Andrew Kuhn August 24, 2018

BUKS follow-up: A catalyst could emerge within a month

Member write-up by VETLE FORSLAND

I wrote up BUKS on the website earlier this month. After discussions with Geoff, we agreed that a follow-up article was relevant, as there were important parts of the thesis that I left out in the original write-up (which you can read here if you missed it).

https://focusedcompounding.com/butler-national-corp-buks-an-illiquid-ben-graham-style-mini-conglomerate-in-aerospace-and-casinos/

This article will focus on a real estate deal that could act as a drastic catalyst for the stock, which is desperately needed.

BUKS’ real estate deal, and why it’s a bargain

BUKS has a buyout option on the Boot Hill Casino, which they have been renting since 2009. They are paying $4.8 million in leases annually on the property right now. If we cap this at an aggressive rate like 8%, we get a valuation on the property of $60 million. BUKS has the option to buy the very same property for $45 million – or $16 million below what we can expect is a conservatively fair price.

That difference alone is worth BUKS’s entire market capitalization.

And, that $60 million valuation isn’t just from a lease cap assumption. The CEO himself, Craig Stewart, said in an earnings call that the official appraisal is «significantly higher» than the $45 million price tag, which he again claimed was «definitely substantially under» appraised values. Understandably, an analyst on the call asked for specifics on the appraisal value. He didn’t get a clear answer on his question, as it’s confidential, but Stewart claimed $55 million was «close» to the fair value presented by the bank they’re working with, when he was pressed on the subject. Stewart also revealed that it will cost $1 million to get the deal financed. So, what does this mean?

I got the impression that the leasing contract expires in 2034, as they agreed on a 25-year lease in 2009 (2009+25=2034). Therefore, if they don’t buy out the casino, BUKS is stuck with $77 million in leasing costs over a 16-year period. Instead, they can buy a property for $45 million, when it’s worth 30% above that figure, and then finance it with a one-time expense of $1 million – sound good yet?

If BUKS wanted to, they could buy the casino, and instantly look for a buyer, and potentially make 70% of their market cap in one transaction. However, there is probably more value for the company if they keep the real estate for themselves and cut lease expenses.

What does this mean for the stock?

Obviously, this is a good deal for the company, and the value added to the firm should be reflected in the stock price. However, there is clearly a lot of value in BUKS already that the market is either not seeing, or blatantly ignoring. It might very well be the latter, and I explained why in my original write-up. In a nutshell, the executives, represented by the CEO and his brother, his cousin and his son-in-law, are using BUKS to get generous salaries year in and year out, and they are therefore not acting in the best interest of shareholders.

But, with this deal, the company could be revalued differently by the market. Firstly, when they file an 8-K or publish a press release, it will draw attention from investors. That’s important to keep in mind, as any additional attention from large investors could move the stock price of this nano-cap. Secondly, the balance sheet will be expanded by a matter of $50 million, ballooning the financial size of the company, turning BUKS into a highly leveraged company. Today, it has net cash. After this deal, BUKS will trade at a Debt/EBITDA of something like 10 times. This is likely to draw attention from investors, which equals more buyers, as the stock is trading at a significant discount to its fair value. It could further cause an activist investor to investigate the case after some BUKS coverage in the news, another potential catalyst for the company.

So, the market could value the stock differently because it is now heavily leveraged, they’re larger in terms of the balance sheet, and the market will most likely know that BUKS made a great decision buying the Boot Hill Casino.

It’s a good deal for shareholders for all of the reasons listed above; they will cut costs, make at least $10 million of the deal from a pure trading point of view, causing the market to give more attention to BUKS, potentially triggering a re-pricing or the entrance of an activist investor. The stock also trades around $6,000 worth of stock on average every day. After BUKS announces this real estate deal, algorithms and micro-cap daytraders will trade the stock, as they always do, leading to significantly more volume and a higher stock price.

Risks

Few things could go wrong with a bet on the stock before the real estate deal is announced. However, is it possible the deal doesn’t go through?

Maybe, but it’s not likely.

The CEO said in the earnings call that he wasn’t going to tell investors if it was going to happen, but he claimed, «all the indications are, this should happen». Given the fact that they have financing for this objectively great deal, this probably will happen, and it will happen soon.

Because, in the same earnings call, they were considering putting in the application with the state, as they’d need permission to own the casino, after the Kansas primaries. The primaries already found place on August 7th, but the CEO claimed «we don’t know for sure that everything is going to happen like it needs to happen to make all this work in August. But we’re – how elections work, you never know what you are going to get». He later added that «it’s moving along».

As I interpret it, we can expect news on this front within a month’s time. I don’t see what could cause any large drop in the stock until then, even if the deal doesn’t go through, as the market hasn’t priced in the deal at all. BUKS has found a stable trading range in between $0.20-$0.25, after the market has spent a decade plus valuing this stock as a dead stock, largely because of the management.

Therefore, I believe a bet on this stock now could be a good wager, with a possible exit at entrance price one month down the road, if the deal for whatever reason fails to cross the finish line. However, if the real estate deal goes through as planned, we might see a substantial price increase immediately, and the event will put BUKS on the map again, this time as a dirt-cheap value-play.

Additional crucial information to know before investing in BUKS

There are more things going on with BUKS that are not as positive as the real estate deal. I have two points in mind: the poison pill in place, and the risk of a share dilution.

The Poison Pill

There is currently a poison pill in place that could prevent a hostile takeover from an activist if an investor buys more than 15% of the shares outstanding, which could be critical in an activist campaign. This poison pill could explain why Joseph Daly hasn’t acquired more than his current 12%-position in BUKS. But, there is nothing stopping multiple activist in joining Daly here. Furthermore, I doubt an activist campaign will need close to 50% of the stock to succeed. Management aren’t owners of more than 19% of the company today, and if you read the earnings transcript I have cited multiple times throughout this article, you can tell that investors aren’t satisfied with the status quo. So, a group of activists – or perhaps a pair – owning around 30% of the stock, could have the power to push through several changes with the help of an additional 20% in voting power from smaller investors. It has happened many times before. Just recently, Cornwall Capital managed to beat Keweenaw in a proxy battle with only 26% of the voting power.

Share dilution

A huge reason behind shareholder’s concern with BUKS, is the large amounts of additional shares that could be flushed into the market. The company has already registered 12.5 million shares for issuance, but nothing has been issued officially yet. BUKS claims that they plan to grant them over a 3-5-year period for an incentive-based compensation package for executives. So, there is a 20% dilution overhang on the stock, which could be another factor in why BUKS is trading at the substantial discount it’s trading at. While the company told investors they would provide additional information at the 2018 annual shareholder meeting, I didn’t find any clarifications in the proxy. However, I fear that, despite a long shot, BUKS will use the real estate deal as a reason to compensate executives with additional shares.

Summary

To summarize, this follow-up article strengthens the case for buying BUKS, despite the two negative factors I closed the article with. The real estate option they are sitting on, plus their cheap financing cost, is simply too good from a financial point of view to ignore. And in a negative scenario, where the deal goes through, but the company dilutes shareholders and an activist investor fails to take a significant position because of the poison pill, there is still not much room for downside from $0.20. The poison pill has been in place for years now, so it’s most likely priced in by the market, and the 20% dilution overhang, if realized, will be compensated by the 30%+ profit BUKS will make from the real estate deal.

 

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