture and said yes.

• Took advantage of low hanging revenues opportunities.

  • If you sell the luxury suites in your stadium, you don’t have to share the revenues with other NFL owners as you do the typical ticket revenues. The suites could sell for $400,000 to $1.5 million and after a few years he had 95%-98% of them filled. This turned into $50 million profit just from selling these.

  • Moved the free press seats that were the best seats on the 50 yard line to the 5 yard line and sold these 50 yard line seats.

  • There were no ads inside the stadium. He placed ads inside the stadium and sold these ads to local businesses.

  • At the time they couldn’t sell beer and alcohol at the games. Jerry lobbied and wined and dined the city council to grant him a stadium license to sell alcohol. This turned into $1.5 million to $2 million per game in profit.

  • Hired sales and promotion people and cut positions that weren’t generating revenue.

His cowboy purchase can be boiled down to a few key characteristics: 1) There was a forced seller, 2) The cowboy franchise is a scarce asset as NFL franchises are rarely if ever expanded. This creates a lack of supply with all demand growth going to the limited franchises in existence and acts as a tailwind, 3) No one wanted it as it was shopped to 75 other parties, 4) Extremely low hanging revenue opportunities that were just common sense to implement.

These key characteristics in his investments are what everyone should be on the look out for and has made Jerry Jones one of the richest men in the world today.

Interesting Reads

A couple of interesting reads this past weekend:

1) Tom Murphy 2000 HBS Interview

2) Ben Graham 1955 testimony before congress

Gulf & Pacific Equities Corp.

An interesting stock I came across to put on my watchlist is Gulf & Pacific Equites Corp. (GUF.V). It’s not something I would invest in now but would need some sort of catalyst for this idea to work and don’t see it right yet.

Gulf owns 2 malls, a retail property and a piece of land in Western Canada. All of the assets are owned in small towns. One mall is located in St. Paul, Alberta and is 100% leased with good tenants (Tim Horton’s, Dollar Tree, Mark’s and more). The other mall is located in Cold Lake, Alberta and is not 100% leased but has good tenants as well (Pizza Hut, Sobeys, Taco Bell, etc.). The retail property is located in Three Hills, Alberta and is leased 100% to Dollarama long-term. And then there is a vacant land owned in Merritt, BC which management doesn’t give any value to.

The company began operations in 1999 and this is the income statement the past 2 years:

It looks extremely profitable but the profits the past two years are really as a result of the FV adjustments in the way they mark up or down their properties and run it through the income statement. It is essentially breakeven on an operating basis. But what got me more interested was the balance sheet:

The stock trades at $0.42 with fully diluted shares outstanding of 22,660,685 for a market cap of $9.5m. Right from the balance sheet you can see it is trading for 43% of book value. If you include the FV adjustments as real income (which I don’t) it would be trading at 8x last years earnings. In the notes, management states it recently had appraisals done for the 3 properties as well as completed their own appraisals and the two large malls were worth $48.35m and the smaller location was $2.01m.

The CEO owns 52% of the shares through his investment company Ceyx Properties Ltd. and insiders own a combined 55%. Two other shareholders own another another 28% so the shares are in just a few hands which leaves the remaining 17% shares to the public.

There is a pretty compelling case to be made that this should just be privatized to a larger retail/mall operator:

• Reduce public company and management costs. Management and the board are paid just over $400K a year which would drop straight to the acquiror’s bottom line as well as public company/audit costs not included in that $400K number.

• Access to lower costs of capital from merging with a larger entity.

• Become part of a larger mall portfolio which would reduce business risk as there would be many malls in the portfolio.

• The CEO is currently running this company as well as another publicly traded junior gold miner, Plato Gold Corporation and he is also the CEO of Ceyx Properties Ltd.

• Gulf & Pacific won’t ever get the appropriate earning/FFO/book value multiple because it is too small and illiquid.

In order for me to get real interested, I would need to see discount to book as well as cheap on an earnings/FFO/cash flow multiple. If the Cold Lake mall can get near or to 100% leased it might get there. Or management decides to liquidate and pay proceeds out to shareholders. Until then I am just going to add it to my watch list.

Disclosure: Stock watchlist

Liquidating Cannabis REIT with a Catch

Two posts ago I talked about “seasoned liquidations” and I just happened to have found exactly that. Nova Net Lease REIT is selling its main asset, Class A Units of an operating partnership, for $3.71m USD, or $0.50 per share, after undergoing a strategic review. This represents a 456-498% premium to the 30-day VWAP. Nova will then wind down its REIT and subsidiary corporation and make a liquidation distribution to shareholders relatively quickly in the next month or two in the amount of US $0.40-$0.43/unit. In the press release the distribution is to be expected in 30-60 days following the completion of the sale and in the circular it just says first quarter of 2025. This could provide upside of between 12% - 22%. Its trading OTC at $0.3526 as ticker NNLRF and on the Canadian Securities Exchange at $0.375 with ticker NNL.U. The only problem: I haven’t been able to get any order filled as the volume is dreadful so I thought I’d just share it anyways as a good case study for finding inefficient mis-pricings in the smaller market areas. And maybe someone reading this will be able to get a buy in before the distribution.

Nova owned a cannabis industrial investment property as well as a JV that held two cannabis investment properties. This is the organizational chart with what they sold.

From reading the documents, they effectively had a 35% economic interest in the LLC they sold. So after this sale, they are going to be left with Verdant Growth Properties Corp. and the REIT at the top, both of which are going to be wound down. If you look on page 74-75 on the circular PDF, you can see the financial advisor’s liquidation value calculations for the LLC which comes to roughly the distributable amount.

The transaction was announced in November and unitholders held a meeting to vote on the transaction December 20. The shareholders voted to complete the sale and it closed on January 9. Management stated $0.40-$0.43 in the press release was the estimated distribution and in the Fairness Opinion that amount is given as more precisely $0.42/share in US dollars.

Based on the net difference between $0.50 per share and expected payout of $0.42, the estimated liquidation costs are about $596,000, which seems about right for a relatively quick/small liquidation. They also released the CEO when the agreement was entered into and replaced him with the CFO with no additional compensation. Also, not that it matters much, but I don’t think I have seen the financial advisor, or someone who works for the financial advisor, provide a fairness opinion and they themselves own a stake in that company.

The spread is available because the liquidity is tiny. I am a little disappointed I haven’t been able to get my ordered filled but I know there will be plenty more of these to play and hopefully someone can take advantage of the spread.

A-Z on the Canadian Securities Exchange

This January I thought I’d go A-Z on a small backwater exchange here in Canada, the Canadian Securities Exchange. This is the exchange one tier below the TSX Venture, which itself is a tier below the TSX. I downloaded the excel list of companies from the CSE website and started at the top.

The game of investing is turning over the most rocks until you find something that seems extremely compelling. This could come from reading investor letters, investment pitches, running screens, following news flow, etc. But you aren’t going to see what truly are the best opportunities unless you go through every stock on each exchange. The beauty of looking at every stock is that you can than compare it to your existing portfolio as opposed to waiting for investments to come around.  The problem with this is it is extremely time consuming and you usually end up finding a lot of junk/unprofitable companies as you can see from my notes on the right below.

While there is no exact tell for what I was looking for when going through each company’s financial statements, I wanted to see actual businesses that were profitable or at least almost profitable with a strong balance sheet. Everything else was an immediate pass. How else can I value a business if there is no real business?

A couple observations

• For a country with vast natural resources, Canada has a TON of unprofitable mining companies.

• A lot of these companies should probably just be liquidated/not publicly traded.

• Going A-Z is never easy and I found myself thinking I should just skip the names that just seem like an obvious pass but if everyone thinks like that there might be some hidden gem.

• Once you get into the habit of starting, it can become a bit addicting trying to see each company everyday. At the end of each session I found myself wanting to look at “just one more” which would usually turn into 10 more.

• My goal was to do at least one letter of the alphabet each day and I would usually surpass that because some letters didn’t have many companies.

I managed to make a list of at least some interesting companies to keep an eye on and thought I’d share the top 10 companies I thought were the most interesting.

1) ZTEST Electronics Inc.

Develops and assembles printed circuit boards and is currently undergoing a strategic review. Almost doubled revenues from 2023 to 2024 with net income going from $165K to $1.7m. Shares outstanding of 36.5 + 2.7m warrants +1.1m options with a stock price of $0.40 for a market cap of $16.12m. Trading at 9.5 times last years earnings and if they can grow again at the same rate this year, it seems really cheap. Strong balance sheet with cash balance of $2.7m against debt of just over $100K.

 2) BioHarvest Sciences

They synthesize plant based molecules and have a market cap of $110m with insiders owning 37.9% of the company. Their revenues and gross margins have exploded the past couple of years. In 2021 they did revenue of $2.1m and gross margins of 31.9%. In the TTM of Q3 2024, they’ve done revenue of $22.4m and gross margin of 54%. Huge growth that is hard to argue with.

The only downside is they are still losing money but on a lesser scale as a couple of years ago. Also, their shares outstanding have gone up as they have raised money to fund the growth. This is one I will be keeping my eye on for when 1) potential profitability will inflect, 2) no need to raise capital anymore, 3) if the valuation makes sense and 4) if I can get comfortable with the business/industry.

3) Eagle Royalties

A junior mining company but it holds 35 royalty interests in certain projects in Western Canada covering different commodities. It was spun off from Eagle Plains Resources in 2023 on a 3 for 1 ratio. Extremely strong balance sheet with total assets of $4.8m with cash comprising $3.5m of that and a note receivable of $1.25m against total liabilities of $303K. Market cap is $6.6m but they just diluted shares from 28m to 57m, with fully diluted 66m. Royalties seem lumpy as they just received one so far this year for $3.75m which turned into net income of $2.9m in the last 12 months. Insiders own 20-30%.

4) Happy Belly Food Group

Seems like an interesting small business. Has a bunch of different brand food locations/consulting and also earns royalty and franchise stream income. Sales have been growing as of September 30, 2024 as they have done 5.2m in past 9 months vs 3.8m last year same period. However, still burning money and diluting but looks like cash burn has come down. Total assets of $9.1m with cash making up $3.6m of it against $3.6m of convertible debt.

5) MTL Cannabis Corp.

One of the rare profitable cannabis companies I’ve seen, although they did lose money in 2023 but they under went a RTO mid 2023. With 117m shares outstanding, 7.7m warrants and 6.5 options, there is a market cap of $48.5m using a stock price of $0.37 (not using the treasury method). While I don’t love the balance sheet of $22.6m debt against $3.2m cash, there is $18.5m of PP&E backing that up as well. Sales have been growing, going from $32m September 2023 last 6 months to $42m September 2024 last 6 months. This takes into account $10m of excise taxes as well and if the government were to change this in the next few years, it could fall right to the bottom line.

Operates 2 segments: 1) Licensed producer that just did $11m in operating income and $8.5m net income past 6 months, 2) CHC segment that did $430K operating income and $100K net income past 6 months as well. On a consolidated basis when taking corporate expenses into account, its 9m operating income and $3.4m net income. Annualize that for the year could be $18m in operating income and $7m in net income against a market cap of $48.5m for 7 times earnings.

6) Namesilo Technologies Corp.

Nice little domain name business run by Paul Andreola. Holds 1.2m in bitcoin investments as well as some other of his investment picks (Atlas Engineered, Ceapro Inc.). Does just over $40m in revenues and is profitable on an operating basis of $3-4m. Only debt is 3.8m convertible and large amount of liabilities is the deferred revenue of almost $30m of a the total $43m in liabilities.

7) Nova Net Lease REIT

I will most likely be writing this up in a couple of days but it is a Cannabis REIT that owns one investment property and a JV that owns two other properties that are profitable. Just agreed to sell most of the assets and liquidate. Stock price of $0.36 with units outstanding at 7.4m, market cap is $2.6m. The book value without making any adjustments to the properties or JV is $12m, which means on my rough math it is trading at 22% of book value. But this could be as a result of them consolidating the JV onto their statements so their true economic ownership doesn’t show through. Granted it is losing some money and burning a bit of cash but the JV is profitable according to the notes in the financial statements.

8) Urbana Corporation

Investment company with a net asset value of $427m or 10.32/share. Currently trading at $6.19 which means it is valued at 60% of net asset value. Investments are made up of both public and private amounts. Public is $202m on balance sheet and private is $297m with some private debt investments of $6m. Management in September was granted by TSX to allow a NCIB to repurchase 10% of the company’s shares which means management agrees it is undervalued. Smart capital allocation to purchase below asset value which would bump up the NAV per share after the buyback. Reading past investment pitches on them, they have always traded at a large discount.

9) ICEsoft Technologies Canada Corp.

Licenses its technology and its SAAS product to businesses and government clients. They do the mass notifications that pop up on your phone if the government needs to let people know of certain emergencies. Seems like losses have come way down and they are near breakeven. Trades at a roughly $5m market cap when taking the warrants into consideration. Annualizing their current quarters revenue, trades for about 2.5 times revenue. The balance sheet isn’t the greatest with only $111K in cash against $1.2m of convertible debt. Not a buy to me as I need a clean balance sheet and profits but one to keep an eye on.

10) Victory Square Technologies Inc.

Investment company with investments made in the tech. sector and consilidates a bunch of their investments on to the financials. Has a market cap of $45.7m but they own a 64% stake in Hydreight Technologies (Ticker is NURS.V) that is worth roughly $60m as the stock has gone crazy the past year. They also own other investments that I am sure are worth more. Could be interesting if they ever try to unlock some of this value.

Honourable Mentions

—> Grown Rogue, Plaintree Systems Inc, Royalties Inc.

I am hoping to do the TSX Venture exchange in February/March. The CSE only has about 771 listings whereas the TSX Venture has I think triple that amount so it will take me a bit longer to do obviously.

Two Deep Value Special Situations Down Under; Seasoned Liquidations

I’ve recently come across two deep value situations in Australia. Both I own. The first one: 

Deep Value Situation #1 - Pacific Current Group (PAC.AX)

I first became aware of Pacific in July 2023 when major shareholders Regal Partners and River Capital offered to buy them at $11.12/share. Pacific owned 16 stakes in numerous tier 1 and tier 2 boutique asset managers, one of them being at the time GQG. This was then followed by GQG Inc. (who Pacific had an investment in and is itself publicly traded) indicating they would submit a bid as well. PAC then ran a strategic process and received multiple offers. Regal withdrew their offer in September 2023 and GQG Inc. submitted a bid for $11/share all cash in November 2023 without having obtained River Capital’s support. River Capital then got back in with a bid, but this time for $10.5/share in cash. Long story short, Pacific’s strategic committee disbanded in November 2023 as it wasn’t able to get any binding offers. 

What’s happened since then? Essentially a public liquidation, selling down to 11 boutiques as of August 2024.

The company has announced even more sales since August. All of these sales have changed the NAV percentage of the business dramatically:

Cash went from 2% of NAV last year to 43% as of June 2024 and this is still a growing amount. The company is now proposing to repurchase 25m shares in an off-market share buy-back, which equates to 47.9% of the shares outstanding. The shareholder vote is to take place January 30, 2025 with the 3 major shareholders representing 49% voting for it. However, they have not decided if they will tender their shares into it which creates a bit of a risk of the full buyback being used.

In order to determine potential returns, I’ve tried estimating the adjusted NAV as of this write up along with a scenario where all the shares are and aren’t bought back. There are a ton of moving pieces in the underlying NAV since last reported on June 30, 2024. Not only the recent sales but also some of the sale proceeds are to be collected over a period of a year or two. On top of that, the majority of the funds under management are reported in USD but the stock trades in AUD which must be accounted for.

Based on the assumptions above, I am getting to $14.38/share of adjusted NAV since the June 2024 NAV of $13.47/share. Below are the IRR estimates assuming a 2 month hold:

If the company is able to fulfill the full repurchase authorization, there is barely any downside with some upside depending where it trades after repurchase. The IRR on this, assuming a 2 month hold, could be a respectable 62% if it trades at a 20% discount after.

What happens if the tender is only able to be filled for half the amount allocated? Assuming only 12.5m shares can be repurchased, there is still a small IRR to be made if it trades at a 20% discount to adjusted NAV.

I’ll note that the stock is trading just below $12 so the IRRs on these numbers could be a bit greater than what I have from using the $12 beginning price. I didn’t account for any fair value uplift in potential sales as well that could provide a bit more return to the stock/NAV. Also, if the company isn’t able to get the full allocation, I imagine they could possibly do a special dividend or just sell it all/wind it down completely. The CEO is still listed as “Acting CEO” which makes you wonder what the end game is here. 

The real risk that could reduce the IRR is any delay in shareholder vote and rulings from the Australian Tax Office as these have caused a delay since May. But with the vote at the end of the month I would think this happens in March when scheduled.

I am long and see this as an extremely low downside bet with some upside and the chance of earning a high IRR. The opportunity is available because it’s a small company with 3 shareholders making up almost 50% of the shares which creates limited liquidity for larger funds to enter into.

Deep Value Situation #2 - Merchant House International Limited (MHI.AX)
Merchant is a textile manufacturer that makes boots, shoes and other home products. It is based in Hong Kong and listed on the ASX but domiciled in Bermuda. It has the “ick” factor in an investment that people turn their noses up at but I think this cigar butt has one last puff. They decided in August 2024 to liquidate the company, distribute the proceeds to shareholders and delist from the ASX once they sell their last remaining property. The liquidation announcement sent the stock from $0.04 to $0.15. As you can see, the business is of extremely low quality with declining sales and net tangible assets in the prior 5 years.

Merchant has 94.2m shares outstanding and currently trades at $0.15 for a market cap of $14.13m. The average volume for the shares is 100,000 shares or $15,000 a day.

The business consisted of 3 real main businesses with a couple other small/dormant subsidiaries:

1. Footwear Industries of Tennessee Inc. (FIT) which was sold in 2023 for gross proceeds of $3.28m USD and net proceeds of $2.63m for its fixed assets net of liabilities. The land and buildings in this sale had a book value $US 788K and sold for profit in the sale of $1.965m USD, amongst some other small assets. The main thing to note is the property sold above book value here.

2. Forsan Limited (Forsan) was a 33.79% ownership in a JV with Mr. Wu Shu Xin for Tianjin Tianxing Kesheng Leather Products Company Limited based in China. This was sold on May 30, 2024 for $8.3m AUD before taxes, costs and other payments. The company completed the sale on January 9 2025 for $4.9m USD. 

3. American Merchant Inc. Most of the value of the overall company is in this subsidiary as it holds a large piece of textile PP&E located in Bristol,VA. It was recently shut down as of September 30, 2024 and to be put up for sale. According to their website they have invested more than $24m in state-of-the-art equipment in the plant. This article also gives some background of the facility, equipment owned and its sale. Below is a picture of the plant:

And a location of the factory from google earth:

4. Various subsidiaries -  Pacific Bridges Enterprises Inc and Loretta Lee Limited. I am assuming Pacific Bridges is not worth anything. Loretta Lee Limited currently has a contingent liability of US$994,996 that must be returned plus interest owing from a court case.

The company has recently stated in their September 2024 Half-Year report release in late November that they have received expressions of interest from potential buyers and expects the sale process to be complete within 12 months.

Liquidation Proceeds 

So what can you expect to get in the liquidation? I lay out a bear, base and bull case with various assumptions on the amount the plant will sell for. Even in a draconian scenario where it only goes for 50% of stated book value, you would still get a decent return.

I haven’t been able to really find any precedent transactions for this type of asset in the area. But as stated earlier they were able to sell their FIT division for above book value. In 2022 they sold their 30% interest in Jiahua for $AUD 3.3m and it was carried on their books at $AUD 1.9m. And in April 2021 they disposed of their subsidiary Carsan for net proceeds of $AUD 21m for roughly 1x revenues and 3.8x book value based off my calculations from the segment’s book value of $AUD 5.5m as disclosed on page 20-21 of the 2021 annual report. In my model I have 4 boards of directors but one resigned in August but I left 4 in to be conservative.

The CEO owns 61.2m shares or 65% of the company and should be highly incentivized to get the best price and the company liquidated as quick as possible.

Many things can go wrong with this investment:

• The sale process can drag out which will eat into your IRR.

• The plant may not sell for 50% above book or might not be able to find a buyer thereby wiping out your downside. These are not very “attractive” assets but they have garnered some interest as per the release and the company has a history of selling these types of assets.

• The company might have to sell off pieces of equipment each before they can sell the entire plant. This would prolong the amount of time it takes to liquidate.

• Management can change their mind about liquidating and hoard the cash for an acquisition.

• Management can pilfer the company by paying out large salaries leaving shareholders left with nothing. This risk is the one that I worry about the most because you are always on the outside looking in in non-control liquidations like these in foreign jurisdictions. However, the release did state they wish to distribute the proceeds out to shareholders so hopefully there is no pound of flesh taken before that occurs.

I have a small position in this because while I don’t love the asset they have to sell, their history of getting north of book provides such a large discount to fair market value that you are well compensated for that risk. It also helps that this situation is uncorrelated with the overall market.

This investment brings me to a topic I’ve read about and think is extremely interesting in liquidation scenarios.

Seasoned liquidations

I read about a technique called “seasoned liquidations” in the book Merger Masters: Tales of Arbitrage. In the chapter about John Bader from Halycon Capital Management, he explains that a seasoned liquidation is one where the assets have actually been sold and are just sitting in cash waiting to be distributed to shareholders. All that needs to be accounted for in this situation is claims the company still has to pay out and the timeline. I think this technique is extremely smart, especially in situations where the assets have not been sold yet and it can be hard to put a value on the assets. There might not be as much upside using a seasoned liquidation approach, but your risk decreases dramatically because you are not relying on valuing the remaining asset to be sold. Just the cash in the register essentially.

This situation can be applied in the Merchant House pitch above due to the nature of the remaining asset. Once the price of that asset is sold, your risk of capital impairment would go dramatically down as you will be in a better position to see all the cash less payments to be made, the timeline of receiving your capital back and the stock price. Of course the stock will move before you are able to purchase it but the idea is to squeak out a few percentage points of return with minimal downside as it will most likely trade at a discount to full value. It is a very valid approach to liquidation investing and can be used in your special situation arsenal.