Case Study: Geoff’s Investment in Bancinsurance – Letter to the Board of Directors

A reader sent me this email:

I came across your Barnes and Noble write up on GuruFocus. I noticed in the comments section you mentioned two letters you sent to the board of directors of an insurance company you owned. Would I be able to get those off of you?

Sure. Here’s the case study. Read what I did. And think about what you would have done.

Background: Years ago, a microcap specialty insurance company, Bancinsurance (BCIS), was involved in a bail bond reinsurance program that caused a 29% loss of shareholder’s equity.

Bancinsurance’s auditors resigned. A.M. Best cut Bancinsurance’s financial strength rating. NASDAQ delisted the stock. And the SEC sent a Wells Notice telling Bancinsurance the SEC was investigating the company’s executives.

At this time – 2005 – I began following the stock. On February 3rd, 2010, the SEC told Bancinsurance it was not going to act against the executives. I decided to buy Bancinsurance stock.

I started selling other stocks I owned to round up cash. In March, Bancinsurance’s bid and ask prices were below $5. I started buying at $4.75.

On March 23, 2010, the Bancinsurance board announced the CEO – who owned 74.17% of all Bancinsurance shares – was offering to buy out other shareholders at $6 a share. I bid for all stock at or below $6 a share throughout this period. I probably accounted for the majority of Bancinsurance’s trading volume from this point on.

On April 7^th, 2010, I sent a letter to Bancinsurance’s board of directors.

Geoff Gannon’s 1st Letter to Bancinsurance’s Board of Directors

Talk to Geoff about Bancinsurance (BCIS)…

Barnes & Noble: Stock Price Moves and Short Sellers – Can a Stock Move Without News?

A reader sent me this email:

In your blog post you mentioned that surprises move stocks…is there a surprise reason that could have caused BKS to move to $18 last week that you might know of?

Most of Barnes & Noble (BKS) is owned by Riggio, Burkle, and Aletheia. Many of the folks who trade Barnes & Noble are short the stock. There’s nothing wrong with that. In the long-run: the stock will reflect the business. That’s true whether or not people are shorting it.

The move you’re talking about was made possible by shorting. If someone decided they didn’t want to stay short through the board election, they might move the price, because the supply of traded stock is small compared to the amount sold short. A scheduled event – like a board election – can make this worse, because shorts may want out at the same time longs decide they’ll stay put.

It’s like a baseball game where everyone decides they’ll leave in the 8th inning to beat the traffic. It doesn’t mean there was news. It doesn’t even mean people made up their mind at that moment. Some shorts may have always planned to get to a more neutral position for the annual meeting. And some longs who normally traded in and out of the stock might’ve figured they’d chance it and stay through the annual meeting.

Volume was higher than some days. But it wasn’t huge for a stock everyone knew had big news coming out.

Talk to Geoff about Barnes & Noble (BKS)…

Earning Power: Free Cash Flow Margin Variation – Price-to-Sales Ratio

I only care about the price-to-sales ratio where the past record proves sales turn into cash profits. If a stock has a low price-to-sales ratio and no retained earnings, no free cash flow, etc., I ignore it. Same with net/nets that have no retained earnings – unless they’re liquidating.

I look at the free cash flow margin (FCF/sales). I go back at least 10 years. If I’m real interested, I go back as far as EDGAR goes – usually 13 to 17 years.

I figure the historical free cash flow margin’s mean, standard deviation, and variation coefficient (standard deviation/mean). I love a super low variation coefficient like Pepsi (PEP) or United Technologies (UTX) – both around 0.10. But I’ll take Barnes & Noble around 0.75. BKS’s price-to-sales ratio is so low, I don’t need the free cash flow margin to be what it used to be to make money in the stock.

I won’t buy something with lots of free cash flow margin variation unless it’s a net/net. Even then: I focus on net/nets that once had lots of free cash flow with little variation.

So I don’t look at price-to-sales ratios alone. I look at something like:

(Sales * FCF Margin) * (1 – FCF Margin Variation)

I’ve never written that down. And I don’t mean it literally. I don’t mean you can value stocks that way. But those are the moving parts I see in my mind’s eye: sales, FCF margin, and FCF margin variation.

That’s how I think about earning power.

Talk to Geoff about Earning Power…

Barnes & Noble: What Happens Next? – Is This Yahoo and Microsoft All Over Again?

A reader sent me this email:

I believe your thesis was to be long because of a proxy battle and buyout of either Riggio or Burkle…It reminds me a bit of the YHOO MSFT situation where…MSFT would pay whatever, but the deal never got done and YHOO went in half.  You may be right that Burkle wants the company for $20, but at what point does he…walk away?  What do you think happens next here?

There are differences between Barnes & Noble (BKS) and Yahoo (YHOO). The biggest are:

•  BKS is cheap; YHOO wasn’t
•  Len Riggio owns 30% of BKS; Jerry Yang owned 4% of YHOO
•  Ron Burkle owns 19% of BKS; Carl Icahn owned 6% of YHOO

Microsoft didn’t own Yahoo stock. So the positions of Microsoft, Yang, and Icahn were different from those of Riggio and Burkle.

Riggio, Burkle, and Aletheia own most of Barnes & Noble. They have money at risk. They can only get it out by selling in the market and driving down the stock price or selling in a deal.

Burkle is different from Microsoft or Icahn. Burkle didn’t start out wanting control of Barnes & Noble. He just wanted to be a big investor. He’s an influence investor not an activist like Icahn.

Burkle wants the best price. He doesn’t think he’ll get it from Riggio.

What’s next?

I expect Burkle and Riggio will argue about the Barnes & Noble sale process in court and in the press for the next 3 months.

Talk to Geoff about Barnes & Noble (BKS)…

Barnes & Noble: Stock Price Moves and Breaking News – Benjamin Graham’s Mr. Market

A reader sent me this email:

Hello Geoff,

I am a recent college grad who is just starting to become interested in the stock investment world…I happened to hit upon your articles on BKS early last month and I’ve become quite interested in what’s going on with the company since. I’m a bit confused as to the logic of today’s stock price drop at the beginning of the…day and I’m wondering if you could shed some light. Last week’s jump…to almost 18 appears to reflect the news that three proxy advisors supported the current management team, so I’d think the investors feel the same and thus the increase in price. Why is it then that when the current management announced their win today, the stock sharply dropped by almost…$1 before slowly rebounding up? Thank you.

– Steve

I’m not sure last week’s jump to $18 had anything to do with proxy advisors. Advisors split the way you’d expect: Glass-Lewis for management; ISS for dissident. Investors aren’t pro-Riggio. The timing of the price move just made it look that way to you.

Surprises move stocks. When Barnes & Noble said it might sell the company, investors were surprised. The trial verdict and the proxy endorsements were not surprises.

Board election odds were 50/50 and neither outcome was decisive for buyout chances.

Don’t study stock moves. Use Benjamin Graham’s Mr. Market metaphor. Think of the market as someone you can take advantage of instead of someone you can learn from.

Talk to Geoff about Barnes & Noble (BKS)…

Bonds: Interest Rates and Asset Prices – What’s the Right Earnings Multiplier?

Here’s a follow-up question from a reader who’s still troubled by the idea of multiplying a stock’s 10-year average earnings by the inverse of AAA bond yields to estimate the stock’s intrinsic value:

Suppose bonds yielded 0%. That would imply an infinite valuation for companies…What is the price-to-coupon multiplier you would use at an extreme?  Say bond yield of 0%, 1%, etc.    

You’re focused on bond yields instead of bond prices. Saying assume 30-year AAA corporate bonds yielded 1% is like saying assume stocks traded at a P/E of 100 or farmland sold for $50,000 an acre. Can you do math with those numbers? Sure. Can you see them in the wild? No.

I use 30-year AAA corporate bonds instead of government bonds. Their lowest yield was 2.53% in 1946. That means a multiplier of 39.53.

For 1881-2010 the multiplier range is 7 to 40. Meanwhile: the price to 10 year average earnings for stocks ranged from 5 to 43. Investors have never valued $1 of earnings at less than $5 or more than $43. Nor have they valued $1 in promised AAA cash at less than $7 or more than $40.

To have 1% 30-year AAA corporate bond yields, you’d need to push the price of those bonds up from a historical median price of $21.72 per $1 promise to $100 per $1 promise. That’s a 360% price increase.

It would look like this:

If that happened, I’d buy stocks. I’d be too scared to buy bonds. Wouldn’t you?…

Barnes & Noble: Len Riggio Defeats Ron Burkle – 44% to 38%

The New York Times’s Deal Book is reporting that Len Riggio defeated Ron Burkle in today’s Barnes & Noble (BKS) board election. The vote tally – and so far, only Deal Book is giving numbers – was 44% for Riggio to 38% for Burkle.

Burkle got his press release out first:

…preliminary vote totals show that Barnes & Noble…stockholders not affiliated with either Leonard Riggio or Yucaipa voted overwhelmingly for the Yucaipa nominees and poison pill proposal, but due to the insurmountable voting advantage of Leonard Riggio and other insiders the Barnes & Noble slate prevailed.

Barnes & Noble followed with its own press release. All statements were cut and paste.

So back to Burkle’s:

…it is important that Leonard Riggio himself send a message that the strategic alternatives review process is fair and non-discriminatory… the best way he can support the Company’s efforts to maximize stockholder value is a clear and unequivocal public commitment to support the highest bid for the Company, even if it is submitted by a third party…If Mr. Riggio is unwilling to make that commitment, we challenge the Committee overseeing this process to insist on it as a condition of entertaining a bid from him or, at a minimum, amend the poison pill to allow other bidders to neutralize Mr. Riggio’s voting bloc.

Barnes & Noble is trading at $16.16 a share. My average cost is $15.36. I have no plans to sell. If you have questions for me about my BKS position, just ask.…

Barnes & Noble: How Did Independent Shareholders Vote? – Aletheia

When reading media reports on the Barnes & Noble (BKS) board election, it’s important to read the whole article and ignore some of the surface statements.

For example: some reports say that shareholders decided to backed Riggio. Right now, we don’t know that. Riggio won the shareholder vote. However, most of Riggio’s support came from Riggio himself.

We need to step back and look at how much support Riggio got from people besides himself and his brother. We also need to question Burkle’s statement that “independent” shareholders strongly supported him. Does he mean Aletheia is independent? From his press release, it certainly seems that way.

I’m interested in knowing how folks other than the Riggios, Barnes & Noble insiders, Yucaipa, and Aletheia voted. How did that vote breakdown? How many unaffiliated shareholders didn’t vote?

The New York Times’s Deal Book and Reuters are reporting actual percentages. Neither of the two parties gave numbers in their releases. Both Deal Book and Reuters are saying it was 44% for Riggio. They differ on whether it was 38% or 39% for Burkle. And Reuters says it was 43% instead of 44% in support of the posion pill. So there was a smidge of ticket splitting.

The important question is how seriously we should take what Burkle said about Aletheia’s non-votes. The pro-Riggio vote wasn’t strong. Riggio started with 38% to 39% of the vote. Only about 5% came from campaigning. It’s all about why Burkle couldn’t get to 44%. Not why Riggio could.

Talk to Geoff about Barnes & Noble (BKS)…

Panic of 33: Roman Credit Crisis – Tiberius the Central Banker

Since I linked to a post about monetary policy as asset price policy, here’s an example.

In 33 A.D., there was a shortage of money in Rome. Richard Duncan-Jones, the Bill James of Roman economics, explains it well.

To fix this problem:

…the Senate…required that two-thirds of every loan should be invested in Italian land, and that two-thirds of every outstanding debt should be paid off.

In other words: two-thirds of every debt should be paid for with land.

I assume this meant two-thirds of every debt should be paid for with land at cost instead of market.

The disease was debt deflation. The planned cure was to let borrowers pay their debt in land as if land had never fallen in value.

Unfortunately:

…the loans were actually called…in full, and the property market became glutted with estates of debtors desperate to sell, to the point where land prices collapsed.

Lenders faced a forced conversion of debt into land. They were told 18 months ahead of time. If the market value of land was less than the value of the debt, any sane lender would call his loan before the conversion happened.

To fix this problem:

…(Tiberius) came to the rescue…the debtors having the privilege of borrowing for three years, without interest, on giving landed security to the state for twice the amount of the loan. Thus credit was restored, and gradually it was found possible to borrow from private persons also.

Tiberius used money to fight falling asset prices.…

Barnes & Noble: Delaware Law – When Will the Bidding Start?

A reader asks:

“Do you know what…Delaware law states about when Riggio can make a bid of his own? If Burkle wins, what do you think the odds are that Riggio will make a bid immediately?”

I don’t know what Delaware law says about when Len Riggio can bid for the company. Delaware law is cases like Unocal v. Mesa Petroleum, Ryan v. Lyondell Chemical, and Revlon v. MacAndrews & Forbes Holdings.

Revlon gives directors one job: “get the best price for shareholders at a sale of the company.”

Once two people make a bid for Barnes & Noble (BKS), the board’s job is to get the best price.

Reuters is saying:

“If Burkle doesn’t win at Tuesday’s shareholder meeting, sources tied to this…battle say he is likely to come back with a bid for the…store chain.”

They quote a consultant:

“Offers are likely to start soon after the vote, either from one of the losers or from buyers watching on the sidelines.”

I don’t see why Burkle or Riggio needs to bid immediately. And I don’t see why investors need the instant gratification. My average cost is $15.36 a share. I bought expecting a $20 a share bid. That’s a 30% return. Even investors who buy today – at $17 – would make 18% on a $20 bid. If it took 6 months, the annualized return would still be great. I’d worry more about the people and the business and less about the timing.

But I expect bids soon.…