Blog – Page 18 – Focused Compounding

hiddenvalue August 7, 2018

CountPlus (CUP)

CountPlus Investment Thesis

Market data

Ticker: ASX:CUP

Price: $0.66

Net debt: ~$0m

Market cap: AU$74m

Elevator pitch

After years of poor performance, a revolving door at the C suite and ongoing restructuring charges/impairments, recent insider buying gives us confidence that CountPlus has reached an inflection point in its turnaround. Looking through the one-off charges to cash profitability and assuming no improvement in operating margins (~10% vs. peers >20%) we believe the shares are selling for a pre-tax free cash flow yield of 14%. As the turnaround begins to show up in the reported financials and the company re-instates a dividend policy, we believe the market will wake up to this emerging growth story.

Investment thesis

New CEO who co-founded one of the best performing groups within the network, and who has a non-monetary vested interest in the success of the business due to relationships with many of the employees he mentored, is implementing a strategy he successfully employed while managing Hood Sweeney and recently acquired ~$400k of stock on market
Sticky, diversified, annuity like revenues provide downside protection. Operating margins of 10% due to a loss-making division and poor incentivisation under old model vs. peer group margins 20%+. Every 1% improvement in profitability adds $0.08 in value per share (if capitalised at 8x)
Increased regulatory pressure on the back of a Royal Commission should drive consolidation as sub-scale firms look to partner with a well-capitalised competitor to scale fixed compliance overheads, providing an attractive backdrop in a highly fragmented industry
Current valuation implies extremely low expectations. Assuming no improvement, it should currently be generating $10-12m in pre-tax owner earnings (14%+ earnings yield). Given the low capital requirements of the business, the majority of this cash flow can be used to pay dividends or make acquisitions. As the CEO has a track record of finding and executing value accretive acquisitions, combined with a board rich in M&A experience, and a consolidating industry backdrop, we believe CUP is in a prime position to increase value for shareholders
The convergence of cash profits and reported financials, together with the dividend returning, should provide a hard catalyst for the Aussie small cap community to take another look at the business

History

CountPlus (CUP) was born within Count Financial (Count), one of Australia’s largest network of advisory firms. Count, which is now owned by The Commonwealth Bank of Australia (ASX:CBA) spun CUP off into its own publicly traded entity in 2010 and still retains a 36% shareholding. CUP generates revenues through a network of ~17 firms (wholly and partially owned) with a fairly even split between accounting and financial advice fees.

After an initially successful IPO, CUP began to get into trouble when Count Financial went from a stand-alone public entity, to being acquired by CBA. While this had little impact on the underlying operations of CUP member firms, because of the unique relationship between CUP and Count, CBA began making “loyalty payments” …

Geoff Gannon August 7, 2018

Northfield Precision Instruments Corporation (NFPC) – A Dark, Illiquid Nanocap at an Unlevered P/E of 6

Member write-up by LUKE ELLIOTT

Northfield Precision Instruments (OTC: NFPC)
Quote: $15.00

Let’s go ahead and get one thing out of the way. When I say nanocap and illiquid, I really mean it. Northfield has a market cap of 3.6 Million USD (234,237 shares x $15/share) and its 10/90 day volumes are 0 and 102 respectively. This is a tiny company and the largest daily volume (by far) of shares trading over the last year was 6,400 (around $95,000 USD). For some of you it probably doesn’t make sense to continue reading.

For some background, Northfield Precision was founded in 1952 by three men in Long Island, NY. The first products manufactured by the company were micro spin bearings, precision gear blanks, precision shafting, precision limit stops and miniature slip clutches for the electronic industry. The company went public in 1959. I was unable to determine what year the company stopped filing with the SEC, which probably means it was a very long time ago.

The company looks quite different now. None of the original founders are still at the company and they now manufacture air and diaphragm chucks. A chuck is just a specialized type of clamp. They’re typically used to hold or clamp a rotating workpiece that is being machined. Northfield supplies chucks to part manufacturers in a variety of sectors including automotive, aerospace, electrical/electronic, robotics, medical/optical, and machine tooling. It’s likely that their largest customers are in the aerospace and auto parts industries and in a nutshell, Northfield provides parts that are necessary to manufacture specific metal components for these industries (Examples include transfer case components, water pump components, crankshaft and driveshaft components). Depending on the complexity, one chuck is in the ballpark of between $2,000-6,000 which is typically less than 1% of the cost of the CNC (Computer Numerical Control) Mill or Lathe and typically a small percentage (thought not insignificant) of setting up a new process to produce an auto/aerospace component.

Because the company is dark and does not file with the SEC, I had to request the financials from the company directly and was provided with only the last 5 years. The company was unwilling to send financials further back than 2013. Based on 5 year numbers, durability can be difficult to determine from a quantitative perspective. Focusing on what we do know, we can say that the company certainty ticks the box from a longevity perspective since they’ve been around for 60 years. The company is certainly run conservatively, and like many small businesses (typically family owned), they carry no debt (besides some equipment leases) with a large amount of cash on hand.

Because the products the company sells are both competitively priced and such a small percentage of the total “new part” start-up cost for their customers, keeping the continuity of their customer relationships, timely delivery, and high product quality are what matter most for a company like this. Most customers are unlikely to switch from a supplier they’ve been using for …

Geoff Gannon August 6, 2018

Butler National Corp. (BUKS) : An Illiquid Ben Graham Style Mini-Conglomerate in Aerospace and Casinos

Member write-up by VETLE FORSLAND

Butler National Corp (BUKS) is a $14 million OTC stock that operates in the Aerospace Products industry and manages two casinos. The two unrelated businesses split revenues 40/60, respectively. It trades at an EV/EBITDA of 2.30 (while peers trade at around 10 times) and the company has net cash. While all this sounds attractive, it only gets better; a simple sum-of-the-parts calculation shows that the stock is trading at 29% of its intrinsic value.

The stock trades around $0.20 per share. It’s illiquid. And their assets shows great unrealized value for shareholders. However, the management has done a poor job at utilizing these assets. So, an activist investor or an acquisition may be necessary for the stock to reach its fair value.

About the business – Aerospace

BUKS was formed in 1960. It maintained electronic aircraft parts like switching equipment, navigation instruments, radios and transponders. It has since expanded its Aerospace Products segment. Today, Butler gets revenue from: system design, engineering, manufacturing, integration, installation, services and repairing products for business-sized aircraft. This part of the business has three subsidiaries, namely Butler Avionics, Avcon Industries and Butler National Tempe. The former subsidiary – Butler Avionics – sells, installs, and repairs avionics equipment (the electronic systems used in aircrafts) like airplane radio equipment and flight control systems. Avcon Industries modifies business aircraft mostly by modifying passenger-to-freighter configurations, adding aerial photography products to aircraft, and providing stability enhancing modifications. All of these are crucial parts of airplanes. Butler National Tempe is the defense-contracting part of the business. They focus on electronics upgrades for weapon control systems used by militaries. They also manufacture transient suppression devices and switching units for Boeing aircraft.

About the business – Casinos

In the early 1990s, the management at BUKS decided that they wanted to diversify their revenue away from the cyclical aerospace business. The Board of Directors at the time had contacts with American Indian tribes, so they went into the gambling business by managing two casinos: Boot Hill Casino (a state-owned Kansas casino) and the Stables (a Modoc tribe-owned casino in Oklahoma).

The management agreement with the Stables expires on September 30th, 2018 (less than two months from today). The company’s latest 10-K says ‘negotiations are underway to renew this contract’.

This segment, called Professional Services, is divided into two subsidiaries: Butler National Services (which provides management services to the two casinos) and BCS Design (which provides architectural services on commercial and industrial building designs). While the Aerospace part of the company originated three decades before professional services, 61% of the company’s revenue came from the professional part of the business in 2017, and 67% in 2016. Before then, the 6-year average had been 66%, while assets are always split 50/50 between the two segments.

Quality

There’s not much to say about the quality of the business, because it’s not as necessary as with other companies I write about. This is a value play. …

Geoff Gannon July 26, 2018

Kaanapali Land (KANP): A Super Illiquid Speculation on Hawaiian Land

Member write-up by DAVE ROTTMAN

Overview

Kaanapali Land LLC (KANP) is a business that owns land on Maui, one of the major Hawaiian Islands. Because Kaanapali is the name of the region of Maui that Kaanapali Land LLC owns land in, this report will refer to the business as KANP.

The island of Maui was formed by two volcanos that grew next to and eventually into each other. This is referred to as a volcanic doublet. The western part of the doublet is mostly mountainous forest reserves in the interior. Moving “makai”, meaning “towards the sea” in Hawaiian, the landscape changes to agricultural land. Finally, the coastal areas are filled with residential and commercial activity. It is on the western coast of the west side of Maui that Kaanapali is located, minutes away from the Kapalua Airport.

KANP has a rich history going back over 150 years. In the beginning, the company was called the H. Hackfeld & Company and began as a general store opened by a German boat captain, only later branching into other activities such as sugar production land ownership. Through a series of events around the time of World War I, it became acquired by a group of businessman and was renamed American Factors and later Amfac. Amfac was one of the “Big Five” in Hawaii, a powerful group of corporations that controlled 90% of sugarcane production – a huge component of Hawaii’s economy – during part of the 20^th century. During this time, sugarcane production was Amfac’s focus, and at its peak it owned 60,000 acres of Hawaiian land. Because of their control over such a huge portion of the economy, the Big Five wielded a large degree of political clout. In the 1950s, political change and international competition damaged the economics of sugarcane production in Hawaii, and the Big Five entered a period of decline that was characterized by declining sugarcane production and diversification into other industries. In 1988, Amfac was bought out by JMB Realty for $920 million, a very large real estate developer based out of Chicago. During the continued period of sugarcane decline, much of the property related to sugarcane and other activities was sold off. In 2002, Amfac declared chapter 11 bankruptcy due to operating losses related to agricultural operations and to a lesser extent other smaller operations including golf course businesses, coupled with an unmanageable debt load. The business emerged from bankruptcy in 2005 as Kaanapali Land, LLC and is the reorganized entity from Amfac Hawaii and a few other entities. The stock became available over the counter in 2007. Today, KANP is focused primarily on land development, although it produces a small amount of coffee, too.

Before proceeding, it is relevant to mention that KANP is similar to another business that has been discussed on Focused Compounding: Maui Land & Pineapple (MLP). If you have not read the report on MLP, it is recommended you do so, as understanding MLP will help with understanding …

Andrew Kuhn July 12, 2018

LEAPS: The Joel Greenblatt Way to Bet on Entercom (ETM) and GameStop (GME)

Member Write-up by VETLE FORSLAND

Investing in companies with big upsides (and big downsides) with LEAPS, instead of common stock, to up your return (and minimize risk)

If you believe that a stock is excessively mispriced, and you want to buy that stock, there is a way for you to translate a say, 30% gain into a triple digit gain. It’s called LEAPS, or “Long-Term Equity Anticipation Securities”, and if used wisely, it is one the best ways to leverage your investment returns as a retail investor. Joel Greenblatt wrote about it in “You Can Be A Stock Market Genius”, where he described it as a tool that “has many of the risk/reward characteristics of an investment in the leveraged equity of a recapitalised company”. I recommend reading his bit on LEAPS, starting on page 213, as Greenblatt himself can show its pros and cons much better than I ever could. But, the strategy is basically buying stock options that expire 2 years down the road. Stock options are usually not attractive for long-term investors as they don’t allow sufficient time for a larger repricing, and are dependant on a short-term catalyst. However, as you can own LEAPS up till two years, chances are a stock that is severely and obviously mispriced will reach (or get close to) its fair value during your holding period.

Since, LEAPS are basically long-term options, how do options work? You can buy put options and call options, but in this case we will just look at calls, which is basically the right, but not the obligation, to buy a stock at a specified price within a specified time. For instance, let’s say you purchase a call option on shares of GameStop (GME) with a strike price of $16 and an expiration date of August 10th 2018. This option contract would give you the right to purchase 100 shares of GameStop at a price of $16 on August 10th, but as this right is only valuable if GameStop is trading above $16 on the expiration date, you risk expiring the option valueless. Right now, you can buy one call option on GameStop for August 10th for $0.50, which represents 100 underlying shares of stock, so the cost of a trade of 100 call options will be $5,000 (($0.50 x 100) x 100 shares. If by August 10th, GameStop trades at $17, the buyer could use the option to purchase those shares at $16, then immediately sell them for $17. Therefore, the option will sell for $1 on August 10th, and as each option represents 100 underlying shares, and our hypothetical trader bought 100 options, this will all total a sell price of $10,000. Because the trader bought this option for $5,000, the net profit equals $5,000 – comparably, a common stock buyer would have had to invested $160,000 to make the same profit from the same trade.

If, however, GameStop stock trades for $16.50 at the expiration date, …

Geoff Gannon July 10, 2018

Doubt as a Discount

To Focused Compounding members:
Let’s play a game. I ask you a series of questions. You give me a series of answers. I then test the answers you give to prove them false using as unfavorable a definition of false as I feel like. You have $1,000 in your pocket. You can’t leave the room. You can’t use your phone. And you can’t take off your shoes. I offer you even money odds on each of the following questions asked in succession: 1) What is your gender? 2) How old are you? 3) Who is your biological father? 4) What is your shoe size? 5) How tall are you? 6) How much do you weigh? 7) How many times will you go to the gym this week?
To complete this game, you need to give me seven pairs of answers. One, what percent of the money in your pocket are you betting? And two, what’s your answer. This game can end with you having anywhere from $0 to $128,000. Now: get out an index card. And write down your 7 answer pairs. Don’t read on till you’ve done that. Okay. Let’s assume you did bet all $1,000 that your gender is male. Should you have bet 100%? To answer this question, we need to know what the chances are that you would think you’re male and yet I could prove that answer false under the strictest test. If we assume the only way you could win this bet is if you said male and your chromosomes are “XY” and only “XY” then we can create a range of chances that someone might say they are male and yet fail this test. By my estimates, more than 98% of males would have no doubts they were male and be right even if subjected to the “XY” only test, perhaps up to 2% (an over estimate) of males would have doubts and could lose this bet under the strict “XY” only test, and about 0.2% might not have any doubts and yet could lose this bet. How should you have bet?

One way for figuring out how much to wager on each of a series of bets is the Kelly Criterion. I haven’t met any investors who say they use the “full Kelly”. However, I have met investors who say they use “a third Kelly”. Say the Kelly Criterion tells you to bet 96% on the answer “Male”. Someone using a third Kelly would bet 32%. The third Kelly leads to a bad bet here. Why? The Kelly Criterion sets the limit of how much you should bet given the chances and odds you’ve plugged into the formula. In the case of the gender question: a full Kelly doesn’t ask if you understood what I meant by male. Meanwhile, a third Kelly applies a 67% doubt to your own thinking about every problem you encounter. Betting 32% on the answer “Male” is like saying you’re 98% sure you’re male as you understood …

Geoff Gannon July 1, 2018

Stylistic Skew

To Focused Compounding members:
This week, Vetle Forsland was our guest for two podcast episodes. One was about GameStop (GME). The other was about Entercom (ETM). You should listen to them both. What stood out to me in those two episodes was Vetle’s style as a stock picker. GameStop sells – among other things – physical copies of video games. Entercom owns terrestrial radio stations. A lot of investors think these two stocks are in buggy whip businesses. And so, these investors don’t even bother trying to come up with an appraisal value for the businesses and compare that to the market price of the stocks. For most investors, these two stocks are unsafe at any price. But Vetle is willing to search through other investors’ trash to see if there is any treasure hidden there. That’s his stock picking style.

Vetle’s two podcast episodes went up the same week I started thinking about exactly what I’m going to put in the first letter I will have to write to clients of Focused Compounding Capital Management. The first letter to clients went out today. Andrew wrote that one. It discussed the general strategy those managed accounts will employ. But next month’s letter will be written by me, not Andrew. And it won’t be discussing general strategy – it’ll be talking specific stocks. That letter would be easier to write if each stock stood out as an utterly unique case. I could just rattle off five paragraphs about five different stocks. The problem is that there’s clearly a common – yet unconsciously woven – thread running through those five stocks. I noticed it the other day. I was looking over the five stocks sitting in the planned “Buy” pile for those managed accounts and glanced at a number we don’t normally talk about in these memos: “beta”. As you probably know, beta is an indicator of a stock’s volatility scaled to some index’s volatility. A beta of 1 would suggest similar volatility to the S&P 500. The five stocks in that “Buy” pile for the managed accounts have betas of: 0.64, 0.33, 0.19, 0.17, and negative 0.10. Now, I don’t put much stock in those betas because the actual correlation with the market for these stocks is probably pretty low. I doubt these stocks tend to be green on days when the market is green just to one-third or so of the extent the market is up and red on days when market is red just to one-third or so of the extent the market is down. So, that series of five betas doesn’t mean much. But, it does mean one thing. That wasn’t luck. You don’t draw betas of 0.64, 0.33, 0.19. 0.17, and negative 0.10 randomly out of a hat with every stock in it. Likewise, Vetle probably (a sample size of two is awfully small) doesn’t draw two investment write-up subjects out of a hat randomly and find that both of them just happen to be in industries …

Geoff Gannon June 27, 2018

Maui Land & Pineapple (MLP)

I did an initial interest post on this company on June 27th, 2018:

https://focusedcompounding.com/maui-land-pineapple-mlp-900-acres-of-hawaiian-resort-land-for-250000-an-acre/

This thread is the place for members to ask me questions about the stock, discuss it among themselves, etc.

I’ll start things off by providing links to other opinions on Maui Land & Pineapple (MLP).

Here is a May 15th, 2017 Seeking Alpha post on the stock.

Here is a June 1st, 2016 post on Medium.

This is the 2016 Oddball Stocks post I linked to in my initial interest write-up.

The write-up you’re most likely to be interested in is the Value Investors Club post from earlier this year. However, that site is down as I’m writing this. So, I can’t link to it. You can search for MLP on the site to find it.

As you can see, Maui Land & Pineapple is not in any sense an undiscovered stock. It’s gets written about a lot by value investors.

If you have any questions about the company, information you’d like to share, links to other write-ups on MLP you know about, etc. please do so below.

…

Geoff Gannon June 27, 2018

Maui Land & Pineapple (MLP): 900 Acres of Hawaiian Resort Land for $250,000 an Acre

Maui Land & Pineapple (MLP) owns real estate on the island of Maui (which is in Hawaii). The company has 22,800 acres of land carried on its books at prices dating back to the 1911 to 1932 period. So, book value is meaningless here. The total size of the land holdings is also meaningless here. Of the 22,800 acres, 9,000 acres are conservation land. That leaves only 13,800 acres of potentially productive land. Almost all of that (12,900 acres) is zoned for agriculture.

That leaves 900 acres zoned for residential use.

Let’s compare those 900 acres of land to the company’s enterprise value to get a sense of just how expensive this stock is on a price per acre basis. The company has 19.18 million shares outstanding. As I write this, the stock price is $11.40 a share.

Since we’re talking shares outstanding, I’m going to pause to discuss liquidity. I may run managed accounts focused on the most illiquid stocks out there (because I believe stocks with wide bid/ask prices tend to be less efficiently priced than stocks that trade constantly at almost no spread), but I know some members of Focused Compounding prefer more liquid investments. MLP should be liquid enough for everyone. The stock trades about $300,000 worth of shares per a day. It’s listed on the New York Stock Exchange.

Now, a bonus aside for those interested in ultra-illiquid stocks: if you’re interested in Maui Land & Pineapple after reading this write-up, you should definitely check out is closest “peer” of sorts – Kaanapali Land LLC (KANP). KANP is an illiquid (it trades about $2,000 worth of stock on an average day) over-the-counter stock. I’m not going to discuss KANP here. However, what land it owns – which I think is much more speculative and possibly worth much less than the land I’m about to discuss owned by MLP – is only something like 4 miles from the land we’ll be talking about here.

Now back to the enterprise value calculation. MLP stock is at $11.40 a share and there are 19.18 million shares outstanding. So, that’s $11.40 times 19.18 million equals $219 million. You can find the company’s 10-Q on EDGAR and decide how much net cash or net debt to add to that $219 million to get the correct enterprise value. There’s a tiny bit of cash, a tiny bit of debt, some retirement benefit obligations, etc. For our purposes, all balance sheet items excluding the 900 acres of residential zoned land are a rounding error. So, I’m going to round the market cap up from $219 million to $220 million and call that the enterprise value.

Now, we can calculate the price ratio that matters most here. It’s not price-to-book (meaningless because the land is carried at at 1911 to 1932 values) or price-to-earnings (also meaningless because it includes land sales which are very lumpy from year-to-year). It’s enterprise value per acre. So, that’s $220 million in EV divided by 900 acres of …

Geoff Gannon June 25, 2018

Relative Regret

To Focused Compounding members:
One of the most difficult things for investors to deal with is to watch other get richer faster than you. In the stock market, the same choices are available to everyone. So, if someone is up 20% this year, they are up 20% purely on a collection of opportunities you passed on. Two things make this even tougher for the people reading this memo. One, you judge yourself on your relative results versus a benchmark like the S&P 500. Two, you judge yourself on a yearly basis. Even if your process is superior to that of most other investors – there’s a decent chance you’re lagging this year. Does that mean you’re a failure as an investor? Is it even realistic to set the bar as high as beating a benchmark each and every year?

Let’s think about this another way. Let’s remove the idea of you from this analysis. Instead let’s imagine we are evaluating not an investor but an investment strategy. And, to make this easier, let’s set the pace horse a lot slower. Investing in the S&P 500 is not a bad strategy long-term. What is a bad strategy? Putting 100% of your savings into a commodities basket month after month. History shows that holding a basket of commodities indefinitely barely keeps up with inflation. So, if you continue to make a 100% commodities wager month after month for the rest of your working life you are almost certain to underperform the person who makes a 100% S&P 500 index wager month after month for the rest of his working life. In fact, based on the very long-term past record the annual real edge your neighbor would have over you if he invested 100% in a stock index fund and you invested 100% in a commodities basket would be greater than the house’s edge on a single game of baccarat, blackjack, roulette, or craps.

To simplify this hypothetical, let’s say you get only one investment choice your whole life. Instead of picking specific investments as the years go by – you only get one choice at the start of this 30-year period. And that choice is a strategic choice. You can either pick the 100% stocks strategy or the 100% commodities strategy. You can’t switch. Will there be years in which you regret taking the 100% stocks strategy? In a sense, yes. A basket of commodities will – in some of the next 30 years – outperform a basket of stocks. Yet, to say you would – in those years – actually regret your initial choice of the 100% stock strategy is like saying a casino would rather be the player than the house. If the casino knew the future of each hand, each night of play, etc. – I guess you could say that. However, what exactly is it that an investor is actually regretting in his poor relative performance years? He’s regretting not switching strategies from a long-term superior strategy to …