LICT Corporation

LICT Corporation owns a collection of 14 geographically disparate rural telecom companies. The company traded on the AMEX as Lynch Interactive Corporation until 2006, when it underwent a reverse stock split and deregistered. Since, then the company has been diligent in releasing regular quarterly and annual reports for shareholders. Famed value investor Mario Gabelli and his associate, Salvatore Muoio, own 40.5% of the company.

Nate Tobik at Oddball Stocks did a quality writeup on LICT earlier this year and ably summarized the key issues surrounding LICT’s valuation and investment potential. Essentially, LICT’s extremely low valuation is the result of investor skepticism. The wireline telecom industry is in inexorable decline. The question is not if wireline revenues will eventually slip below fixed costs, but when they will and how much cash can be harvested in the interim. LICT trades as if only a few more highly profitable years remain, but is that really the case? The company’s recent results suggest otherwise.

Wireline revenue is, as expected, declining. However, the rate of decline is slow and seems to have abated for now. Year over year, wireline revenue declined less than 1%. With its focus on rural areas, LICT is better situated than urban-focused telcos. Having grown up in very rural areas, I can attest to how few communications options are available for many residents, and how tightly many hold onto their land lines, even if they own cell phones.

While wireline revenues are stagnant/in slow decline, LICT’s unregulated segment has performed well. Services like DSL and alarm systems have experienced steady growth. DSL is hardly the latest in internet access technology, but it’s the best available option for many. Verizon or Comcast are simply not going to make the investment necessary to provide FIOS or comparable services to remote communities.

With total revenue seemingly having bottomed and even resumed growing, it is possible that LICT’s EBITDA figures have stabilized as well. In fact, twelve month trailing EBITDA of $36.37 million did grow by 0.86% year-over-year.

Despite these encouraging signs, LICT’s valuation has declined continually over the past several quarters.

Since the first quarter of fiscal 2010, LICT’s market capitalization has declined by 17.1% to $49.33 million. Simultaneously, the company cut its net debt by 29.9%, leading total enterprise value to decline by 25.2% over the same period. Trailing annual EBITDA declined by only 11.1% during this period. LICT now trades at its lowest valuation in at least two years, at 3.35 times EBITDA and at a 25.3% free cash flow yield.

So what gives? Investors clearly are taking a dim view of LICT’s future despite encouraging recent results. I see two main scenarios that could unfold.

1. The market is correct. Rural customers accelerate their “wire-cutting” and LICT’s future EBITDA declines at an increasing pace. Furthermore, federal subsidies which support LICT’s business operations in rural areas are reduced or eliminated, further impairing LICT’s profits. In this scenario, LICT may be worth only its current EBITDA multiple, or even less.

2. The market is wrong. Investors have failed to notice or correctly credit LICT for its recent revenue and EBITDA stabilization, or the company’s success in reducing net debt and shares outstanding. LICT’s EBITDA, revenue and earnings stabilize, or show modest increases. The company is able to devote its substantial free cash flow to continued debt reduction, or toward acquisitions or payments to shareholders. In this scenario, LICT’s equity is tremendously undervalued.

I view the second scenario as quite a bit more likely, and I expect the market to gradually realize LICT’s potential. If the company’s stock were to trade up to even a still-depressed 4.0x EBITDA multiple, it would be worth $3,113 per share, a 48% increase from current levels. A 5.0x multiple would mean a price per share of $4,661, 122% higher than at present.

Even if the market never comes to reassess LICT’s valuation, Mr. Gabelli still has avenues available to reward shareholders (the largest of which is himself). At some point, a continually decreasing debt load invites the possibility of a leveraged recapitalization with a large special dividend for shareholders. For instance, increasing debt by $20 million would take the company back to its fiscal position in Q1 2011 when trailing EBITDA was slightly lower than it is today, and could fund an $851/share special dividend.

While LICT Corporation faces risks of obsolescence and a resumption of revenue and cash flow declines, its historically low valuation may tilt the odds in investors’ favor at these levels.

Disclosure: No position, may initiate.

The Reserve Petroleum Company

The Reserve Petroleum Company (ticker: RSRV) was founded in 1931 and is headquartered in Oklahoma City, Oklahoma. Mr. Mason McLain, 85, has served as chairman since 1955. Mr. McLain’s brother Robert, 82, and his sons Cameron and Kyle also serve on the board of directors. Cameron McLain serves as CEO, a role he assumed when Mason McLain stepped down in 2009. Reserve Petroleum explores for and produces oil and natural gas, primarily in Oklahoma and Texas. The company also significant mineral properties.

As a general rule, I shy away from commodities producers. These companies are profoundly affected by changes in commodities prices, which I have absolutely no expertise in predicting. Oil and natural gas are almost completely fungible products, so producers are left to compete on price alone. Furthermore, explorers take on significant risk and commit huge amounts of capital with no assurance of profits. A series of dry wells or a single uneconomical acquisition can destroy serious value.

What’s more, the commodities complex seems to attract far more than its share of stock promoters, snake oil salesmen and con artists. Mark Twain supposedly described a gold mine as a “hole in the ground with a liar on top.” I think the same can be said of an oil well.

Amid the wreckage of hundreds of bankrupt or nearly-so exploration companies on the unlisted market, Reserve Petroleum stands out for its consistent successes. Over several decades, the McLains have proven to be canny oilmen and ethical businessmen. Year after year the company has increased its proven reserves while producing profitably. The company has paid generous dividends to shareholders while gradually repurchasing stock. The upshot for shareholders over the last decade was an astounding 1,500% return, including reinvested dividends. Obviously, the commodities boom of the 2000s provided a strong tailwind, but Reserve Petroleum strongly outpaced the SPDR Energy Index ETF’s total return of about 200% over the same period.

Over the last decade, Reserve Petroleum has shown consistent profitability and free cash flow.

The company’s operating and net margins are excellent. By comparison, Exxon Mobil’s average net margin over the last five years was 8.6% and Chevron’s was 8.8%. The company keeps a tight lid on SG&A expenses, averaging just 10.9% of revenue over the last five years.

The company’s operational efficiency carries over to its balance sheet. Reserve Petroleum eschews debt completely, and traditionally holds large reserves invested in government bonds. At quarter’s end, these excess investments amounted to just over $117 per share, fully 36.5% of market capitalization.

Reserve Petroleum’s exploration efforts have been extremely productive, resulting in large additions to proven reserves year after year.

Proven reserves for both oil and natural gas hit all time highs in the most year. The company’s reserves were primarily natural gas a decade ago, but proven oil reserves grew much more quickly since then.

Reserve Petroleum recently traded with a bid/ask spread of $292/$350. At the mid-point of $324, the company had a market cap of $52.2 million and a trailing P/E ratio of 9.3. This seems like a reasonable value for a debt-free and well-managed exploration and production company, but it ignores Reserve Petroleum’s $18.84 million in cash and securities. Net of those excess assets, the company trades at a trailing P/E ratio of 5.9.

The company seems likely to be in good hands for the foreseeable future. Both the younger McLain brothers are in their mid-50s and stand to lead the company for decades to come. Encouragingly, management’s pay is very reasonable. Together, the company’s four most highly compensated officers earned just over $524,000 in 2011. For an old, unlisted ¬†family firm, insiders own surprisingly little of the company, just 29.4% of shares outstanding. The company has around 1,500 beneficial owners, far more than most firms I examine. This diffuse ownership and lack of a single controlling shareholder may discourage management from using the company as a piggy bank, as so often happens in these situations. To their credit, the McLains seem committed to good corporate governance, even posting corporate governance plans on the company website.

Investors wishing to purchase the company’s stock must be patient. The stock trades with a very wide spread, and often weeks go by with no transactions whatsoever. Still, I think Reserve Petroleum is a reasonably priced operator with attractive assets and competent management.


No position.



Empire Resources Announces 1 Million Share Tender Offer

Empire Resources has been a disappointment since I wrote about the company back in late March. Despite posting solid earnings since, the company’s total return has trailed the market. At a bid/ask midpoint of $2.80, the company trades at just 70.6% of fully diluted book value and a trailing P/E ratio of 6.2.

Today the company announced a tender offer for 1 million shares at a price of $3.00. If the offer is fully subscribed, fully diluted book value per share will increase by 2.4% and the trailing P/E ratio will fall to 5.6.

More interestingly, the company would become majority insider-owned. As of the last available proxy statement, the Kahns and other insiders owned 4,375,000 shares outright. Insiders are also the beneficiary of 416,000 in-the-money options, and own $4 million of the company’s convertible subordinated debt, convertible into 876,200 common shares. If insiders converted and exercised all of their options and debt, they would own somewhere around 54% of basic share outstanding.

I continue to view Empire Resources as attractive at this valuation.

I own shares in the company and may add more soon.