Tower Properties: GAAP Accounting Hides True Asset Value – TPRP

The ranks of unlisted stocks include several real estate companies. I’ve been reviewing these with interest, on the thesis that the combination of low visibility and the difficult accounting of real estate firms often results in unjustifiably low valuations. Sure enough, it often does.

Tower Properties Company owns a collection of office and apartment real estate in the Kansas City and St. Louis areas. Though it is a real estate company, Tower is not a REIT; its earnings are subject to ordinary corporate taxes. Tower was orginally spun off from Commerce Bank in 1990, and the company maintains a close relationship with the bank.

Tower Properties deregistered its stock in 2006, undertaking a 1 for 50 reverse and forward split in order to reduce its number of shareholders to fewer than 300. The company underwent another split in 2008, with shareholders receiving 1 new share for every 30 shares held. Due to the latest split, Tower Properties is one of the highest priced issues on the market. Shares are currently bid at $7,600 and offered at $9,700 each. Only 4,842 shares remain outstanding. At the share price mid-point of $8,650, Tower has a market capitalization of $41.88 million. The company does not pay regular dividends, but did pay a massive $2,065 per share special dividend in early 2012.

Tower owns 1,936 apartment units in eight different suburban complexes. All of these complexes appear to be fairly modern, mid-market communities. At year-end, these units were 95% leased. In its annual report, Tower lists the condition of each of these complexes, with most being in “good” or “excellent” condition. 539 units across two complexes are listed as “average” condition.

The company owns nearly 1 million square feet of office and warehouse space divided among a dozen properties. At year-end, these properties were 96% leased. All of these properties are located in urban or suburban Kansas City or St. Louis.

Tower Properties also holds other significant assets, including 35 acres of undeveloped land adjacent to one of its existing apartment complexes, and 212,060 shares of Commerce Bancshares, worth about $9.65 million. Besides its owned property, Tower also has property and/or construction management contracts in place at five office buildings and one hotel in the Kansas City and Wichita areas.

As of December 31, Tower’s property-level debt had an average interest rate of 5.31% and an average final maturity of 6.63 years, not counting scheduled monthly amortization. At March 31, Tower had only $750,000 in debt at the corporate level.

Perhaps the simplest method of estimating Tower’s value is to determine a conservative net asset value by summing up the company’s properties and other assets and subtracting its debt.

As of March 31, Tower listed net commercial properties of $158.69 million. Adding the $9.65 million in bank stock and subtracting the $127.12 million in total debt yields net asset value of $41.22, or $8,513 per share. Huh. That’s almost exactly Tower’s current market value. This simplistic analysis omits other sources of value like the undeveloped land and the value of property and construction management contracts, but it captures the great majority of Tower’s economic value, at least from an accounting perspective.

In reality, however, Tower’s properties are worth significantly more. In the notes to its 2012 annual report, the company reveals its real estate properties have a cost basis of $188.65 million. This figure is the properties alone and does not include leasehold improvements or furniture and equipment. The accumulated depreciation charged against these properties was $45.47 million as of December 31,2012.

depreciation

At December 31, the book value of Tower’s real estate was 24.1% lower than its cost basis. While consistent with GAAP, this result is non-sensical, since properly-maintained real estate holds its value and frequently increases in value. Would any rational management team allow its real estate investment to deteriorate in value by nearly 1/4th? The economic value of Tower’s real estate almost certainly exceeds its book value by a large margin.

When it comes to real estate, the GAAP treatment of depreciation frequently creates absurd results. GAAP guidelines allow Tower to depreciate its office real estate over 39 years, yet a well-built office building has a lifespan many decades longer. For example, the building across the street from my office was built over 100 years ago. If the same company had owned the building since its construction, the building would long ago have been depreciated to a value of $0 on that’s company’s balance sheet. Yet, the building is worth tens of millions (many times its original cost) and will continue to produce cash flow for many, many decades to come.

In most cases, investors can safely assume that a company’s real estate is worth at least its original cost, and probably more. Inflation increases rents and construction costs, lifting the values of existing structures. Population growth has the same effect.

Assuming Tower Properties’ real estate is worth its cost, net asset value looks radically different.

adj nav

Using cost basis rather than book value nearly doubles net asset value to $15,910 per share. This figure ignores any potential appreciation since purchase, as well as Tower’s other assets like undeveloped land and management contracts.

Concluding that Tower’s value is nearly twice its trading price is a lofty claim, but it is backed up by the company’s free cash flow. Tower’s net income for the most recent quarter was only $108,003, but normalized free cash flow was much greater. Depreciation for the quarter was $2.50 million, yielding funds from operations of $2.61 million, or $10.43 annualized.

Determining normalized capital expenditures is more difficult. Because they tend to vary, capital expenditures are best averaged over multiple years. Over the past three years, Tower’s capital expenditures as a percentage of average undepreciated real estate, leasehold improvements, equipment and furniture were 1.49%, 2.29% and 2.08% for an average of 1.95%. On today’s approximately $230 million in undepreciated assets, that works out to $4.50 million in annual capital expenditures.

free cash

Though Tower’s net income is very low, normalized free cash flow is extremely strong and represents a free cash flow yield of 14.2% at the current stock price.

Exactly what yield a real estate company should trade at is a matter of debate, but a double digit yieldon an appreciating asset is hard to justify. If Tower were to trade at its adjusted NAV of $15,910, it’s free cash flow yield would be 7.7%. Maybe that’s too low for such an illiquid investment, but even a 10% free cash flow yield would result in a share price of $12,250, 41.6% higher than today’s mid-point.

It should be noted that Tower’s free cash flow yield is an after-tax figure, so comparisons with REITs are not apples to apples. Converting to a REIT structure would likely bring appreciation, as REITS tend to trade at a lower yield than real estate C corporations. I don’t view a conversion as likely, but a conversion combined with a stock split and dividend initiation would likely send Tower’s stock higher.

No position.

 

 

 

Logistec Delivers Profits, Decade After Decade – LGT-A, LGT-B

A note: I have decided to expand this blog’s focus to include listed microcap and/or illiquid securities. The unlisted world is and will remain my bread and butter, but I am simply finding more opportunities for profit outside that world than I can ignore.

Logistec is one of those opportunities.

Logistec provides stevedoring and cargo management services. Simply put, Logistec manages the loading and unloading of ships that come to harbor, as well as cargo storage and warehousing. Logistec also has operations in environmental remediation through its subsidiary Sanexen Environmental Services and manufactures woven hoses. Logistec has been in operation since 1952, when it was founded as Quebec Terminals by Roger Paquin.

Logistec operates in 24 ports in Eastern Canada and the eastern coast of the US. Half of these ports are located on the Great Lakes or along the St. Lawrence Seaway. The Great Lakes and the St. Lawrence Seaway are Canada’s connection from its economic centers in Ontario and Quebec to the Atlantic Ocean and foreign trading partners. Ports along these bodies of water allow for goods and commodities from Canada’s interior to be shipped around the world.

ports

Ports and ports operations are great businesses. The world supply of ports is limited due to geography, so ports and associated companies enjoy high barriers to entry and associated pricing power. World trade tends to increase over time, providing a natural revenue growth tailwind.

Logistec is a classic “toll-taking” company that profits on trade volume, irrespective of shipping rates or commodities prices. Logistec is capable of handling all kinds of commodities, including metals, agricultural products and forest products. Logistec enjoys long-term leases at the ports where it operates, ensuring the profits will flow for years to come.

And how the profits have flowed. Logistec’s record of growth and profitability is nothing short of incredible. Logistec has never lost money in its existence as a public company. Beginning in 1969, Logistec has reported 43 consecutive years of profits. The company has paid a dividend in every one of these years. Top-line growth has been impressive as well. From 1969 to 2012, Logistec grew revenues from $5.94 million CAD to $250.86 million CAD, a compound annual growth rate of 9.1%. The company achieved all of this using minimal leverage. To help visualize this achievement, the company provides this graphic on its website.

revenue-since-1969-en

Revenues sank when world trade volumes dipped during the recession, but have now rebounded. A healthier world economy combined with a few smart acquisitions has allowed Logistec to post record revenues and profits figures.

results

For the first quarter of 2013, Logistec reported an impressive revenue increase of 44.0% year-over-year in its marine services division. This increase is largely due to the company’s mid-2012  acquisition of CrossGlobe Transport, Ltd. CrossGlobe operates in three terminals at the Port of Virginia, handling forest products, auto parts and other cargoes. Logistec’s business is slowest when the St. Lawrence Seaway is closed during the cold Canadian winter months, so the addition of another southern port to the company’s operations resulted in a large increase in first quarter revenues and earnings.

While marine services account for the majority of Logistec’s operations, the company’s Sanexen Environmental Services subsidiary is another important profit center. Sanexen provides environmental remediation at industrial and disaster sites (the company is working at the site of the recent Burlington, Ontario train crash) and also does environmental studies. Interestingly, the company has developed a technology known as Aqua-Pipe, which can be used to rehabilitate aging underground water lines. The advanced ages of many municipal water distribution systems could result in increasing demand for pipe rehabilitation.Sanexen’s 2012 revenues rose 14% from 2011, eclipsing $100 million for the first time. Logistec holds a 69.7% interest in Sanexen, with Sanexen’s management holding the remainer.

Logistec maintains a strong balance sheet. Net debt is only $12.18 million CAD, 0.33 times EBITDA. Total debt is $20.12 million CAD, 15.68% of owners’ equity. The company maintains multiple pension plans, but each of these is fully-funded, even at the 2012 discount rate of 3.8%.

For the twelve trailing months, Logistec earned $19.21 million CAD, or $2.97 CAD per share. The company has two classes of shares outstanding. A shares are entitled to 30 votes per share. B shares are entitled to just one vote per share, but receive 110% of the dividends paid on A shares. (If A shares receive $1.00 in dividends, B shares receive $1.10.) B shares currently trade at a precise 10% premium to A shares, though they have historically traded at a slight discount.

A shares currently trade at $28.51 CAD and B shares trade at $31.39. Based on the number of shares of each class outstanding, Logistec has a market capitalization of $192.19 million CAD. Adding net debt gives a total enterprise value of $204.37 million CAD.

On the whole, Logistec trades at 10.01 times trailing earnings. A shares trade at 9.60x, while B shares trade at a 10.57x. The entire capital structure goes for an extremely reasonable 5.57 times EBITDA.

valuation

10x earnings or 5.5x EBITDA is a compelling valuation for a company with Logistec’s competitive advantages and enormously successful track record. Keep in mind that Logistec’s trailing figures include less than a half-year of CrossGlobe’s results. Included, these would push down the multiples a bit more.

The market does not offer many opportunities to purchase businesses of such quality at these multiples. For as long as people across the world demand goods and services, ships will ferry commodities across the oceans. And for every ship that enters the harbor, someone will have to load and unload it, coordinating the process and ensuring efficiency.

One reason for Logistec’s low valuation is its illiquidity and obscurity. Despite its 61 years in operation and exceptional returns to shareholders, the company remains tiny, with a market cap under $200 million. And its shares are illiquid. Logistec is controlled by Sumanic Investments, which is in turn held in equal parts by three daughters of the company’s founder, Roger Paquin. One of these daughters, Madeline Paquin, serves as President and CEO of Logistec. Over the last three months, each classes of shares has gone days without trading, and the highest volume day for either share class saw only 1,900 shares change hands.

Logistec pays a small dividend, with occasional larger special dividends. Shares (both classes) currently yield 1.3%. The company engages in small share repurchase programs, reducing shares outstanding by 1.8% since 2010.

Risks to Logistec’s success include major shifts in global trade patterns, or a great leap in port technology that Logistec cannot afford to adopt. A prolonged global recession would sharply reduce earnings in the short run. Foreign investors must also consider currency risk. The Canadian Dollar has lost ground lately as commodities tumble.

I own shares in Logistec.

A War of Words at Calloway’s Nursery – CLWY

Last December I wrote about Calloway’s Nursery, a tiny chain of nurseries operating in Texas. Calloway’s was profitable, but also highly indebted. My post focused mainly on the company’s earnings power, but some other bloggers chose to focus on the company’s substantial real estate holdings, concluding they were worth far in excess of the company’s enterprise value. Jeff Moore has posted a Google document with full details on his blog.

At that time, Calloway’s traded at $0.73 per share. Shares have since doubled, driven by the news that 19.9% shareholder 3k Limited Partnership (Peter Kamin’s vehicle) will attempt to replace the board of directors. Since that announcement, Calloway’s management and 3K LP have sent letter after letter to shareholders, urging them to support each side’s respective slate of directors.

I have read each letter with increasing amusement. Management’s letters have grown increasingly desperate, seeking to paint Mr. Kamin as a mustache-twirling villainous caricature, a corporate raider who seeks only the destruction of shareholders’ precious company. The letters are filled with dramatic statements, exclamation points and bold-faced type, warning of dire consequences should 3K succeed in electing its directors.

Letters from 3K, on the other hand, are factual and calmly-stated, continually pointing to management’s abysmal track record and sneaky habit of issuing shares to insiders on the cheap.

3K has used its letters to describe some astoundingly poor acquisitions that management has pursued, resultingly in millions of dollars of shareholder money lost. In its most recentl letter, 3K compared growth in book value since 1991 for the S&P 500 Index, versus Calloway’s performance. From 1991 to 2012, the book value of the S&P 500 Index rose 319.9%, from $158.85 to $667.00. Calloway’s on the other hand, somehow succeeded in reducing book value per share from $1.57 to $0.84. That’s right. In 21 years, Calloway’s management generated not a cent of book value growth for the company’s shareholders. Instead, they destroyed 46.5% of shareholder wealth! That is bad, shockingly bad.

3K goes on to point out that even after the recent run-up, Calloway’s shares are down 85% from their IPO price.

Good corporate governance practices call for a majority of a company’s board members to be independent. 3K points out that three of Calloway’s’ five board members are company insiders, resulting in a board that is incentivized to put management’s interests first.

3K also calls attention to Calloway’s’ repeated stock sales to insiders at discounted prices. Per 3K, Calloway’s has issued nearly 20% of shares outstanding to insiders in the last four years alone!

3K describes repeated attempts to work with management in a friendly manner and to attain board representation. 3K was rebuffed at every juncture by Calloway’s’ CEO and chairman, James Estill. In fact, Mr. Estill went even farther, filing suit against 3K and seeking to shut down efforts to call a shareholder meeting.

In its responses, Calloway’s’ management makes no attempt to explain away its awful track record. Instead, management emphasizes recently improved results and the growth in book value per share since 2009. To an extent, management has a point. Book value per share grew at a rate of 11.3% annually from 2005 to 2012. Not exceptional, but acceptable. The company has also made progress in reducing its debt, which now stands at the lowest since 2007. But this recent improvement should come as cold comfort to longsuffering investors who have seen their investment dwindle and dwindle over the years, even as management has enjoyed fat salaries and shares on the cheap.

Calloway’s’ management also claims that the 3K’s slate of directors lacks any experience in the retail sector, but 3K carefully rebuts this assertion in its most recent letter. In fact, 3K’s nominees have extensive experience in both turning around and growing retail operations, having been involved with Tile Shop Holdings and Insurance Auto Auctions, both of which provided excellent returns to insiders and outside investors alike.

Investors are left with a choice: more of the same from current Calloway’s management, or a revamped board of directors and strategy from 3K and Peter Kamin. Despite management’s loud protests and promises of shareholder riches to come, investors should examine their long-term record and find it lacking.

It’s too late in the game for Calloway’s’ management to trumpet a solid strategic plan and pretend that shareholder value is important. Investors should vote out Calloway’s management and allow 3K to streamline the company’s operations and produce real value for shareholders, of which 3K is the largest.

No current position in Calloway’s. (Sold my shares into the run-up when the proxy contest got heated.) May repurchase.

 

 

 

What Do You Do With A Cashbox Company?

A company’s worth consists of the value of its operations, plus the value of any non-operating assets, such as excess cash or unused real estate. Most public companies do not hold significant excess assets. Ranks of activist investors stand ready to force companies to invest excess capital productively or else return it to shareholders.

But what about the exceptions? I know of several unlisted companies that hold cash and securities worth much more than their actual operations. How should these companies be valued by investors? The answer depends on who’s asking.

The value of a company’s excess assets is highest to an acquirer. When the acquisition closes, the acquirer gains complete control over the excess assets and is free to use them in any way. For an acquirer, excess assets are effectively a dollar-for-dollar discount to the acquisition price.

For everyone else, the story changes. Owning a minority stake in a company does not entitle one to determine the use of excess assets or otherwise exercise control. Investors must accept the risk that excess assets will either languish on the balance sheet for years to come or even be squandered on ill-conceived projects or acquisitions.

Because a minority investor has no control over the disposition of excess assets, the value of these assets should be discounted. Yet, so many investors do not. I routinely see investors making statements like this:

“I think Company Z is worth 10x its operating income of $15 million, or $150 million. Plus its excess cash of $20 million for a total value of $170 million.”

Well sure, if that $20 million is available to you. But try calling up the CEO and asking for your proportional share. You won’t get far. So how is an investor to treat excess assets? I argue for a “behavioral” approach, based on how a company has historically treated the excess capital it generates. Let me use an example.

OPT Sciences Corp. manufactures anti-glare and other specialized glass products used to cover instrument panels in aircraft. The company’s products are used in the Boeing 777 and 737, as well as Gulfstream and Dassault jets. OPT Sciences has fashioned a very nice business in this niche. EBITDA margins have averaged 18.2% over the last five years, and net income and free cash flow have been positive in every year since 2003.

For the twelve trailing months ended April 27, 2013, OPT Sciences recorded $1.25 million in operating income, or $1.61 per share. Weighing its consistent record against its limited growth prospects, an investor might assign a value to OPT Sciences’ operations of 6-8x operating profit, or $9.66 to $12.88 per share.

Since this blog post is about valuing excess assets, it should be no surprise that OPT Sciences happens to be massively overcapitalized. At quarter’s end, the company held $10.62 million in cash and securities against zero debt. Even assuming the company requires cash balances of 10% of annual sales to operate, excess cash and securities amounts to $12.81 per share. The company’s share price mid-point is $16.13.

At this point, many investors would conclude OPT Sciences is worth $22.47-$25.69, based on the value of its operations and excess capital. And it may be, to an acquirer. But it is likely not to you, or to any other minority owner, because it may be many, many years before that excess capital is put to productive use.

OPT Sciences has little opportunity for growth investments, yet is unwilling to return excess capital to shareholders. The company has paid only one dividend in recent history, a measly $0.65 payment in December 2012. OPT Sciences is 66% owned by a trust that benefits the children of Arthur J. Kania, a businessman from Scranton, Pennsylvania. Because paying significant dividends would trigger tax consequences for the trust, it is unlikely that the company will make meaningful distributions in the near future. And because the trust owns 2/3 of shares outstanding, no outside investor can force the company to disgorge excess cash. Any would-be investor in OPT Sciences must be willing to purchase a large, unproductive heap of cash and securities alongside the attractive operating business.

Because the company’s excess assets are completely unavailable to investors and will likely remain so, the excess assets are not worth their market value. But they’re clearly still worth something. After all, the trust could be dissolved or the company could be sold or the company could change course and declare a series of special dividends. Determining the fair value of the company’s excess assets is a matter of estimating the likelihood and timing of these possible favorable outcomes. Below are some example scenarios, followed by the present value of the company’s excess capital under each, assuming a 12% discount rate.

Scenario 1 – Business as usual. Every five years the company pays a $1.00 special dividend, and is sold in 20 years for a price that includes the full value of its excess capital. In the meantime, the excess capital appreciates at 3.5% after-tax. Likelihood: 50%.

Scenario 2 – Mr. Kania (who is 81) passes in ten years and the company is sold for a price that includes the full value of its excess capital. In the meantime, the excess capital appreciates at 3.5% after-tax. Likelihood: 35%.

Scenario 3 – The company decides to distribute excess capital to shareholders in equal installments over five years, and continues as a going concern thereafter. Likelihood:  15%.

The present value of the firm’s excess capital is lowest under scenario one.

scen1

Because the full amount of the excess capital is not received for 20 years, its present value is only $3.36 per share. The longer a company fails to invest excess capital productively or distribute it to shareholders, the less valuable the excess capital is.

Scenario 2 is somewhat better.

scen2

Cutting the time it takes to receive full value for the company’s excess capital to 10 years nearly doubles the present value of the excess capital.

Scenario 3 is by far the best for shareholders.

scen3

Receiving all excess capital in equal installments over five years yields a present value of $10.23.

Recalling the various probabilities I assigned to each scenario, the probability-weighted present value of the company’s excess assets is $5.32. Adding this figure to the $9.66-$12.88 range of values I assigned to the company’s operations results in a total value of $14.98-$18.20, neatly bracketing the company’s actual trading price. (I swear I did not work backwards.) Clearly, investors are following some process by which they are heavily discounting the value of OPT Sciences’s excess assets.

The scenarios I used are completely arbitrary and are intended only to illustrate the process. A more complete set of scenarios might include one where the company is acquired within a short time, as well as one where the company squanders the excess assets completely.

No matter how exactly they choose to do it, the point is that minority investors should carefully consider how and when they are likely to benefit from a company’s excess assets. Company ownership structure matters, as does a company’s historical capital allocation policy and current management’s intentions.

What seems like a very under-valued company may not be.

The one significant exception is a scenario where a company is capable of managing non-operating assets to produce a return that exceeds its cost of capital. For example, imagine a wholly equity-financed company with a cost of capital of 9%. If the company has a portfolio of stocks and is capable of earning an after-tax return of 9% on them, that company is doing just fine by its shareholders. However, if the company can only earn 6% after tax, it is better off divesting the funds and sticking to its core operations. The second scenario is far more common, as most management teams lack the talent to manage both their core operations and an investment portfolio.

No position in OPT Sciences Corp.

 

 

 

 

 

 

Liberator Medical Holdings – LBMH

Liberator Medical Holdings is a fast-growing, profitable distributor of medical supplies, focused on managing chronic conditions. Liberator’s balance sheet is pristine and the company recently announced a dividend and buyback authorization.

Many who suffer from chronic conditions, are recovering from surgeries, or are simply feeling the effects of old age require disposable supplies like catheters, ostomy bags, or diabetes treatments. These products can be embarrassing to purchase, or require trips that are difficult for the ill or elderly. Liberator provides these products, as well as post-mastectomy clothing, offering convenient home delivery and works closely with Medicare, Medicaid and private insurance plans. Liberator Medical relies on TV advertising to reach its core market of seniors and the disabled.

Does this descripton of Liberator Medical Holdings reminds you of another company with a similar name and business model? Here’s a hint.

Libertymedical-WilfordBrimleyOnHisDiabetes469-124

Liberty Medical Supply, famous for its Wilford Brimley diabetes commercials, is Liberator Medical Holdings’ much larger competitor. Both companies were founded by the same man, Mark Libratore. Mr. Libratore founded Liberty Medical Supply in 1990 and sold it to PolyMedica in 1996.

Rather than rest on his laurels, Mr. Libratore decided to build a business all over again and founded Liberator Medical Holdings in 1999. The most significant difference is the focus of the two companies. While Liberty specializes in diabetes care, Liberator focuses on urological catheters. Since its founding, Liberator’s revenues and profits have grown at a prodigious rate. Revenues in 2007 were just $2.25 million, but revenues for the twelve months ended March 31, 2013 climbed to $65.76 million.

Liberator turned profitable in fiscal 2009 and hasn’t looked back.

results

Liberator’s margins slumped in 2011 and 2012, but are once again on the rise. Fiscal 2011 was affected by a large increase in advertising expense, which has since trailed off as a percentage of revenue. Recent results show the company in transition from ongoing cash consumption to cash generation.

So just how did Liberator go from practically zero to over $65 million in revenues in only five years? Part of Liberator’s success comes from increased healthcare spending in the US. While the growth rate has been slowing, spending on chronic conditions such has increased significantly over the past decades. An aging population will likely cause further increases. Liberator has also benefited from industry consolidation. The company cites HME News, a Home Medical Equipment industry publication, which explains that increased Medicare accreditation and bonding requirements introduced in 2009 have driven many small competitors out of the market.

But the biggest tailwind behind Liberator’s growth is a change in Medicare reimbursement policy introduced in 2008. Prior to April 2008, Medicare would pay for only four urological catheters per month. In April 2008, the allowable number of catheters was changed to two hundred. The change was made in response to pleas from health groups and physicians who emphasized the safety and infection risks created by requiring patients to use single-use catheters multiple times. Predictably, catheter sales took off, and catheters now make up the majority of Liberator’s revenues.

Liberator’s balance sheet is strong. At quarter’s end, the company held $7.04 million in cash against total debt of $2.50 million. The current ratio was 3.38, and liabilities made up 34.62% of total capital. The company’s strong finances allowed it to declare a 3 cent dividend (ex-date today) and a $1 million share buyback authorization.

At a share price of $1.40, Liberator trades at 17.64x trailing earnings. Of course, valuations based on trailing twelve month figures can be deceiving for high growth companies. Annualizing the most recent quarter’s results gives a trailing P/E of 12.89.

valuation

Liberator’s revenue growth from 2009 to 2012 averaged 34.3%. Growth for the most recent quarter vs. a year prior had slowed to 14.1%, but the company’s growth rate still warrants a premium valuation, not a discount to the broad market.

Multiple value hedge funds are invested in Liberator. Millenium Partners owns 16.03% and Kinderhook Partners owns 8.55%. CEO Mark Libratore owns 36.07% as of the 2012 annual report.

Investors in Liberator will benefit from a growing market for the company’s products and a CEO with a history of success in the medical products market, but risks remain. Liberators’s biggest vulnerability is its exposure to Medicare reimbursement rates. As the government giveth, the government taketh away. The reimbursement rates offered on Liberator’s products could be reduced at any time, which would instantly reduce Liberator’s gross margins. Liberator also experienced some accounting difficulties a while back, ultimately restating several quarterly reports. Liberator’s auditor is Crowe Horwath LLP. Liberator received a clean audit opinion from Crowe Horwath for its 2012 and 2011 financial statements.

Mr. Libratore is 62. He has run the company for fourteen years and may do so for many more, but ultimately he will retire and may wish to sell the company he built. I view the endgame for Liberator Medical Holdings as identical to that of Mr. Libratore’s previous venture: a sale to a larger medical distributor, perhaps even to Liberty Medical. I expect that transaction to occur at a very nice premium to today’s share price, with attractive dividends along the way.

I own shares in Liberator Medical Holdings.