Conrad Industries – OTC:CNRD

It might be time to take another look at Conrad Industries. This Louisiana shipbuilder has suffered through a string of bad years. Is there a recovery taking hold? Well….no. Thus far, 2019 looks just like 2018 and the company’s backlog has yet to show signs of a meaningful increase. But with its shares down 75%+ over the last five years, Conrad now trades below net working capital and at less than half of tangible book value. The company holds net cash equal to 40% of its market capitalization and is currently operating at just over break-even on a cash flow basis.

Conrad is one of a small number of US shipyards still in business. Conrad has operated on the Gulf Coast for several decades, building, repairing, and converting all manner of vessels in operation in US waters. The shipbuilding industry is very deeply cyclical and Conrad has always had its ups and downs. The most recent cycle peaked for Conrad in 2014. The company benefited from a wave of fleet renewals as vessels built in the 1980s reached the end of their lives and from strong demand by energy companies riding high oil prices. In the five years from 2010 through 2014, the company earned profits of more than twice its current market capitalization. In other words, when times are good they are very good. Then again, when lean times come Conrad can go years without generating a profit.

The company is well-aware of the nature of its industry and has stewarded shareholder capital well. During the high times, the company paid several special dividends and bought back quite a lot of stock. (However, the company showed discipline in avoiding repurchasing stock when shares were at record highs.) Management continued to invest in the business, including purchasing a neighboring parcel of land to expand operations, but avoided making major capital commitments just before the industry downtown set in. Conrad’s cautious approach and its strong cash position have allowed the company to weather the down years with relative ease.

Conrad has dealt with the downturn by attempting to pick up more repair work and by trying to break into the liquid natural gas bunkering barge industry. Repair work keep the company busy, but it carries low margins compared to building new ships. On the plus side, steady repair work at least keeps Conrad’s skilled labor force busy, well-trained, and ready for whenever demand picks up. Demand for liquid natural gas bunkering barges has been slow to develop, but the company is hopeful that demand will increase as more vessels are converted to burn natural gas instead of more polluting fuels.

A promotional video from Conrad on its LNG bunkering barge.

As I sit at my desk in Pittsburgh, I am in no kind of position to predict where we are in the shipbuilding cycle for Gulf operations. Perhaps the next round of newbuild orders is about to arrive. Probably not given the state of the energy industry, but ships don’t last forever. I do think that at the current price around $10, shares of Conrad are fully backed by net working capital, plus another $11.50 per share in tangible book value comprised of property and equipment. Unless Conrad’s current doldrums continue for a decade or longer, it appears difficult to suffer meaningful impairment at the current valuation.

Alluvial Capital Management, LLC does not hold shares of Conrad Industries. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

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Robertet Groupe – Euronext RBT, CBE

Robertet Groupe is a producer of high quality botanical ingredients headquartered in Grasse, France. Situated on the French Riviera, Grasse is known as the world capital of perfume, both for the raw ingredients it produces and the many perfumers working or trained there. In 2018, over 3,500 perfume industry workers harvested 27 tons of jasmine flowers, as well as dozens of tons of myrtle, lavender, roses, and other fragrant blooms. In 1850, François Chauvé and Jean-Baptiste Maubert built a factory in Grasse. In 1875, Paul Robertet bought the company, retaining Maubert, and hired some French guy named Gustave Eiffel to draft up a new, modern factory. 170 years later, Robertet remains controlled and managed by descendents of Jean-Baptiste Maubert. While headquartered in Grasse, the company has operations and production facilities around the world.

Robertet’s largest end market is natural materials for the perfume industry. Essences, oils, aromatics, etc. The use of natural products in perfumes has declined over time in the face of synthetic alternatives, which tend to be cheaper, easier to use, and in some cases more environmentally sustainable. But many luxury perfume producers continue to use naturally-sourced scents and essences, believing their customers prefer it. After all, much of the appeal of luxury products is in the impressions they evoke. Who doesn’t prefer the romantic thought of jasmine flowers swaying in a Mediterranean breeze in France to the idea of lab-coated scientists with test tubes and autoclaves in some dumpy factory by the interstate?

Robertet’s second-largest end market is food ingredients and flavorings. Both perfume components and flavorings have been excellent markets for most of the last century, and Robertet’s success shows it. From its humble beginnings 170 years ago, the company’s sales now exceed Eur 500 million annually and its market capitalization exceeds Eur 2 billon. Europe accounts for 36% of Robertet’s revenues followed by North America at 33% and Asia at 19%. Net margins sit at 10%. The company avoids debt. Long-term organic revenue growth can be reasonably expected to grow at a mid-single digit rate.

Now to valuation. Robertet is not exactly your prototypical “value” stock like most others that pop up on this blog. Robertet benefits strongly from its stellar operating history and the perceived quality and rarity of its assets. At a recent price of Eur 877, Robertet shares change hands at roughly 23x trailing EBITDA. Shares are up 72% in the last year. Pricy! Then again, flavorings and fragrances companies tend to enjoy high valuations based on their strong long-term growth outlooks, the competitive structure of the industry, and the recession-resistant business models they enjoy. Robertet’s closest comparable in public markets is Givaudan. This Swiss giant trades at 25x EBITDA. International Flavors & Fragrances trades at 17x, but manufactures more commoditized products in more cyclical end markets.

At least one major investor believes Robertet deserves its premium valuation. In September, private Swiss flavors and fragrances giant Firmenich took a major stake in Robertet, buying a 17% holding from long-time investor First Eagle Investment Management. Firmenich paid €683.30 per share and indicated a willingness to purchase more shares from the Maubert family or take over the company outright. It’s difficult to overstate Firmenich’s industry credentials. The company does nearly $4 billion in annual revenue and dedicates an incredible 10% of revenues to research and development, with 3,700+ active patents to show for it. If Firmenich likes Robertet’s assets, it means they are the real deal.

The market obviously believes such a combination is likely to happen and has bid shares of Robertet up 28% over Firmenich’s purchase price. In my view, the current valuation prices Robertet for perfection. I would not be rushing to buy based on idea that Firmenich would happily bid 40% or more over its initial purchase price for the the remainder of Robertet. After all, Firmenich can afford to be patient. The company can easily wait for investors to cool a bit on Robertet and come in with a much more reasonable bid in a year or two. What’s another couple years to a family firm in business since 1895?

Fortunately for anyone interested in Robertet, there is a way to gain economic exposure and avoid much of the massive premium investors have attached as they anticipate a buyout offer. In addition to its ordinary shares, Robertet has a small number of investment certificates outstanding under the ticker CBE on the Euronext. These certificates carry identical economic rights, but hold no voting power. Naturally the prices of these certificates have risen with Robertet shares, but they do trade at a 16% discount to the ordinary shares. The investment certificates are very illiquid, but they offer a substantially cheaper point of entry for investors.

While I am fundamentally bullish on the flavors and fragrances industry and Robertet in particular, I think it is worth waiting for some of the present excitement to fade before considering an investment in Robertet. I do believe traditional “value investors” systemically underestimate the intrinsic values of premier companies with unique or irreplaceable assets, but there is a point at which a company’s valuation cannot be justified by any reasonable estimate of future cash flows. Still, investors looking for exposure to high quality, globally diversified companies with wide economic moats should add Robertet to their watchlists.

Alluvial Capital Management, LLC does not hold shares of Robertet Groupe. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

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Crawford United – OTC:CRAWA

A note: Recently the blog has been having issues with some readers being redirected to a sketchy Chinese pharmaceuticals site. I believe the issue has been resolved, but please reach out to me if you encounter anything weird. Much appreciated!

It’s been a little while since I did a post on a major holding of mine. For those tired of random value ideas and OTC curiosities, here’s a profile on a company where my firm has meaningful capital at stake.

Before I begin, let me offer some words of caution. Shares of Crawford United are highly illiquid. Investors must use caution when attempting to transact. Crawford United is a tiny, insider-controlled company and the ability of outside shareholders to influence the company’s in any way is extremely limited. Please do not buy or sell shares of Crawford United (or any other security mentioned on this blog) without doing your own in-depth research.

Crawford United is a Cleveland-based holding company with interests in multiple industrial subsidiaries. Founded as “The Hickok Electrical Instrument Company,” the firm has been in existence for over 100 years. Like most other companies of similar vintage, Crawford has seen its share of ups and downs. For most of its existence, Crawford served the automotive industry. As the Big 3 struggled in the early 21st century, Crawford’s fortunes declined and losses mounted. The company began extricating itself from the automotive industry with a series of highly accretive acquisitions, the first in 2017. Today, the company is highly profitable, well-financed, and cash generating. The company’s shares have responded, but the market does not yet fully appreciate the magnitude of Crawford’s turnaround. Shares of Crawford trade at around 8x 2020 earnings with meaningful earnings growth potential.

Today’s Crawford United consists of three segments, each acquired within the last three years.

Federal Hose was acquired in July 2016 for $1.65 million in Crawford stock and $4.8 million in promissory notes. The Painesville, Ohio company is a manufacturer of hydraulic, metal, and silicone hosing for industrial applications.

Next came Akron, Ohio’s Air Enterprises in June 2017. The company paid $10.25 million, funded almost entirely with revolving and term loan facilities from JP Morgan. Air Enterprises designs and engineers air handling systems for large facilities like hospitals, factories, and arenas.

Crawford completed its acquisition trifecta with the July 2018 purchase of CAD Enterprises in Phoenix, Arizona. For this manufacturer of precision aerospace components, Crawford paid $21 million. $12 million was paid in cash and the balance in a subordinated note.

In June 2018, Crawford divested its legacy automotive testing unit. With the move, Crawford formally ended its century-long involvement with the automotive industry.

In total, the company invested $38 million over three years to reinvent itself. The outcome has been wildly successful. I believe the company’s purchases were both well-priced and well-timed. Below is a look at the operating results of each segment over the last twelve months.

All of Crawford’s segments are operating profitably, but the Air Enterprises figures leap off the page. The segment (purchased for only $10.25 million) produced operating income of $7.8 million over the last four quarters. That is an absolutely eye-popping figure. In the two full years it has owned Air Enterprises, the subsidiary has already earned more than its purchase price in operating income. How on earth did Crawford manage this? Was this the mother of all distressed purchases? In short, the answer is yes. Crawford bought Air Enterprises from Data Cooling Technologies, LLC. At the time of the Air Enterprises transaction, Data Cooling Technologies was experiencing extreme financial difficulties. Selling Air Enterprises was a last-ditch and ultimately unsuccessful effort to stave off bankruptcy. Crawford was in the right place at the right time, cash in hand.

While Air Enterprises is Crawford’s star, its other acquisitions are also solid performers. In particular, CAD Enterprises positions the company well in the lucrative aerospace components market. The highly specialized and regulated nature of the industry limits entry by new competitors, and the long-term growth of international aviation should increase demand for the segment’s services. Federal Hose doesn’t appear to have much revenue growth potential, but it has produced robust earnings and margin improvement in recent years.

For the last four quarters, Crawford reported operating income of $10.2 million, or $1.5 less than its operating subsidiaries’ EBIT. That $1.5 million in corporate-level costs is very reasonable. Going forward, I expect operating income to trend higher as the company’s various acquisitions are integrated and improved. This ignores any growth in the various end markets. Assuming 2020 EBIT of $10.5 million, my estimate of next year’s earnings and free cash flow looks like this.

At a share price of $20, Crawford United trades at 8.9x my estimate of 2020 earnings and at a normalized FCF yield of 11.8%. Total debt of just over $20 million is not quite 2x EBIT and leaves plenty of capacity if another acquisition opportunity comes along. Interest coverage as measured by EBIT/Interest expense is nearly 12x. Return on equity will exceed 40%, a figure that should be sustainable for years to come thanks to Air Enterprises’s spectacular success. I think a more reasonable yet still conservative value for Crawford United would be in the neighborhood of 12x my 2020 EBIT estimate. That would value the enterprise at $126 million and shares at $33 or so.

Crawford appears extremely cheap on an earnings and cash flow basis, with plenty of room to improve results. That’s the good. Now let’s take a look at the risks the company faces.

By far the largest downside risk to Crawford’s results is cyclicality. Air Enterprises is exposed to the building cycle. In a down economy where fewer large facilities are being built and major remodeling/expansion is postponed, results will suffer. Federal Hose is similarly exposed to the health of the industrial economy. CAD Enterprises is likely the least economically sensitive with the strongest secular growth trends in place, but will still rise and fall with the health of the aerospace industry. In short, this is not the type of company anyone should be paying 20+ times earnings to own unless we’re at the bottom of an economic trough. Revenues will fall from time to time, and the relatively high fixed costs common to most industrial businesses will take a bite out of profits. However, I believe Crawford’s businesses have yet to see their results peak this cycle. <9x earnings is far too cheap.

The other major factor to consider is management. Crawford is firmly under the control of insiders thanks to their majority ownership of both Class A and Class B shares. The company has a variety of related-party transactions to evaluate and consider. Insiders provided convertible loans to float the company through its toughest years and received large quantities of shares as a result.

Investors should also note that although the company’s recent acquisitions have been successful, Federal Hose was purchased from related parties and CAD Enterprises does business with related parties. I believe the prices paid for these businesses were attractive and the motivations behind the deals were sound, but transacting with related parties always invites the possibility that shareholder value will become a secondary consideration.

Transactions like these don’t particularly concern me as they have served shareholders well. Still, shareholders should remain wary of future related-party transactions. Management compensation is reasonable and I believe the board is motivated to increase the company’s value via their large ownership positions. Crawford’s future success depends on the whims of the company’s largest owners, so investors must be comfortable with their skills and motivations.

Alluvial Capital Management, LLC holds shares of Crawford United for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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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Red Alert for Dark OTC Stocks

The SEC has proposed rules changes that would effectively shut down all trading in non-reporting OTC-traded companies. I am strongly opposed to these rule changes. As proposed, the new rules would eliminate the ability of holders of non-reporting OTC company shares to transact in the marketplace. Holders would only be able to sell their holdings by identifying a willing buyer without the benefit of market makers or electronic trading. The resulting prices and valuations for these trades would surely be punitive in the extreme.

I urge the SEC not to preside over the destruction of hundreds of millions in shareholder wealth by implementing these misguided changes. The goal of protecting investors from fraud and manipulation is laudable, but the collateral damage in this instance would be extreme.

I have submitted a comment to the SEC explaining my views. My comment can be found here. (I will change the link once the SEC has processed my comment and it appears on their public site.) Many other investors in dark OTC companies have taken the time to submit their thoughtful comments.

If you are an investor in non-reporting OTC-traded companies and would like to ensure continued quotation for your holdings, I ask that you also submit a comment to the SEC expressing your dissatisfaction with the proposed rules changes. Please take steps to protect the value of your investments, otherwise you may find yourself holding virtually untradable shares in effectively private companies.

The SEC’s public comment portal is accessible here. Please submit your comments for the September 25 entry titled “Publication or Submission of Quotations Without Specified Information” File number S7-14-19. Previously submitted comments can be read here. Thank you for reading!

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A Pair of Cheap, Well-Run California Banks

I have never had great luck finding obvious value in California banks. Nearly without exception, these banks trade at large multiples of earnings and tangible book value. This makes sense. After all, much of the state enjoys a strong economy and good demographic trends. It’s a favorable environment for a bank to call home compared to say, southern Indiana or post-industrial regions of Pennsylvania or Ohio. Still, I do manage to find an interesting Golden State bank now and then. Here are brief looks at two banks, both very successful and trading at undemanding values.

River City Bank (Ticker:RCBC) is the Sacramento area’s largest business-focused bank. The company was founded in 1972 by Jon S. Kelly, a Sacramento broadcasting, telecom, and real estate titan. Mr. Kelly remains the largest shareholder. The bank operates 12 branches in 5 counties and focuses on commercial real estate loans, which make up over 80% of its $1.7 billion loan portfolio. The bank maintains strong capital ratios and has low levels of non-performing assets, leading to a “Superior” rating from Bauer Financial. Like many other business-focused banks, River City Bank enjoys a high proportion of non-interesting-bearing deposits. The bank’s balance sheet exceeds $2 billion with nearly one-quarter of that total invested in government debt securities.

River City’s most impressive accomplishment may be its efficiency. In 2018 and 2017, non-interest expenses were under 40% of net interest income. Without the need for a large branch network in order to service retail accounts, River City can economize on staffing and premises expenses. This has allowed the bank to earn >1% on its assets despite a rather pedestrian net interest margin.

With shares trading in the high $180s, River City Bank has a trailing P/E ratio of just over 10. Tangible book value per share sits at $148 for a price/tangible book ratio of 1.28. Shares trade cheaply because of their extremely low liquidity and the perceived risks of commercial lending compared to traditional lending. River City has a long history of successfully managing these risks, and I expect the bank’s strong balance sheet and high lending standards will help them manage whatever the next down cycle brings.

Headquartered one hundred miles or so west in Santa Rosa is Exchange Bank (Ticker:EXSR). Exchange takes a very different tack, operating as a traditional community bank and lending mainly against single-family houses. Founded in 1890, the bank has had only 8 presidents in its history. Exchange Bank maintains a conservative balance sheet, with tangible equity of $241 million on a $2.5 billion balance sheet. Like River City, Exchange Bank invests heavily in government securities and has a high proportion of non-interest-bearing deposits. Exchange saw its deposits swell last year as customers received insurance settlements from the area’s terrible fires. Deposit levels are now normalizing as homeowners rebuild.

Exchange Bank’s efficiency ratio hovers around 70%. That’s good, even if nowhere near as low as River City’s. However, Exchange also earns a much larger net interest spread, allowing it to generate a healthy return on assets and equity. Exchange Bank also benefits from its profitable trust and investment management group. In October 2018, Exchange purchased First Northern Bank’s trust department.

With shares trading in the mid-$160s, Exchange Bank trades at a trailing P/E ratio of just 7.7. Tangible book value per share sits at $141 for a price/tangible book value ratio of 1.16.

Shares of Exchange are illiquid for a unique reason. Rather than passing shares down to his heirs at his death, Exchange Bank co-founder Frank Doyle established a trust that would own 50.44% of the bank’s shares for the benefit of the community. Today, dividends received by the trust are distributed to the Frank P. Doyle and Polly O’Meara Doyle Scholarship Fund for students attending Santa Rosa Junior College. That works out to $3.8 million annually. What a legacy!

The fact that over half of Exchange Bank’s shares are effectively owned by the community makes a buyout or merger much less likely, which probably contributes to their cheap valuation. That doesn’t mean shares cannot perform well for shareholders. After all, the Hershey Company has a similar ownership structure and shareholders have been quite well-treated over the years.

Both River City and Exchange Bank appear under-valued. River City is the more aggressive of the two and will likely grow its balance sheet and earnings more quickly, but is more sensitive to economic conditions. An environment of falling interest rates and a flat or inverted yield curve will present challenges for both banks.

Alluvial Capital Management, LLC holds shares of Exchange Bank for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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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NII Holdings Liquidation – NIHD

I ran across a liquidation scenario that is a rarity for this blog. It’s exchange-listed and relatively liquid! Unfortunately, evaluating the range of potential outcomes involves handicapping some legal outcomes. I consider most ideas with litigation angles beyond my circle of competence. However, I’d still like to present this idea in case it falls within the bailiwick of any of my extremely intelligent readers.

NII Holdings has a not-so-distinguished history as a wireless network operator in Central and South America. The company has always struggled against better-funded competitors with superior product offerings. NII went through the bankruptcy process a few years back, selling Nextel Mexico to an AT&T subsidiary. Now, the company has announced a sale of its remaining Brazilian operating subsidiary to América Móvil. Following the closing of the sale and the settling of certain escrow accounts, the company will liquidate. The implied value per NII Holdings share was $2.59 as of March 18. This figure is only a preliminary estimate and is subject to change due to fluctuations in the BRL/USD exchange rate, actual liquidating expenses, and the outcome of certain ongoing litigation. With shares currently changing hands at $1.74, shares could offer substantial upside if all goes as expected.

Here is a slide from the company’s recent presentation showing the projected sources and uses of cash.

The Nextel Brazil asset sale is fairly straightforward. Provisions in the sale agreement protect NII from losses due to cash burn at Nextel Brazil between now the the closing of the deal. Nextel Brazil does have some BRL-denominated debt which could fluctuate in value between now and then.

NII’s net financial debt is also fairly simple. In my experience, companies err on the conservative side when estimating liquidation costs. Nobody wants to be the subject of a shareholder lawsuit for providing estimates that turn out to be far too rosy.

The Mexico escrow is where things get dicy. This asset relates to the sale of Nextel Mexico to New Cingular Wireless Services, an AT&T company, in 2015. As part of the deal, one-tenth of the purchase price was placed in escrow against potential tax penalties for years prior to the purchase. A few small tax payments were deducted from escrow, and a portion of the escrow holdback was eventually released to NII. However, $106 million of the original escrow balance remains in limbo with New Cingular Wireless refusing to allow its release. New Cingular claims it has the right to maintain the escrow while certain tax items and audits remain open, while NII claims the opposite. The parties are involved in court proceedings over the issue. NII projects a net recovery from escrow of $75 million. They suggest this amount is a conservative projection, though of course the projections depends on a legal outcome in NII’s favor or New Cingular releasing the balance to NII voluntarily.

In addition to uncertainties over the Mexico escrow asset, exchange rate developments, and actual liquidating expenses, timing will have a major impact on the ultimate outcome for NII shareholders. The Nextel Brazil sale will carry an 18-month $30 million escrow holdback. The company expects to be able to distribute between $1.00 and $1.50 per share following the closing of the Nextel Brazil sale, but investors will have to wait a while for the liquidation process to reach its end.

Allow me to present four liquidation scenarios, ranging from optimistic to dreadful.

The Ideal Outcome: The sale of Nextel Brazil closes as planned two months from now at the end of August, 2019. 60 days after that, the company distributes $1.50 per share, or $152 million. Six months from then, New Cingular Wireless agrees to release the entire escrow amount, of which NII receives $75 million. 30 days later, NII distributes another $81 million or $0.80 per share. 18 months following the closing of the sale, the $30 million Nextel Brazil escrow is released. 60 days later, NII shareholders receive the proceeds as a final liquidating payment of $0.30 cents per share.

In this scenario, NII shareholders will have received $2.60 per share over the next 22 months. Total return to shareholders is 49% at a spectacular 92% IRR.

The Realistic Outcome: The sale of Nextel Brazil closes slightly later than planned six months from now at the end of December, 2019. 60 days after that, the company distributes $1.25 per share, or $127 million. Nine months from then, New Cingular Wireless and NII reach a legal settlement and NII receives $50 million from escrow, with another $10 million to be received 12 months later in full satisfaction of the escrow holdback. 30 days later, with liquidation costs running higher than expected, NII distributes another $40 million or $0.40 per share. 18 months following the closing of the sale, the $30 million Nextel Brazil escrow is released. 60 days later, NII shareholders receive the proceeds plus the final piece of the Nextel Mexico escrow as a final liquidating payment of $0.40 cents per share.

In this scenario, NII shareholders will have received $2.05 per share over the next 26 months. Total return to shareholders is 18% at an attractive 16% IRR.

The Unfortunate Outcome: The sale of Nextel Brazil closes far later than planned nine months from now at the end of March, 2020. 60 days after that, the company distributes $1.00 per share, or $101 million. The legal maneuvering over the Nextel Mexico escrow drags on another year and NII finally settles for just $30 million just to be done with the whole thing. Thirty days later, the company distributes $25 million, $0.25 per share. 18 months following the close of the Nextel Brazil sale, the company receives just $20 million from the escrow account, having paid out $10 million in penalties for some dodgy tax returns in previous years. 60 days later, the company pays a final liquidating distribution of $0.20 per share.

In this scenario, NII shareholders will have received $1.45 per share over the next 28 months. Total return to shareholders is -17% at a distressing -13% IRR.

The Disastrous Outcome: The Nextel Brazil deal falls apart and the company remains locked in its dispute with the AT&T subsidiary over the Mexico escrow. Shares fall 50% over the next six months. Another trip through bankruptcy seems likely.

Clearly, a wide variety of outcomes is on the table here. If after some diligence one comes to believe a positive outcome is highly likely, this could be a very attractive scenario. Personally, I simply don’t know enough, nor do I wish to dedicate the time it would take to feel confident in my assessments. If NII’s share price fell to the point where even the pessimistic scenario offered a good return, perhaps that would change.

Regardless, this will be a fun scenario to watch. Let me know if you have any insights to share.

Alluvial Capital Management, LLC does not hold shares of NII Holdings, Inc. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

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Ricegrowers Limited – Value in This Agricultural “Co-op?”

I’m dropping by the old blog today to provide a quick look at an interesting situation in Australia. In early April, Ricegrowers Limited chose to list its stock on the Australian Stock Exchange for the first time. Ticker: SGLLV. Previously, class B shares traded on the National Stock Exchange of Australia, a somewhat obscure and inaccessible exchange with limited trading volume.

Ricegrowers Limited is the corporate parent of SunRice, a nearly 70 year old producer of many varieties of rice. The company has growing, packaging, and distribution facilities around the world. Historically, Ricegrowers functioned much like an agricultural co-op. Its shares were owned exclusively by rice producers and their affiliates and the company was run primarily to maximize the return to these grower-owners. While technically a corporation and not a cooperative or a mutual, the practical difference was small. With the ASX listing, Ricegrowers has chosen to allow non-affiliates to purchase its shares for the first time. The firm will now function as a truly public corporation and will

Ricegrowers’ financial results show a fundamentally decent business at work. Return on equity has average almost 12% over the last five years. (Averages are critical for agricultural producer like Ricegrowers. The results of any particular year are highly unpredictable due to growing conditions and global market demand and supply.) Ricegrowers does employ a decent amount of leverage, but most of its debt is cheap, seasonal debt used to smooth out the cash flow cycle associated with the annual harvest.

The reasons Ricegrowers intrigues me are two-fold. First, the company trades at a discount to book value despite adequate profitability. At a price of AUD 6.50 per B share, Ricegrowers has a market capitalization of AUD 381 million versus book value attributable to shareholders of AUD 416 million. Nearly all of this book value is tangible. Companies earning their cost of capital and still trading below book value are something of a rarity in today’s markets. Second, Ricegrowers is a company with plans! In conjunction with its ASX listing and removal of ownership restrictions, the company published a guide to its ambitious growth strategy. The company intends to double revenue by 2022, while maintaining a double digit return on capital. The full document is available here, but be warned, it’s quite the tome.

For the first time, investors can access one of Australia’s premiere agricultural companies. They are able to buy the company at a discount to book value at a time when the company expects to achieve significant growth while maintaining profitability.

Alluvial Capital Management, LLC does not hold shares of Ricegrowers Limited. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

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Alaska Power & Telephone – APTL

Alaska Power & Telephone (“APT”) is a classic OTC Adventures stock. It operates in a geography that is remote to most, in a relatively boring industry, with little chance of entering the limelight any time soon. Despite operational success, a strong balance sheet, and a rising share price, the company remains obscure and ignored. I first profiled APT way back in 2012 when shares changed hands at a mere $17 compared to today’s $60. Practically nobody read OTC Adventures at the time, so let me reintroduce the company.

APT has been in operation since before Alaska even achieved statehood. The company provides electrical power and telephone service to many Alaskan communities, including some extremely remote outposts. APT’s regulated power activities are 75% hydroelectric and 25% fossil fuel. Its telecom activities span traditional regulated exchange activities and non-regulated broadband services. In 2017, revenues from broadband-associated offerings surpassed traditional telecom revenue for the first time.

From the company’s 2017 annual report.

Because APT operates two completely different businesses, it is necessary to evaluate each in order to derive a value for the whole. The power business is the smaller and simpler of APT’s segments, so let’s start there.

In 2012, APT’s power business produced revenues of $20 million, with EBITDA of $8.0 million and EBIT of $4.9 million. In 2017, the segment brought in revenue of $19.9 million, EBITDA of $8.5 million and EBIT of $5.1 million. If there’s a textbook stable business out there, this is it. The power business has nearly no growth potential, but also enjoys practically guaranteed profits. The earnings stream from the power segment is essentially an annuity and should be priced like one. Electric utilities in the lower 48 are valued highly. Anywhere from 12-20x EBIT is common depending on asset types, underlying electricity demand dynamics and the regulatory environment. APT’s power segment probably deserves… less. Alaska’s population is stable at best, particularly in the interior areas APT serves. In other words, the demand for electricity will grow slowly. Combining a lackluster demand picture with the reality of APT’s tiny size makes me think a 10x EBIT multiple is fair. That would put the value of APT’s power operations at $51 million based on 2017 figures. On an EBITDA basis, that’s a 6.0 multiple. Are both measures too conservative for a regulated electric utility? Possibly. But if there’s anything I’ve learned, one must be very careful not to pay too much for a slow-growth/no-growth business. When there’s little or no top-line growth to bail you out, every point of the purchase multiple matters.

The “telephone” part of of APT’s business is both larger and more dynamic. Until recently, APT’s telecom segment was like nearly every other rural telecom: facing a slow erosion of revenue from traditional wireline services and scrambling to make up the losses with unregulated broadband offerings. APT was relatively successful in doing so, but the telecom segment was only moderately profitable and certainly not a growth engine for the company. All of that changed with the FCC’s A-CAM program. This rural infrastructure program has already had a tremendously positive impact on the financials of many rural telcos, and will continue to do so for a decade to come. If you’re unfamiliar, A-CAM is essentially an enormous subsidy that telcos can receive if they commit to extending broadband internet access to nearly the entirety of their service areas, including areas far too sparsely populated or remote to justify service under previous funding mechanisms. Naturally, rolling out this service requires a significant amount of incremental capital expenditure. But the net effect is a dramatic increase in both profits and cash flows for many rural telcos, and APT is one of them.

In 2016, APT’s telephone segment (regulated and unregulated services included) earned revenue of $24.7 million, EBITDA of $9 million, and EBIT of $5.4 million. In 2017 with the addition of the A-CAM subsidy, telecom segment revenue soared to $36.4 million, with EBITDA rising to $15 million and EBIT nearly doubling to $10.3 million. Investors should expect to see elevated capital expenditures in telecom for some time to come, so not all of the increased GAAP profits will fall to free cash flow. However, the great thing about investment in fiber is its longevity. Once in the ground, the expensive part is over. Good quality fiber optics can easily last decades and decades, much longer than copper cable or coaxial fiber. The investment APT makes now in expanding its fiber network will be producing revenue in 2049, long after the investment has been fully depreciated. As the rural telco managers I talk to like to say, fiber is “future-proof.” Even in the coming 5G world, fiber networks will serve as the backbone enabling 5G wireless services.

Well and good, but what’s it worth? Other rural telcos trade at EBITDA multiples of 5-6 depending on the attractiveness of their geographies, their opportunity for profitable investment in fiber, the competitive landscape, and balance sheet strength. I value APT’s telecom segment at the high end of this range. APT is well-situated with little threat of new competitors entering their markets and plenty of rural Alaskan households and communities needing broadband services. Compared to highly leveraged rural telcos like Consolidated Communications or Shenandoah Telecommunications, APT carries little debt. For the twelve trailing months ended September 30, 2018, APT telecom produced EBITDA of $15.4 million. We know that APT will receive an additional ~$800,000 in annual A-CAM funding from the FCC’s recent enhanced offers. So we can call EBITDA $16.2 million. A 6x multiple would value the telecom segment at $97.2 million.

Now to the liabilities. Based on its debt amortization schedule, APT had total debt of $48.2 million at year-end. A large portion of this debt is owed to CoBank, a quasi-governmental bank that lends to rural infrastructure owners and operators. CoBank functions much like a mutual and pays out annual “patronage dividends” to borrowers, effectively reducing their borrowing costs. Because it is able to borrow on such friendly terms, I believe the economic value of APT’s debt is below its stated value. I won’t reproduce it here (gotta leave some work for my very industrious readers), but I created a schedule of APT’s debt obligations and discounted the cash flows assuming a spread of 400 basis points over treasuries for each time period. I arrived at a value of $45.5 million, which seems fair to me. This includes the effects of an interest rate swap struck at 7.62% on the largest portion of APT’s debt. This debt is being amortized rapidly and will be gone in five years. I expect APT will receive a much better rate the next time they approach CoBank.

So $51 million for power, $97.2 million for telecom, less debt of $45.5 million values APT equity at $102.7 million, or $80 per share, 33% higher than today’s prices. Once again, this is conservative. I did not give APT credit for any balance sheet cash, nor the CoBank patronage stock it holds. It’s not difficult to imagine some EBITDA growth in coming years from their fiber roll-out either.

While APT appears cheap on the numbers, investors must be prepared to truly think like owners. Shares are very illiquid, and most are held by company insiders and employees. It’s highly unlikely that a bid for the company will emerge, so you’ve got to trust insiders to run the company well. On the whole, they have stewarded the company well. Management took a detour into empire-building a decade ago with disastrous results, but they appear to have regained their discipline. I am happy to hold APT for the long term.

Alluvial Capital Management, LLC holds shares of Alaska Power and Telephone Company for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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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Can Philly Shipyard Turn Around? Oslo:PHLY, OTC:AKRRF

Philly Shipyard has a problem. The company has run out of ships to build. Once it completes its current order for Matson, there are no more orders.

Philly Shipyard is (no surprise) located in Philadelphia. Anybody who’s traveled I-95 through the city may have noticed the company’s facilities to the east.

The shipyard has a storied history, with ocean-going vessels built there starting in 1871. The US Navy was a major customer through most of the 20th century. Unfortunately for the shipyard, the end of the Cold War saw a sharp decline in the need for new vessels and none were built after 1970. The shipyard officially closed in 1991 with the property reverting to the city’s ownership. A long campaign by several stakeholders saw the shipyard gain new life, leased long-term to Norwegian conglomerate Kværner in 2000. Philly Shipyard delivered its first new vessel in over 30 years in 2003. Kværner was subsequently taken over by Aker, which listed a minority stake in Philly Shipyard independently on the Oslo stock exchange in 2007.

The following decade was good for Philly Shipyard. A busy order book allowed the company to report consistent profits and pay large occasional dividends. Philly Shipyard’s customers were domestic shipping companies needing vessels for Jones Act operations in American waters. But shipbuilding is a deeply cyclical industry, and the downswing is here. Facing an indeterminate period of inactivity, Philly Shipyard has instituted layoffs and prepared equipment for long-term storage.

All is not hopeless for Philly Shipyard. The company is in discussions with an undisclosed shipper to construct two new tankers, and is bidding on the contract for the US Maritime Administration’s National Security Multi-Mission Vessels. If the company is successful in winning these bids, better times are ahead. If not, the construction bays will sit idle.

Against this backdrop, it is unsurprising that Philly Shipyard’s shares have fallen to their lowest level in years. At NOK 31, shares are down 85% since cresting at over NOK 200 in 2014. The company now trades at a substantial discount to net current assets.

While its shares trade in NOK, Philly Shipyard reports in US Dollars. At September 30, Philly Shipyard had net current assets of $72.1 million. (In this figure I include restricted cash, which is only restricted as collateral against outstanding debt, and cash to be received from the nearly-complete liquidation of a subsidiary.) Book value is $119.2 million. Philly Shipyard’s market capitalization is NOK 390 million/$45 million. Shares trade at a 38% discount to my adjusted net current asset value, and only 38% of book value, virtually all of which is tangible.

This isn’t quite the complete picture. Philly Shipyard can be expected to operate at a loss and burn cash until it can secure new ship orders. The company is limited in how deeply it can cut employment by provisions in the long-term lease with the city. However, if the shipbuilding cycle bottoms at any point in the next few years and if Philly Shipyard can keep itself afloat until then, shareholders could be richly rewarded when profits return. For context, Philly Shipyard paid dividends totaling three times its current market capitalization between 2014 and 2017. When times are good for Philly Shipyard, they are very good. The question for investors is when and if good times will come around again.

Alluvial Capital Management, LLC does not hold shares of Philly Shipyard ASA. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

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Left for Dead: Manning & Napier – MN:NYSE

It’s no secret that the active investment management industry has seen better days. Decades of high fees and uninspiring returns have spurred investors to reallocate their dollars to passive index-following strategies. Declining assets under management not only reduces the earnings that active managers collect, but also the multiple at which the market is willing to capitalize those earnings. As the industry continues to struggle, active asset managers have seen their valuations and stock prices decline. And yet, active managers still hold trillions in assets under management. Active strategies aren’t going away any time soon. 

You wouldn’t know that from looking at certain asset managers. The heavy pessimism surrounding the active asset management industry has lead the market to price certain managers as if they will soon cease to exist entirely. A prime example is Manning & Napier, Inc.

By any benchmark, Manning & Napier is an extraordinarily successful manager. Founded in Rochester, New York in 1970, the firm grew its AUM to a whopping $50 billion by 2013. At one point, the firm’s flagship large cap equity fund beat the S&P 500 for 11 years running. M&N went public in 2011 with a slightly unusual structure. Manning & Napier, Inc. owns a minority interest in the underlying management company, Manning & Napier Group, LLC. In 2011, M&N, Inc.’s ownership in the management company was 13.2%. It has since increased to 18.2% as owners of the management company have converted their interests to shares of the public company over time. 

Unfortunately, the IPO represented the high point for Manning & Napier and its investors. Soon after, the performance of the company’s largest and most important funds began to suffer. The redemptions started coming and they haven’t stopped since. From the peak in 2013, AUM has now declined by more than half to $23.1 billion at September 30, 2018. Over the last five years, Manning & Napier shares are down nearly 90%.

Today, M&N appears to be a mere $25 million market cap speck. In truth, the company is a little larger. Remember that M&N owns only 18.2% of the underlying investment manager. On a full ownership basis, the market is valuing the entire manager at $138 million. 

An investment manager with $23.1 billion under management for $138 million. That’s a value of 0.6% of assets under management. That’s low, even for a shrinking company in a despised industry. By way of comparison, Hennessy Advisors is valued at 1.4% of AUM and Silvercrest Asset Management Group is valued at 0.9% of AUM. But that’s not the whole story. Turns out Manning & Napier has a wealth of cash and securities on its balance. The only meaningful liabilities besides normal payables is an $18 million tax liability which will come due over time as the company continues to exchange its shares for additional ownership in the underlying manager. Cash and securities, net of the full tax liability equals $128 million. That makes M&N’s actual market value something close to $10 million. That’s right, $10 million or a mere 4 basis points of AUM buys you $23.1 billion in AUM. 

So what’s the catch? There’s got to be some horrible issue facing Manning & Napier. An SEC action, maybe litigation by former employees? No and no, but the company does have some serious cost issues. With half the AUM it once had, it seems M&N has had difficulty cutting costs to match its new reality. And that has had a terrible effect on operating margins. In 2015, the company earned $129 million in EBIT on revenue of $138 million for an operating margin of 40%. In 2017, EBIT declined to $52 million on revenue of $202 million for a 26% margin. Through the first three quarters of 2018, EBIT has continued to plunge far faster than revenues. 

I understand Manning & Napier’s reluctance to let go of long-time employees and its desire to maintain a robust infrastructure in hopes of a turnaround. But at some point, there must be a reckoning. The last quarter’s EBIT margin dipped to 11%, and it could go negative in the fourth quarter given the market’s path these last few months. Again, for comparison, Hennessy Advisors put up a 45% operating margin this year, and Silverspring did north of 20% this last quarter. Slightly different models, sure. But the point remains there’s no excuse for earning so little on the revenue stream from over $20 billion in AUM. The glory days are over. They may come again, but for now it’s time to tighten the belts a few inches. 

Manning & Napier appears exceptionally cheap, but investors must be comfortable with the risk that the company fails to address its AUM slide or failing that, cannot address its cost issues. On the other hand, solving one or both of these challenges could result in a massive upswing in profits and equity value. 

Alluvial Capital Management, LLC does not hold shares of Manning & Napier Inc, Hennessy Advisors, or Silvercrest Asset Management Group. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. 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.

Alluvial Capital Management, LLC manages a value investing partnership, Alluvial Fund, LP. If you are a qualified investor and would like more information, please contact us at info@alluvialcapital.com or visit alluvial.capital.

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