Undervalued Quality – Nathan’s Famous Inc.

Where did the summer go? After quite a long break from the blog, I’m back to talk about the newest stock I’ve been purchasing for Alluvial’s clients: Nathan’s Famous Inc.


Nathan’s will be a familiar name for any New York natives (which I am not, but I know many blog readers are.) Founded in 1916, the company has never deviated from its business of selling hot dogs made with its proprietary blend of spices. These days, the company focuses on franchising and branding revenues. There are around 300 franchised Nathan’s Famous locations around the world, and five company-owned locations. Nathan’s branded hot dogs and other foods can be purchased at many supermarkets and wholesale clubs, and the company sponsors the annual hot dog eating contest at their flagship restaurant on Coney Island.

I’ll go into detail below, but the crux of my thesis rests on a simple assertion: Nathan’s is a premium business, therefore it should command a premium valuation. Nathan’s trades at a very pedestrian valuation. Therefore, Nathan’s is undervalued and is an attractive investment. Just what qualities a “good business” possesses has been explored at length by better investors than I, and I won’t waste words on that topic. Instead, I’ll illustrate the ways in which Nathan’s business characteristics demonstrate its quality.


Nathan’s has a strong history of growth, and there is more to come. Over the last ten fiscal years, Nathan’s revenues grew at 11.5% annually. Nathan’s trailing revenues surpassed $100 million for the first time in the most recent quarter. There is no reason to expect this growth to halt any time soon. At $100 million in revenue, Nathan’s is still a tiny, tiny player and will not run into issues of market saturation for many years. Furthermore, in 2014 the company signed a new product licensing agreement with the world’s largest pork processor, Smithfield. The agreement replaces a previous licensing agreement and provides hugely improved economics for Nathan’s. The new agreement more than doubles the gross sales royalty Nathan’s receives for Nathan’s branded products and features high and increasing minimum annual royalty payments.

Then again, any company can grow. All it requires is a willingness to commit capital, whether through internal investments or external acquisitions. Growth in itself is not inherently good if it requires excessive additional capital. What makes Nathan’s special is its ability to create sustained growth with minimal capital commitment.

Pricing Power/Brand Value

From fiscal 2010 through fiscal 2015, Nathan’s experienced torrid growth and an associated increase in operating income. Revenues rose 95%, from $50.9 million to $99.1 million. Operating income rose more, jumping 135% to $20.0 million from $8.5 million. And what did Nathan’s have to invest to grow operating income by $11.5 million in five years? Very little. Assuming operating cash of 2% of revenues, invested capital increased by just $2.3 million over the stretch.

When a business is able to produce significant profit growth without a corresponding increase in its capital base, it indicates pricing power. Now, investors must distinguish between illusory pricing power that is the result of cyclicality, such as the increased earnings that commodities producers can show when demand growth outstrips supply growth, and authentic pricing power that is the result of brand strength. Seeing as the demand for summertime comfort food remains relatively stable from year to year, it is highly unlikely that Nathan’s results are attributable to some hot dog super-cycle. Rather, Nathan’s strong brand and popular products allow it to command price increases year after year and to achieve better terms on licensing agreements as they come up for renewal.

Operating Leverage and Margin Expansion

Quality businesses find ways to do more with a dollar as they grow, and Nathan’s is no exception. The growing revenue base allows the company to spread its fixed costs over a large base, and the ongoing move into licensing revenues over restaurants sales has resulted in high and higher contributions to the bottom line. Compared to other revenue sources, royalty streams have nearly no associated costs. As a result, Nathan’s operating margins have surpassed 20% and are set to continue their increase. Compared to just five years ago, nearly an additional nickel of every dollar of sales falls to operating income.

Free Cash Flow 

Quality businesses produce copious and consistent free cash flow. Some may reinvest the majority of it into the business in order to further drive growth (above and beyond that which is naturally created by pricing power) but many return most or all cash flow to shareholders. Nathan’s is one of these. In the ten years ended in fiscal 2015, Nathan’s produced total free cash flow of $55 million. Of that $55 million, Nathan’s spent $49.6 million to repurchase shares. How many companies can devote 90% of free cash flow to share buybacks and still triple revenues over the same period? Better yet, the majority of the share repurchases were done in 2008 and 2009, when Nathan’s shares traded at depressed levels. With little need to innovate and minimal capital needs for expansion, Nathan’s appears set to continue returning nearly all cash flow to shareholders in a tax-efficient manner.


I think I’ve made a case for Nathan’s as a “premium” business. There’s more I could talk about, like the company’s astronomical returns on capital and its highly incentivized insiders, but let’s move on to valuation. What is the proper price for an “average” business? It depends on a number of things like interest rates, capital structure, industry growth rates, and margins. But in general, I think the average publicly-traded business is worth at least 10x operating income, assuming a normal economic growth outlook. I usually think I’m getting a good deal if I can pay 8x or less. Premium businesses, on the other hand, can and should command a premium valuation. I don’t hesitate to pay 12, 14, or even 15 times operating income for a business that can truly produce excellent growth with modest investment, while increasing its margins at the same time. I find that the market systematically undervalues these rare companies.

The market currently values Nathan’s at just a hair over 10x adjusted trailing operating income. Before getting further into that, let’s take a look at how the market values Nathan’s competitors. I’ve ranked the chart by historical revenue growth. The calculations are my own.


I don’t mean to say that all these business are directly comparable to Nathan’s. In fact, most are traditional restaurant operators, not licensors. Rather, I provide this chart simply to point out that despite superior growth, margins, and asset utilization, Nathan’s valuation is the lowest I can find among American restaurant companies. Of the companies included in the chart, DineEquity is the most similar to Nathan’s. Despite actually shrinking by 14.3% annually and becoming more asset-intensive along the way, DineEquity trades at a 39% valuation premium to Nathan’s.

So why does Nathan’s trade at this large discount to its peers, most of which are distinctly less attractive from a business perspective? I believe the biggest reason is the large leveraged dividend recap that Nathan’s just did. In March, Nathan’s took on $135 million in senior secured debt at 10%, due in 2020. Nathan’s used the proceeds of the debt offering to pay a $25 per share dividend. Since the dividend was paid out, Nathan’s shares have fallen 36%. Post-transaction, Nathan’s finds itself with very high headline leverage, and also set to see its net income drop substantially year-over-year, neither of which most investors like to see. The $135 million in debt will reduce annual net income by almost $1.80, and now the company appears to have EBIT/cash interest expense coverage of just 1.5x.

To a casual observer, Nathan’s may now appear leveraged to the hilt, with deeply impaired earnings power. However, things are not  as they seem. Despite its large debt load, Nathan’s has $60 million in cash and securities on its balance sheet. The company also has well over $200 million in guaranteed cash flows it will receive between now and 2032, and will probably receive a great deal more. The licensing agreement with Smithfield specifies minimum annual royalties of $10 million in the first year of the contract, growing to $17 million by the last year. Simply put, Nathan’s risk of encountering financial difficulties due to its leverage is practically zero.

I also expect Nathan’s earnings power to be restored in short order. Powered by the new licensing agreement, I expect the company’s growth to continue with an associated gradual increase in operating margins. Earnings rise quickly as leveraged firms grow. Nathan’s interest expense, while high, is fixed, and incremental earnings will flow to equity owners.

So what do I think Nathan’s is worth? It’s hard to say, exactly, because much depends on how successful the company is in increasing its royalty revenues, and how much of that $60 million sitting on the balance sheet is used to repurchase stock. But I do expect Nathan’s to continue to grow its operating income at a double digit rate, and that will quickly result in an increased business value. Sooner or later the market will realize the dividend recap hasn’t permanently crushed Nathan’s earnings power. I expect substantial appreciation from Nathan’s Famous shares in the coming years.

Alluvial Capital Management, LLC holds shares of Nathan’s Famous, Inc. for client accounts. Alluvial may buy or sell shares of Nathan’s Famous, Inc. at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Why Be Unlisted?

An OTC stock is one that is unlisted and doesn’t trade on an exchange. For some, being unlisted indicates a company that is extraordinarily risky with high potential for fraud. In other words, uninvestable. But for others (like me) unlisted stocks are merely a different category of stocks with their own advantages and disadvantages. Still, those of us who consider unlisted stocks part of our investing universe should ask ourselves just why a publically-owned company would choose to remain unlisted. After all, the norm for companies with a significant number of shareholders is to list on a national exchange. Listing on the NYSE or NASDAQ is costly, but the cost is surely more than covered by the benefits of increased liquidity and the higher valuation afforded listed companies.

Allow me to present a brief list of common reasons why companies remain unlisted and trade OTC, from the most benign to the most sinister. I have seen each of these reasons time and time again across thousands of unlisted stocks, both in the US and abroad.

No Need for Capital

This is perhaps the best reason for a company to remain unlisted. Recall that listing on a national exchange typically boosts a company’s valuation to a higher multiple of revenues or cash flows. This indicates a decreased cost of capital, which is extremely beneficial for companies that rely on a flow of fresh capital from investors, especially equity capital. At higher valuations, equity raises result in a smaller percentage of the company being sold in secondary offerings, which benefits existing shareholders.

However, for investors in a company that produces excess capital, a higher valuation can reduce long-term returns. A responsible company will return excess capital to shareholders either through cash dividends or through share repurchases. In either case, a lower valuation is beneficial to long-term holders as they reinvest dividends or as their ownership increases proportionally via buybacks.

A good example of this process in action is Computer Services, Inc. Investors in Computer Services have enjoyed a 12.7% compounded annual return over the last decade, seriously outpacing stock indexes. Computer Services generates substantial excess capital and routinely repurchases stock and increases its dividend. Since 2005, the company has repurchased 16.2% of its shares outstanding. This large decrease would have been muted if the company’s shares had traded at a higher average valuation during the period. Reinvested dividends and share repurchase programs would have netted far fewer shares.

Sadly, these types of companies are all too rare. I can think of only a handful of unlisted companies that regularly generate excess capital and return it to shareholders. Most companies that enjoy these characteristics are either privately owned or have long since by bought by larger competitors.

Small Size

Some companies are simply too small for an exchange listing to be viable. I have seen various figures thrown around for the cost of maintaining an exchange listing, but most estimates indicate that an NYSE listing costs close to $1 million annually when the reporting and compliance costs are included. A NASDAQ listing is cheaper, but both are prohibitive for companies earning only a few million in operating income. Some of my best investments have been in companies earning only $2-10 million per year, and the cost of an exchange listing would have been a material drag on earnings.

Companies too small to support exchange listings are a fruitful market segment for value investors. Because they are both tiny and unlisted, many of these companies receive little press and go under-researched, leading to frequent mis-pricings. Some of these companies possess a valuable option that can result in big returns: uplisting. Many of these tiny companies grow rapidly, and will eventually seek to list. Investors who bought in prior to the listing often do very, very well. I’m almost always thrilled when one of my small holdings announces an uplisting, because I know the increased exposure will result in a higher valuation.

Can’t Meet Listing Standards

The NYSE and NASDAQ require a level of disclosure that some businesses either can’t or won’t meet. Sometimes businesses in the midst of restructuring or restating are unable to file timely financial reports, eventually disqualifying them from listing. And sometimes companies simply do not want to provide the detailed reporting that standard filings require.

This lack of disclosure is a mixed bag. Sometimes important details are left out, but often the incomplete filings provide opportunities for value investors willing to do additional legwork. In the absence of standard filings, some investors conclude the elevated risk of fraud is enough to disqualify a company for investment. That’s fair enough. But I don’t automatically exclude a company from consideration for not disclosing every detail down to its receivables aging schedule. I know of many companies that choose not to release fully-detailed filings simply because of the expense and effort involved.  (Others, of course, provide incomplete disclosure in order to obfuscate and distract from untoward actions. But that’s the next topic.)

In cases where business details are easily verified, incomplete disclosure may be sufficient. I know of a few real estate companies trading OTC that reveal little about the details behind their operations. Yet the holdings are easily verified through public tax records and the assessments and reassessments listed there are invaluable in estimating the real estate’s value.

Shady Insiders

Sometimes companies choose to remain unlisted because the behavior of insiders would never stand up to the increased scrutiny that comes with listing. Excess compensation, empire-building, entrenched management and rampant self-dealing are common in companies of any listing status, but are much easier for unethical management teams to accomplish off-exchange.

There are numerous companies that walk the line between ethical and unethical treatment of shareholders, and some that engage in outright abuses. For example, some years ago I became a shareholder (one share only) in a company that refused (and still refuses) to provide any financial information to shareholders unless they would sign a non-disclosure agreement indicating the shareholder would not share the information with anyone else, including other shareholders. Seeing no alternative, I agreed to this demand and signed the agreement. Sure enough, management’s rapacious actions were obvious soon as I saw the financial statements. Though the company did over $100 million in revenues per year in an industry with reasonable operating margins, operating profits were positive in only one of the previous five years. The reason? Management saw fit to pay themselves over $8 million annually. The board was clearly there only to approve management’s demands, and were paid handsomely for providing effectively no responsible oversight. There is nearly no hope that this company will ever change its ways, and management likes it that way.

Companies like these are probably best avoided by smaller investors, even if the financial metrics look promising. In these cases, management represents a huge intangible liability that offsets any potential under-valuation.

Ramifications for Investors

When evaluating an unlisted stocks, investors should consider the company’s motivations for remaining unlisted and incorporate their conclusions into their subjective opinions of company and management quality. Sometimes remaining unlisted indicates a high quality company with a shareholder-oriented management team. After all, why list if you don’t need capital and you want to maximize returns for shareholders in the long run? Listing might produce a short-term gain at the expense of long-term returns. And in cases where a company’s economics can’t support the expense of a listing, doing so would only be a vanity move meant to bolster management’s prestige at the expense of shareholders.

On the other hand, there are plenty of instances where a company remains unlisted for bad reasons, and investors should approach these companies with caution. When management is a liability, investors should incorporate the liability into their estimate of intrinsic value.


Alluvial Capital Management, LLC holds shares of Computer Services, Inc. for client accounts. Alluvial may buy or sell shares of Computer Services, Inc. at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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When Ownership Structure Creates a Bargain – Schuler AG

I like companies where a highly concentrated ownership structure leaves only a small percentage of shares in the public float. In this way, sometimes even relatively large companies can be nearly uninvestable for firms of any meaningful size. Now and then this can lead to significant mis-pricing, as market participants who would ordinarily take advantage of the opportunity cannot act.

A prime example of a situation like this is Schuler AG. Schuler is a German metal forming company, just one of Germany’s plethora of successful small-to-medium-sized enterprises often called Mittelstand. These companies share a number of characteristics, among them a focus on efficiency, mastery of niche products and/or processes, a partnership model of owner/employee relations, and a focus on exporting.


Schuler produces the massive, complex and incredibly expensive industrial presses used in many manufacturing processes like automotive manufacturing, coin minting and many others. Recently, Schuler has introduced a line of energy-efficient presses. The company has also made large investments in China. In fiscal 2014, Schuler’s revenues were 1.2 billion Euros while operating income surpassed 100 million Euros for the first time. Because Schuler’s products represent major capital expenditures for its customers, Schuler’s results tend to be cyclical. Still, the company’s revenues have grown by a healthy 7.8% over the past decade. Over the course of the decade, Schuler’s operating margins show a general uptrend. A cyclical company’s operating margins should never be examined in a vacuum; one year’s results say little about normalized margins. But I think it’s safe to say that Schuler has a enjoyed a sustainable increase in operating margins in tandem with its top-line growth. The three year period from 2012 to 2014 produced real Eurozone GDP growth of a cumulative 2.3%. During this period, Schuler’s operating margins averaged 8.3%. The years 2004 through 2006 produced real Eurozone GDP growth of 8.1%, but operating margins for that period averaged a miserable 1.3%. I think it’s safe to assume modern Schuler is not the same company it was a decade ago and future operating margins will look more like those of recent years.

In addition to its operating improvements in recent years, Schuler has undergone a balance sheet transformation. At the end of 2009, Schuler had Eur 51.9 million in cash against Eur 298.1 million in debt and pension liabilities for net debt and pension liabilities of Eur 246.2 million. A mere five years, later, Schuler has piled up a cash balance of Eur 482.5 million. Debt and pension liabilities have fallen to Eur 211.0 million for a net cash balance of Eur 271.5 million. This remarkable change was almost entirely the result of free cash flow generation. From 2010 to present, Schuler raked in Eur 459 million in free cash flow.

Let’s imagine you’re a financial buyer, say a private equity firm. What would you pay to buy Schuler? Using any of the various reasonable approaches to valuation, you could come up with a wide range of fair values. But I guarantee any reasonable bidder would pay quite a bit more for Schuler than its current trading price suggests. Schuler’s market capitalization is Eur 877.9 million. Subtracting the net cash results in an enterprise value of Eur 606.4 million. Schuler shares are being valued at just 5.9x trailing EBIT and 4.9x trailing EBITDA. Shares go for 13.2x trailing earnings, while net cash represents over 30% of Schuler’s market capitalization.

So why does such a successful company trade so cheaply? Schuler has great cash flow and is substantially over-capitalized. The product line is advanced and demand for industrial presses should only grow as the world economy expands.

One reason: ownership structure. Over 95% of Schuler shares are in the hands of Andritz AG, a large Austrian industrial holding company. Andritz had been buying up Schuler shares for years, including those owned by Schuler’s founding Schuler-Voith family. Andritrz brought its ownership to over 95% in early 95% following a buyout offer in early 2013. Following Andritz’s purchase, Schuler shares delisted from the major German exchanges but remain listed in Munich. Trading volume has declined, but over 1,000 Schuler shares still trade hands daily.

Because less than Eur 45 million worth of Schuler shares are in public hands, the company is completely uninvestable for mid-sized or larger institutions. But smaller investors can easily build up a meaningful position if they view Schuler’s value proposition as attractive.

There is a catch, and it’s the chief risk of owning shares in a company that is dominated by a single shareholder. It’s the possibility of a forced merger by the controlling shareholder at an unfair price. I am not a lawyer, and my interpretation of German securities law should be viewed as only a layman’s opinion. But it appears that a company that owns over 95% of another is able to execute a mandatory squeeze-out, purchasing the remaining shares outstanding for cash. The acquiring company sets the buyout price, which is reviewed and approved by independent external auditors. The minimum price is the 3-month average trading price of the target company’s shares.

Schuler’s 3-month average trading price is just 2% below the current price, so shareholders are not currently at risk of a takeunder. I also must assume (and not having any sense of the German legal system, this is only an assumption) that the external auditors in charge of evaluating any takeover by Andritz would not look kindly on a buyout price below the current trading price. And it’s not like paying remaining shareholders a price above the current trading price would be burdensome for Andritz. For example, a 40% premium to the current price would cost only an extra Eur 17 million, a rounding error for a firm of Andritz’s size.

Nonetheless, Schuler shareholders could lose their shares to squeeze-out done at well below fair value. Investors should weigh this risk against the potential gains from investing in a company of Schuler’s quality at a rock bottom valuation.

Alluvial Capital Management, LLC does not hold shares of Schuler AG for client accounts. Alluvial may buy or sell shares of Schuler AG at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.


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Podcast Pitch: Command Center, Inc.

The other day I participated in an investing podcast hosted by Fred Rockwell of TheBulldogInvestor.com. We discussed a variety of investing topics germane to the micro-cap world. Anyone interested in listening to the podcast can find it here or on iTunes.

At the end of the podcast, I described a stock that I like a lot and have purchased for Alluvial Capital Management clients. The stock is Command Center, Inc. The stock ticker is CCNI. As I type, the stock price is $0.70 and the market capitalization is $46.2 million. Frankly I believe I described the stock fairly well in the podcast but I’ll summarize my views below.

Command Center is a temporary labor provider to blue collar industries like light construction, hospitality, various trades and others. The company has 55 storefronts in 22 states. A number of factors combine to make Command Center stock attractive at these price levels.

Savvy Leadership/Improved Operations

Over the past few years, Command Center has turned itself from an unfocused and struggling company to a well-run and very profitable operation. Management focused on winning high-margin business, controlling operating costs and making each company store responsible for its own profitability. The result has been rapid growth in operating income even as top-line revenue has contracted. CEO Frederick “Bubba” Sandford deserves a lot of credit for the company’s recent success.

Strong Balance Sheet

The company’s success has resulted in a lot of cash flow, and Command Center has used that cash to all but eliminate its debt and build up a substantial cash cushion. Excess cash is around $6 million, or 13% of market capitalization.

Low Valuation

Command Center trades at just 6.2x operating income and 5.7x EBITDA (I may have said 7x operating income on the podcast, so please excuse my memory lapse.) The company has a small NOL balance but will likely become a normal taxpayer in 2016. Those are low ratios for any industry, but especially for the staffing industry where low capex requirements and growth potential leads investors to assign high valuations. Command Center’s larger competitors trade at an average of 10.1x EBITDA per the company’s March 2015 investor presentation. Were Command Center to trade at 9x EBITDA, shares would reach $1.05.

Opportunities to Reward Shareholders

Command Center has indicated it will use its cash either to repurchase stock, or to conduct small acquisitions or open new storefronts. The company has approved a $5.0 million share repurchase plan. On the topic of acquisitions, the company notes that many smaller competitors are “mom-and-pop” type operators that can be acquired for only a few times cash flows. Either returning capital to shareholders or investing it productively would be positive outcomes that would benefit shareholders.

Here’s a link to the company’s recent investor presentation, which does a good job illustrating the company’s turnaround and future opportunities. I believe Command Center shares are worth far more than the current trading price and I look forward to seeing what company management can do in 2015 and beyond.

Alluvial Capital Management, LLC holds shares of Command Center, Inc. for client accounts. Alluvial may buy or sell shares of Command Center, Inc. at any time. 

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Lessons Learned

In the comment left on my last post, a reader suggested I discuss what I’d learned from the performance of the stocks mentioned in my earliest blog posts at the beginning of 2012. I thought that was a good idea. With the benefit of hindsight, it is clear where my analysis of the various stocks contained solid reasoning and great foresight, and where it most assuredly did not. I present five lessons I have taken from my progress as an investment practitioner.

Normalize, Normalize, Normalize

Nearly every value investor has a story of discovering a company trading at low, low multiples of cash flows and earnings and buying in, only to see earnings and cash flows begin a steep decline. What looked like a bargain based on current profits was actually fairly-priced or even over-valued based on forward-looking profit measures. Conversely, nearly every investor can remember passing on a company due to high valuation multiples, not realizing that earnings and cash flows were about to explode as the company’s economic outlook improved. These cases illustrate the risks of valuing cyclical companies using peak or trough results. Great danger lies in assuming good times will last indefinitely, and also in assuming bad times will do likewise. Excepting cases where demand for the company’s goods or services is likely to remain in decline (newsprint, wireline telecom, most types of coal) or likely to grow at an above-average rate for long periods to come (healthcare, data and data services) investors are well-served to estimate mid-cycle earnings and cash flows and use those as the basis for valuations, not current results. Homebuilders, shipbuilders, construction, and semiconductors are all examples of industries that deep boom and bust cycles, and estimating earnings power based on only a short part of the economic cycle is hazardous to one’s wallet.

Knowing this was what lead me to successfully identify Schuff International as an attractive security, though current earnings and cash flows were weak. The financial crisis took an immense toll on construction spending, but I was reasonably sure that Schuff’s profits would eventually rebound. In 2011, Schuff earned only pennies of operating income per dollar of assets employed, but I knew it had once earned far more and believed it would again, one day. As the economy recovered and companies and governments once again launched major building efforts, Schuff’s profits rocketed and so did its share price.

Don’t Sit Across The Table From Management

Not every company I invest in has a stellar management team. Some seem half-asleep, content to let cash pile up on the balance sheet without any clear plan to use it productively. Some have their hands stuffed a little deeper in the cookie jar than I think is fair, and pay themselves excessively. Others are unfocused, choosing to pursue distracting side ventures rather than concentrate on the company’s strong core offerings. All of these I can forgive, so long as the company’s operations are going well and shareholders are being treated fairly. What I can’t accept is when management acts in opposition to shareholders, scheming to deprive them through abusive related-party deals or absurd compensation. I also cannot accept when managerial compensation is totally divorced from performance, allowing management to profit even from outright failure.

I overlooked this possibility when I was analyzing Webco Industries. The company’s financial statements disclosed little, making it difficult to see just how richly management was rewarding itself from quarter to quarter. Furthermore, I failed to see that management had chosen to “bet the firm” on a massive and costly expansion when other steel companies were struggling with weak demand and pricing. Since my post, Webco has struggled to produce sustained profits and remains saddled with a great deal of debt. Despite the poor results, management continues to grant themselves thousands of additional shares each quarter, a huge number for a company with under 1 million shares outstanding. Since my write-up, Webco’s management has granted itself shares worth between $2.4 and $4.5 million, depending on the share price at the time of the grants. In a time period where the share price has been cut in half, management has seen fit to transfer ownership of 4.5% of the company from shareholders to themselves. I’m not saying Webco would have been a successful investment without this compensation. The challenging economics of the steel industry would likely have prevailed. But knowing how management treated shareholders at the time of my investment might’ve made me question just who would reap the benefits of any future profits.

Beware Of Customer Concentration

If a company depends on just a few customers for the majority of its revenues and profits, those customers have significant bargaining power over the company. These customers may be able to win price discounts or better payment terms. If the worst case scenario occurs and these customers end their relationships with the company, financial results can fall off a cliff. This risk is elevated with micro-cap companies, many of which depend on a limited customer base in a small geography.

QEP Company was severely affected by the loss of a major customer. I rationalized the loss as manageable, believing the company would be able to replace the lost revenues in short order. I should’ve run for the door. Several quarters have gone by and the company has spent millions of shareholder wealth on acquisitions, yet results have not recovered. If I’d properly discounted my estimate of QEP’s worth for its high customer concentration, I may have avoided a costly mistake.

Perception Lags Reality

The stock market is very efficient. New information is almost immediately incorporated into stock prices. The biggest exception to this general efficiency I’ve found is the market for micro-cap and thinly-traded stocks. Information seems to move at a trickle in these market niches, leading to opportunities for sharp-eyed investors. At the smallest and least liquid end of the market, stock prices seem oddly tied to out-dated perceptions of company health and value. Once-distressed companies that have cleaned up their acts trade at low valuations long after the turnaround is in full swing. On the other hand, once healthy companies with trouble on the horizon often retain premium valuations well after the stormclouds have arrived.

When I found Alaska Power & Telecom, the company was only a few years removed from a brush with bankruptcy. The company had shutdown its loss-making operation and had secured new financing, and was making progress in reducing its leverage. Despite this progress, the company traded at a dismally low multiple and offered great value. As the market’s opinion caught up, shares appreciated to a more realistic valuation. Now, who’s to say I wouldn’t have made the same mistake as the market if I’d known of the company in 2010 and 2011? Perhaps the company’s prior difficulties would have colored my analysis and kept me from investing. As investors, we must strive to keep out estimates of value forward-looking and avoid being anchored by past company failures or successes.

Investing Doesn’t Take Place In A Vacuum

As much as some of us would wish it, investing is so much more than a numbers game. Beyond the figures on the financial statements, uncountable factors can influence the success of an investment. Leadership changes, technological and demographic changes, government actions, even weather will influence the companies we buy in profound ways. While many of these impacts cannot be anticipated, investors should attempt to incorporate those that can be into our estimates of company value. Luckily, the SEC requires companies to help us in this task. I am convinced that one of the most valuable sections of any SEC-filer’s annual report is the “risk factors” section. Yet, it is perhaps the least-read section. It’s easy to understand why, as this section is typically full of legal boilerplate and bland, generic verbiage. Yet companies will often disclose threats their business faces that are discussed nowhere in the remainder of the filing or in quarterly earnings calls.

Another early post of mine discussed a metals supplier, Empire Resources. My investment in Empire Resources worked out well, but it would have worked out much better except for government action. When the government failed to renew the General System of Preferences in mid-2013, it resulted in substantial cost increases on raw materials imported from the company’s main suppliers. I gave little thought to the possibility of this negative government action. After all, the company didn’t seem to express much concern in quarterly earnings presentations. But there it is in the company’s 2012 annual report under risk factors:

“During 2011 and 2010 approximately 54% and 42%, respectively, of our purchases of aluminum products were from countries that were considered developing countries whose exports were eligible for preferential tariff treatment for import into the U.S. under the generalized system of preferences or duty free. There can be no assurance that any of our suppliers will continue to be eligible for such preferential tariff treatment or that the generalized system of preference will be renewed after its expiration on June 30, 2013.”

I should’ve built this risk into my estimates of future earnings for Empire Resources. Perhaps I wouldn’t invested anyway, but perhaps some other stock would have looked relatively more attractive, and I could have made more by investing in it instead.

Hopefully this list of concepts and their explanations will be helpful in your quest for the next great stock. Investing is a never-ending learning process, and I owe a great debt to other investors who have taught me lessons along the way.

Again, I’ll be in Toronto April 14-16 for the Fairfax shareholders’ meeting and would enjoy meeting any blog readers who will be in town.

Alluvial Capital Management, LLC may hold shares of securities mentioned for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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A Look Back

The other day I realized it’s been three years since I started writing OTC Adventures. That’s a long time in the life of a blog! When I started, I had no idea that my writings on micro-caps, illiquid stocks and other obscurities would find an audience, let alone eventually allow me to launch my own RIA practice. These days nearly all my time is spent in seeking out great investments for my clients, but I still enjoy writing here when I can.

In recognition of how far this blog has come since those first posts, I’d like to look back at the first companies I’ve profiled and see what’s become of them. I’ve learned and grown as an investor since I wrote these posts, but I like to think these early analyses hold up well.

Today I’ll tackle the first five stocks I wrote about.

QEP Company

I wrote up QEP Company on January 17, 2012, when the company traded at $14.25. In the post, I expressed optimism that the company’s strong results would continue and the company would benefit from deleveraging. Well, that’s not exactly what happened. The company wound up losing a major contract and with it, much of its future sales and profits. QEP attempted to make up for the loss with a succession of acquisitions, but as yet, all efforts to return to growth and grow profits have been for naught. Margins are under pressure and trailing EBIT has declined to $5.31 million, down 70% since my post. Perhaps somewhat surprisingly, the stock has risen 18% since my post.

Schuff International Company

My post on Schuff went live on January 29, 2012, when shares changed hands at $9.00. At the time, I cited the company’s large share repurchase, low multiple of normalized earnings and improving industry conditions as reasons the shares would move higher. Shares soon dipped all the way down to $6.50, but then began a steady march higher. Improved operating conditions provided a tailwind, but the biggest gains came when company management sold their majority stake to Phil Falcone’s HC2 Holdings for $31.50 per share. A follow-up tender offer took HC2’s stake to over 90% and it seems like the end of the road for Schuff shareholders, even as many believe the company’s shares are worth twice as much or more than HC2’s purchase price. (Meanwhile, any holders who jumped over to HC2 following the buyout have seen returns of 180% atop the already healthy returns from Schuff shares.) In the end, Schuff shares returned 250%.

McRae Industries

Next, I tackled McRae Industries, writing about the company on February 5, 2012 when class A shares went for $12.77. The family-owned bootmaker was attractive due to its strong balance sheet, healthy demand for both its work/military and Western/fashion boots, and a modest valuation of current earnings. Since the post, McRae’s revenues and earnings have risen at a healthy pace and the stock has followed, though shares still trade at very low multiples, especially considering the more than $20 million in cash and investments the company has accumulated. McRae shares have provided a total return of 168%.

Webco Industries

The Webco Industries post went live on February 14, 2012. (Can you tell I was single at the time?) The stock price at the time was $125. I deemed Webco attractive based on a track record of profitable growth, expansion efforts, and a deep discount to tangible book value. Sadly, it seems that the discount to book value was warranted. Webco finished a major expansion only to find the anticipated demand absent, and profits have been scarce since. Weak steel prices, high leverage and an ever-increasing share count have lead to returns of -48% since my post.

Alaska Power & Telephone

I wrote up APTL on February 23, 2012. At the time, shares went for $17. I was attracted to the company based on its low valuation. By my estimate, the combination of stable telecom and utility assets ought to have merited a much higher valuation. I also appreciated the company’s efforts to clean up its balance sheet and restore credibility following some unfortunate efforts to expand into construction. APTL executed its business plan, paying down debt and restarting a dividend. The company now plans to construct a new hydro-electric plant and build out its data offerings. Shares have provided a total return of 32% to date.

On average, the first five stocks I wrote about returned 84%, which holds up well against the return of the iShares Micro-Cap ETF (IWC) which returned 55% since the end of 2012. As usual with any basket of stocks, a few produced dynamite gains, a few gave a respectable return, and a few were duds.

In many ways, 2012 was an ideal time for micro-cap investors. The immediate danger of the financial crisis had passed, but the market still priced many of these companies for failure, or at least as if they would never grow again. The virtuous cycle of increasing earnings and expanding multiples has provided many investors with excellent gains, but it has also left the ranks of obviously cheap stocks looking very thin. Finding the remaining bargains requires investors to search more broadly, perhaps in foreign markets and unusual securities, and more deeply, picking apart financial statements and industry news to find the value beneath.

In a few days I’ll take a look at how the next set of stocks I wrote about way back when has performed, before returning to “regular programming.”

On another note, I’ll be in Toronto on April 14-16 for the Fairfax Financial shareholders meeting and associated festivities. I’d enjoy meeting blog readers and fellow value investors of any stripe. Let me know if you’ll be in town.

Alluvial Capital Management, LLC holds shares of McRae Industries, Inc.  for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Granite City Food & Brewery Explores a “Strategic Transaction” – Will Shareholders Benefit?

I’ve happened across an interesting situation in Granite City Food & Brewery, Ltd. On Monday evening, the company released its preliminary 2014 results and also announced it would explore a “strategic transaction.” These words are music to investors’ ears, because they often portend a sale of the business in the near future, or some other value creating action by the company. As I read the announcement, I felt that little twinge of excitement that always arrives when I suspect I’ve stumbled onto something good. The market felt the same thing and bid shares up 27% on Tuesday to close at $1.85, with a bid/ask mid-point of $2.20. While the price rise cooled my interest a little, I was still eager to begin my due diligence, hoping I might find a cheap company ripe for a rich takeover offer.

Turns out things aren’t quite that simple. Granite City’s results are not strong, and the company’s track record is one of mediocrity and missed expectations.

Granite City Food & Brewery is a restaurant company with two different concepts: Cadillac Ranch and Granite City food & brewery. The Granite City concept has 31 locations in the Midwest and Cadillac Ranch has 5 locations: Miami, Indianapolis, National Harbor, MD, Minneapolis and Pittsburgh. The Granite City concept emphasizes a casual American menu and polished interiors heavy on natural materials, and serves the company’s own beer. Cadillac Ranch is a throwback concept that emphasizes roll n’ rock and automotive decor and offers dancing and musical entertainment.

Cadillac Ranch is the company’s newer concept. The chain was founded in 2009 and purchased by the company in 2011. If you think the concept sounds a little uninspired, you’d be right. The restaurant industry is intensely competitive, and success for a new entrant requires both an interesting concept or presentation and good food and drink offerings at the right price point. Come up short on any one of those factors and customers will happily spend their dollars at another of the dozens and dozens of other restaurants clamoring for their business. Unfortunately for Cadillac Ranch, the reviews are in, and they’re not good. The restaurants garner a meager 2.5 out of 5 stars on yelp.com with hundreds of reviews from various locations. Guests repeatedly complain of indifferent staff, cold or mis-prepared food and a cheesy atmosphere. I’m not surprised by the poor rating. There’s a Cadillac Ranch in a shopping center outside my own city, and every restaurant in the whole complex is of the bland, corporate chain variety. Seems right that Cadillac Ranch would offer more of the same.

The Granite City-branded restaurants enjoy much better reviews, but it bodes ill for the company that its newer concept has suffered such a lackluster market reception. The poor results are readily apparent in Granite City’s financial statements. Though revenues grew 41% from 2009 t0 2014, the growth is almost entirely the result of huge investment in new restaurants. Sales per unit actually grew just 14% over the same time period, a period in which restaurant receipts surged as the economy recovered following the Financial Crisis.

Here’s a look at Granite City’s financial statements since 2008. While the company has grown, it hasn’t once produced a profit and has repeatedly sold equity and taken on additional debt to fund its expansion. The figures I’ve presented below look slightly better than the actual statements, because I’ve added back one-time expenses like pre-opening costs to EBITDA and EBIT.



With results like that, it shouldn’t be hard to understand why the company’s stock has gone nowhere in the last five years. What makes the results more difficult for investors to stomach is how the results compare to management’s own projections. Granite City released a presentation in 2012 projecting its restaurant-level EBITDA would increase by $7-8 million in 2013/2014. The actual results? Restaurant-level EBITDA was virtually flat, even as revenues rose 12.5% from restaurant openings.

With results like these, it’s not surprising that Granite City’s owners are thinking about cashing out and letting someone else enjoy the headaches. So who are these owners, and what kind of price might Granite City fetch?

Granite City is controlled by Concept Development Partners, which is in turn controlled by CIC Partners, a private equity firm. CDP took over in 2011, providing financing in the form of convertible preferred stock. Since then, CDP has received another 482,000 common shares through dividends on its preferred stock, and purchased 3.125 million common shares in a stock offering in 2012. Through its ownership and through a voting agreement with the former majority owners, CDP controls 78% of the voting power of Granite City shares, and holds a 67% economic interest in the company.  Thus far, the involvement has not been profitable. CDP paid $2.37 per share to purchase 3 million shares from the previous controlling shareholder, and paid $2.08 per share to buy an additional 3.125 million shares in 2012. At the current trading price, that’s a loss of about $2.2 million.

So, CDB is seeking to cut its losses and offload Granite City to somebody else. The price that Granite City fetches will depend on the buyer’s belief in its ability to bring the company to profitability and to what degree corporate-level costs (as opposed to restaurant operating costs) can be cut.

At its present bid/ask mid-point of $2.20, Granite City has a market capitalization of $32 million, assuming all convertible preferred stock is converted into common shares. The company has net debt and capital leases of $53 million (as of September 30) for an enterprise value of $84 million. Adjusted 2014 EBITDA was $10 million, and operating income was $2.4 million. I constructed a peer group of other similar restaurant operators with EBITDA below $100 million, to see how Granite City’s valuation compares.



Granite City Food & Brewery trades about 3 EBITDA turns below the peer median valuation. Then again, a discount is deserved. Granite City is both unprofitable and the most leveraged of all its peers, so it carries a significantly higher risk of financial distress. The leverage ratios for some peers are likely under-stated, since many restaurant companies make significant use of operating leases. However, I doubt anyone would dispute my characterization of Granite City as “highly-leveraged” as a consumer discretionary company carrying net debt and capital leases of 5.3x EBITDA.

Because Granite City is so leveraged, its equity could command a wide variety of market values depending on its EBITDA multiple and potential cost savings. The chart below illustrates various share prices at different EBITDA multiples and corporate cost savings. (The company hasn’t yet released its official 2014 financial statements, so I’ll use 2013’s corporate expenses.


It’s not tough to get to a share price well above the current price using even modest corporate cost reduction assumptions and an EBITDA multiple at or slightly above the current valuation.

Once again though, it’s not that simple. This multiple and cost savings matrix ignores several other factors that any Granite City buyer would have to consider.

  • Incremental operating capital – Granite City is not profitable. Any potential turnaround would take time, and the company would need a source of additional cash to bridge the losses until breakeven was achieved. Whether equity or debt, an acquirer would have to factor the additional capital requirements into the bid price.
  • Capital expenditures – Cadillac Ranch isn’t working, and any acquirer would have to sink lots of cash into figuring out why not, and then fix the issue. Maybe it’s as simple as a revamped menu, or maybe the chain requires a complete rebranding. The costs could easily run into the millions, and the acquirer would need to reduce its bid accordingly.
  • Long lease terms – many of Granite City’s restaurant locations have lease terms of a decade or longer. This can be a positive or negative factor, but its typically a negative factor for struggling operators. Ordinarily, a restaurant owner dealing with some struggling units could choose to stop the bleeding by boarding up shop and vacating when the lease expires. Granite City does not have that option. Even if the company shut down certain restaurants tomorrow, it would still be on the hook for another decade of lease payments. A company can often negotiate a lump payment for breaking a lease, but it’s yet another cost an acquirer would have to account for if their strategy included shuttering any underperforming locations.

I could go on, but you get the idea. Maybe Granite City will find an optimistic (or naive) buyer willing to pay a high multiple and assume low turnaround costs and big cost savings. In this case, shareholders will make a handsome profit. But maybe acquirers will notice the company’s dismal history, underperforming properties and offer little, expecting huge “repair” costs. I don’t know enough to feel confident one way or the other, and I doubt additional research will lead me to a strong conclusion. And let’s not forget it’s not even a foregone conclusion there will be any strategic transaction. The company could instead choose to conduct a large capital raise, merge a private competitor into the company, or even do nothing at all. For these reasons, Granite City is a pass for now.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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GTT Communications, Inc. – GTT

Hello! I took a little break from blogging in order to move and also to onboard a sudden rush of new Alluvial clients. Now both tasks are mostly completed, and I’m back to talk about one of my favorite “growth” companies. Before I get into the specifics, let me take a little time to discuss what I mean when I say “growth” company.

Most investors want the companies they invest in to grow. They want management to roll out new and improved products and service offerings, tap into new customer markets, and generally increase company profits and cash flow on a per-share basis. This typically requires diverting a portion of operating cash flow to capital expenditures and R&D, and investors generally accept this, as long as it’s done judiciously.

What many investors dislike is when companies repeatedly raise external capital in order to fund acquisitions. There’s good reason for this. Many of these companies engage in acquisitions with no clear economic rationale, over-pay, then screw up the integration process. The end result is an enterprise worth the same or less, but with each shareholder’s stake diluted. So why does this happen? In my opinion, it’s because running a business and engaging in productive M&A activity are two different skillsets, and not every manager has both. Many successful executives who have done a great job building a business via organic growth start to believe they have the magic touch, and begin empire-building.

However, there are some management teams that excel at both day-to-day business operations and at making productive acquisitions, and their track record shows it. One of these management teams leads GTT Communications. GTT operates a global fiber network that offers bandwidth and connectivity to a host of major companies and government organizations. GTT uses its network to provide a variety of internet services that make it easier for its customers to access remote servers and work seamlessly between locations world-wide. I’d be lying if I claimed to understand every last service the company offers, but it’s clear that these services are in great demand and increasingly essential for modern commerce and governance. Just how important these services are can be seen in how GTT’s revenues and profits have grown. Take a look at the quarterly revenue and EBITDA history stretching back to 2007. I don’t expect any slowdown in the growth in demand for GTT’s services for years and years to come.


It might not be quite clear from the graph, but GTT’s revenues grew from just $13.7 million in Q1 2007 to $49.2 million in Q3 2014. That’s a compounded quarterly growth rate of 4.4%. Annualized, it’s 18.7%. Along the way the company went from near break-even to substantially EBITDA positive.

The increasing demand for GTT’s services wasn’t responsible for the entire increase, though. You’ll notice a few sudden leaps in revenues from 2007 to now. GTT bought Colorado-based WBS Connect in late 2009 and Tinet in early 2013. Both of these acquisitions resulted in greatly increased revenues and improved margins, resulting from the company’s increased scale. Along the way the company also completed several other acquisitions, including nLayer and IDC Global. These acquisitions allowed GTT to broaden its service offerings and extend its reach globally.

Because these acquisitions required additional capital, GTT has repeatedly issued equity and taken on additional debt. Any time investors see a pattern of capital raises, they should ask “was it worth it?” After all, growth for growth’s sake is often detrimental. If returns from acquisitions do not cover the cost of the incremental capital required, shareholders’ investment is impaired. In GTT’s case, the answer is unequivocally “yes, it was worth it!” GTT’s strategy of raising capital to fund acquisitions has resulted in all-important scale. In other words, the increased asset and revenue base has allowed GTT to realize increasing EBITDA margins and returns on invested capital. The chart below illustrates GTT’s EBITDA margin and annualized EBITDA/Average Invested Capital from Q1 2007 to Q3 2014.


GTT’s EBITDA margin shows a steady climb from below breakeven to the mid-teens. Meanwhile, return on invested capital now surpasses 30%, indicating increasing capital efficiency. These are very, very healthy trends for a growing company and they support increasing equity values. And sure enough, equity value has increased. GTT shares went for $1.28 five years ago today, and are up almost ten-fold since.

I have some theories as to why GTT’s acquisitions have been so successful, but before that, let’s talk about valuation. Readers will notice I’ve mentioned only EBITDA thus far, and not operating income or net income. There’s good reason for that, and it has to do with GTT’s business model. When GTT purchases another company, it records a large value for the acquiree’s intangible assets, like customer lists and relationships. These intangible assets produce large amortization deductions, even though little ongoing capital expenditure is required to maintain their worth. This is a big advantage at tax time! GTT’s amortization charges wipe out a large chunk of operating income. After interest charges, the result is negative taxable income, though the company’s free cash flow is positive. Here’s a look at GTT’s depreciation and amortization vs. capital expenditures over time, as well as free cash flow versus net income.

CaptureSince 2007, GTT has recorded total depreciation and amortization of $54.7 million while dedicating only $21.5 million to capital expenditures. Over the same period the company earned a statutory net loss of $82.2 million, while recording free cash flow of $38.5 million, ex-restructuring costs and net investment in working capital. (I am trying to estimate GTT’s “steady state” investment needs, hence the exclusion of growth-related expenses and working capital investment.)

Since September 30, GTT completed a few important transactions that change the reported financial figures. First, the company spent $40 million to acquire American Broadband. American Broadband reported $55 million in revenues for the trailing twelve months. Nothing regarding the company’s profitability was disclosed, but I’ll err on the conservative side, estimating an EBITDA margin of 15% and incremental annual EBITDA for GTT of $6 million from the acquisition. In order to fund the acquisition, GTT recently completed an equity offering of between 3.5-4.0 million shares, raising $42.0-$45.2 million. The exact number of shares sold has not yet been released, so I’ll use the mid-point of each figure. Using these assumptions, GTT’s valuation looks like this:


That’s a lot of language and pro forma calculations to make a simple point. At the current market value, GTT offers a high single digit cash flow yield to the enterprise, even after accounting for capex. This wouldn’t be an unusual valuation, except for the fact that GTT’s organic revenue growth is nearly 10% and should remain so for many years to come. I am wary of valuing any company too generously, regardless of growth potential. Nonetheless, I think a yield of 5% would not be too aggressive, given GTT’s track record and prospects. That would equate to a share price of $18.99. A 6% yield would be $15.42.

Now, back to GTT’s deal-making prowess. What is it that has made the company such a successful acquirer? In my opinion, it’s nothing more than a highly incentivized management team with a long history of entrepreneurial success in the sector. Prior to the recent equity issuance, GTT’s management owned about 35% of the company, worth many times their collective annual compensation. GTT management’s personal fortunes are closely tied to the value of GTT stock. This gives them all the reason they need to avoid empire-building and careless use of shareholder capital, and instead remain laser-focused on completing only the transactions that will truly increase GTT’s value on a per-share basis.

Still, all the incentives and focus in the world are worth little if management simply lacks the talent for company-building through acquisitions. Fortunately, GTT’s leaders have strong pedigrees in the telecom industry. Between them, chairman/former CEO/largest shareholder H. Brian Thompson and current CEO Richard D. Calder, Jr. have spent time at MCI Communications, LCI International, Comsat International, Broadwing Communications and many other well-known telecom companies, all regular acquirers. I am confident that company leadership has a deep understanding of the markets that GTT serves and will continue to guide the company well.

In nearly every earnings report and transaction announcement, GTT’s management mentions a clear revenue and EBITDA target: $400 million in annual revenues and EBITDA of $100 million. That goal is still a ways off, but I suspect they’ll achieve it sooner of later and shareholders will do well along the way.

Alluvial Capital Management, LLC holds shares of GTT Communications, Inc. for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.

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Thanks for a Great Year!

Today’s post is a simple one, with just one purpose, to say thanks! to all the readers who have helped make 2014 a great year for OTC Adventures and for Alluvial Capital Management, LLC.

Just as in years past, your responses to my writings (praise and criticism alike) have provided invaluable insights and have helped make me a better investor. I am convinced that my readers are among the most experienced and astute value investors out there, and I am grateful for you sharing your wisdom with me. Side note: if you reached out to me this year and I failed to respond, I apologize! I get a lot of e-mail and despite my best efforts, occasionally I fail to respond in a timely manner. Please don’t hesitate to reach out again.

2015 promises to be an exciting year for me, both personally and in my blog and business efforts. In the next three months alone, I’ll be marrying my lovely fiancée and purchasing a home here in Pittsburgh (where your dollar still goes very, very far!). Your well wishes are appreciated for the many changes and challenges sure to follow. The OTC Adventures blog will continue with posts coming at a similar pace as I navigate the demands of my RIA business and personal life. As for Alluvial Capital Management, I am hopeful that 2015 will bring a unique set of value investing opportunities and another year of good performance for my clients.

I wish you all the best in your own endeavors in 2015, in investing, in your careers and in your relationships with friends and family. While professional and financial successes are worthy pursuits, let’s not forget to invest our time in those we love.

I’ll be back in 2015 with many more value investing ideas, focused as always on the small, the illiquid and the ill-understood. Until then, Happy New Year!

– Dave Waters, CFA


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BFC Financial/BBX Capital Part Two – Value in Complexity

Time for part two of my discussion of BFC Financial and BBX Capital, two related and complex companies. These companies possess significant value in the form of cash, loans, and real estate, shared ownership of a very valuable timeshare company, Bluegreen, and over one billion in NOLs. Due to the complicated ownership structure and a litigation overhang, the market has priced these companies at a massive discount to a conservative reckoning of their assets and earnings power.


In part one, I estimated BBX Capital’s valuation at $631.6 million, or $39.46 per share. Valuing BFC Financial is actually a little easier. BFC’s value consists of some corporate cash, its 51% stake in BBX Capital, its 54% stake in Woodbridge/Bluegreen, and its NOLs. Since I already examined the value of BBX and Woodbridge/Bluegreen in the previous post, all that remains is to analyze BFC’s corporate cash and NOLs.

Due to consolidation, BFC’s balance sheet looks much more complex than BBX Capital’s.

BFC balance sheet


In truth, it’s not so bad. Most of the confusing entries belong to Woodbridge/Bluegreen or BBX Capital. Once those are removed, the picture becomes much clearer. For example, BFC’s balance sheet lists cash of $246.5 million. But of that, $160.2 million belongs to Woodbridge/Bluegreen, and $56.6 million belongs to BBX Capital/FAR, LLC. That leaves $29.7 million in cash at the BFC Financial level. (This excludes restricted cash, which I am ignoring for the purpose of this analysis.) Much of the remaining assets can also be ignored. All the various loans and real estate assets belong to BBX, and the notes receivable are associated with the Bluegreen timeshare business. Much of the property and equipment is as well, and the remainder is not material to BFC’s valuation. (Some of the property & equipment is attributable to some minor businesses the complex owns, which I am also ignoring for the scope of this analysis.)

The liabilities are much the same. The BB&T interest belongs to BBX’s FAR, LLC and the notes payable are Bluegreen’s, as are the junior subordinated debentures. (As discussed in the last post, $85 million worth of the debentures are Woodbridge obligations.) That leaves only the deferred taxes, share redemption liability, preferred stock and the ever-mysterious “other liabilities.” With the exception of the share redemption liability and the preferred stock, it’s somewhat unclear exactly what amount of “other liabilities” and deferred income taxes are obligations of BFC versus Woodbridge/Bluegreen or BBX. I don’t believe that BFC’s other liabilities require any ongoing cash flow to service or amortize, making them largely irrelevant to this valuation.

BFC possesses over $300 million NOL state and federal NOLs. However, around $80 million are limited by the company’s 2013 merger with Woodbridge. Estimating value of the NOLs is tough because BFC doesn’t reveal how much are state and how much are federal. For that reason, I’m ignoring their value entirely, even though they are certainly worth something. For the NOLs, I am including only 54% of those of Woodbridge and Bluegreen, which I value at $12 million using very conservative estimates.

All that’s left is to add up the values of BFC’s assets and liabilities.


I estimate the value of BFC shares at $9.62. Just like with my BBX estimate, this value is intended to be conservative and could be markedly higher if Bluegreen is worth more than 8x pre-tax income, or the companies utilize their net operating losses well.

So why, if these companies really possess so much value, are they trading at 35%-40% of my estimates? It all comes back to one thing….


The CEO of both BFC Financial and BBX Capital is Alan B. Levan. Mr. Levan is a colorful character, to put it lightly. As chief of BFC Financial and BBX, he’s pulled off a number of successful deals and transactions, but he’s also managed to anger many minority shareholders in businesses he has purchased. On more than one occasion, these shareholders have brought lawsuits.

In 2012, the SEC brought charges against Levan his actions during the financial crisis. The SEC alleged Levan and BankAtlantic had failed to write down loans in distress and had made misleading statements about the company’s financial standing to investors. As is typical for cases like this, the SEC and company attorneys battled in court for months and filings flew, but the case gradually crept forward.

In the meantime, Levan revealed plans to merge BBX and BFC Financial together, with BBX Capital shareholders receiving 5.39 shares of BFC for each share of BBX. Following the transaction, BFC would uplist to a major exchange. The benefits to shareholders would be  significant. No longer would investors have to look at two different companies to see the value of Bluegreen, and no longer would each company’s balance sheet show many confusing items and minority interests. With better visibility, clearer financials and an increased market cap, it’s not hard to imagine a new set of investors coming on board and pushing the share price upward.

With the planned merger in progress, the SEC’s case moved to trial. A summary of the SEC’s case and the counts against BBX and Levan can be found here. The trial took six weeks, but just last week the jury made its decision: guilty.

The monetary penalties won’t amount to much. The maximum civil penalty to BBX Capital for each charge is only $500,000. And there’s even a chance the decision will eventually be vacated. Previously, a judge reversed a jury’s finding on private litigation brought on roughly the same issues. The company’s statement in response to the guilty verdict is here.

Though the monetary cost of the guilty verdict is small, the harm to shareholders is large, for a few reasons. First, the planned merger between BFC and BBX is off for the time being. This means markets will continue to be presented with two complex and confusing entities, and will likely continue to undervalue them. Second, Levan and the companies will undertake an expensive and drawn out appeals process, which could result in years of legal fees and continued uncertainty. Levan seems to honestly believe himself above reproach in his conduct, and will fight hard to be allowed to continue to lead his companies.

So, investors in both BBX and BFC may have to exercise some patience. Their disappointment with the verdict and the merger cancellation are obvious by the share price movements, but the values of the company’s assets are unchanged and growing. The litigation will eventually be resolved (with or without Levan remaining at the helm) and the companies will be merged or otherwise resolved into one entity. Assuming leadership avoids any disastrous decisions and the economy in general avoids a financial crisis redux, patient shareholders should eventually realize an excellent return from today’s share prices.

Alluvial Capital Management, LLC holds shares of BBX Capital Corporation and BFC Financial Corporation for client accounts.

OTCAdventures.com is an Alluvial Capital Management, LLC publication. For information on Alluvial’s managed accounts, please see alluvialcapital.com.

Alluvial Capital Management, LLC may buy or sell securities mentioned on this blog for client accounts or for the accounts of principals. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at info@alluvialcapital.com.


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