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.
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. It’s something Graham could buy – not Fisher or Buffett in his later years. Gross margins have been steady in the mid-thirties, while EBIT margins are hovering in the high single-digits. In other words, there is not much exciting about the stock in this part of the analysis. It’s not particularly asset-light, it’s not operating in an up-and-coming sector, and growth prospects are dim. Furthermore, it’s trading at a share price in the range of $0.20-$0.25, its stock is very illiquid, and the company is generally neglected by the investment community. So, why am I interested in this company?
Because a sum-of-parts analysis shows it’s incredibly cheap.
Valuing the Aerospace segment
Their most recent 10-K shows that this part of the business generated $906,000 in EBITDA in 2018. This is down from $2.44 million in 2017, and the average EBITDA for this segment since 2012 has been $1.67 million. A basket of larger peers I found trades at an average EV/EBITDA of 13.8, which would give us a potential value for the Aerospace segment of $23.10 million.
Could any of the larger Aerospace companies buy BUKS at that price?
Remember, as BUKS is a tiny company, overhead costs swallow up an unnecessarily large percentage of its revenues, leaving margins razor-thin. A potential buyer would be able to cut costs drastically, making the company a great buy. The management alone costs the company $1.20 million, expenses that would be cut immediately after an acquisition, and economies of scale would possibly synergize the business further.
Valuing the Professional Services segment
Valuing this part of the business is different from valuing the Aerospace segment, as it would make less sense for a larger peer to swallow this minnow. An acquisition of a casino management business wouldn’t provide synergies to the same extent as a manufacturing business, besides cutting executive salaries. But, this part of the company is still trading at a big discount, which the market most likely would realize if the Aerospace segment would be acquired.
In 2017, the Professional services segment generated EBITDA totaling $2.98 million slightly down from $3.05 million in 2016. The six-year average EBITDA of this segment is $2.91 million, which shows that this business is a lot less cyclical in nature, which makes sense. A basket of public companies that manage casinos trade at an EV/EBITDA of 12. However, these companies, for the most part, are not set up in the same manner as BUKS. BUKS manages two casinos, and they get a percentage share of the net income every year that these two casinos generate. Peers sometimes own casinos outright, combined with managing some, and others have a larger basket of casinos to manage, which is safer in terms of contracts expiring etc. So we should discount the multiple here a bit – I’m not sure how big of a discount is reasonable, but a 50% discount sounds conservative. If we slap this 6x multiple on the Professional services average EBITDA, we get an enterprise value of $17.47 million.
Valuing other assets
BUKS also owns some real estate – which should be taken into account when valuing a company this small – and has a net cash holding. These two totaled together, if we take the figures from the balance sheet at face value, equal $10.60 million.
Adding up the sum of the parts
These three parts added together gives us an enterprise value of $51.17 million, or $0.79 per share – 243% higher than today’s share price of $0.23. If a takeover would happen within the next decade, and if the market would revalue the company at my calculations, this is a compound annual return of 13%. If things happen really fast – which could happen if an activist investor sees the opportunity I see – the stock could compound at 28% over the next five years. Luckily, the latter could very well happen.
But first, let’s talk about the management, and why BUKS shareholders have to rely on an activist to monetize the value the company is sitting on. Basically, BUKS operates like a family business. The CEO, Clark Stewart, employed his son as the vice president, his brother as an executive officer and engineer, and his son-in-law Jeff Shinkle as an architect for their architectural services segment, which from my understanding, doesn’t bring in a whole lot of value for the company. The latter part makes me think that the architectural services segment could have been a strategy to get more of their family involved in the business. These four family members make more than $1.2 million combined every year, while the CEO owns just a tiny bit more than that figure worth of stock in the company, while continually making $500,000 thousand a year in salary. It would make sense that the CEO is in the business for making money for himself and his family, instead of providing value to his shareholders – if his main goal was the latter, he would own more shares – but he doesn’t. So why bet on this company if the management is not actively trying to increase the per share value, which has stood still since the early 2000s?
The answer to my last question is the largest shareholder in the company, Joseph P. Daly, who owns 10.3% of the company. Daly is the founder and CEO of Essig Research, which owns EssigPR, where he keeps a third of his shares. Essig specializes in consulting for aerospace manufacturers, which makes Daly a good candidate as a board member of the company, where he could be of value to the executives. Daly has taken an active role in other microcaps, buying up shares and influencing the management to take rational shareholder-friendly decisions, and the same could happen with respect for BUKS. While he hasn’t tried to do any of that yet, it could certainly change in the future. And, if he gets a seat on the board of directors, he could assist another activist investor if one would eye this opportunity as well, propelling a catalyst.
Furthermore, the company is buying back some stock. They have approved a $750,000 buyback program through May 2019, and they bought back more than $200,000 during the fiscal year that ended in April 2018. Although that’s not a lot, it could be the start of a significantly larger buyback program, which they could afford with their cash pile on the balance sheet.
BUKS is a mediocre company trading at a large discount to its intrinsic value, but I’m struggling to see a path to that high figure, unless one of three things happen:
- A larger peer acquires the cheap Aerospace segment;
- An aggressive activist investor, with the support of Joseph Daly, takes up a fight with the management. Remember that these campaigns are often expensive for both parties, and it’s doubtful if BUKS would afford (or want to spend a bunch of money) fighting off an aggressive activist.
- The BUKS management stops treating their company as a salary machine, and tries to monetize the value the company is sitting on.
Neither of the three options above are unthinkable. It has happened before to much larger companies with a much higher insider ownership percentage. Right now, eight directors and officers own 19% of the company, a figure that has remained steady for several years now.
BUKS is a company every microcap investor should keep on their notepad, although there is no hurry to acquire shares – volume is always low, and it’s unclear exactly when the stock could rally closer to its intrinsic value.