OTC Adventures by Alluvial Capital

This post concerns an extremely illiquid and difficult-to-trade security. As always, I make no recommendation as to whether or not you should buy this security. If you do, please do so carefully.

Detroit Legal News is one of the old guard of OTC-traded “dark companies.” In DLN’s case, the “dark” part of the phrase is not particularly apt. The company provides quarterly reports with limited financials and full audited annual statements with footnotes, publishing them through OTCmarkets.com. Still, the company withdrew its SEC registration decades ago and has traded over-the-counter with limited volume ever since. The company was featured in the classic Walker’s manuals. Here is a picture of Detroit Legal’s entry in the 2002-2003 edition.

Detroit Legal News operates in possibly the most unattractive industry there is: newspapers. Fortunately for the company, its newspapers are niche publications created for the legal community of Michigan. The papers cover court proceedings and legal developments. Critically, the papers also publish legally required notices. These notices must be published in a paper such as those Detroit Legal News publishes. The rates the company can charge for these notices are dictated by the state government, but the fact that these notices must be published provides a recurring revenue stream for Detroit Legal News as its other revenue streams have come under heavy pressure. The company is well-aware that any any time, the legislature could change these publishing requirements, and has invested in software and online resources in case these legal notices go fully electronic.

Detroit Legal News owns 55% of its newspaper subsidiary, with another 35% held by Bridgetower Media. The member operating agreement of the newspaper subsidiary (Detroit Legal News Publishing, LLC) includes an intriguing “shootout” provision under which during the 60 days prior to each November 30, any member of the LLC can declare a value for the whole of Detroit Legal News Publishing, LLC. Then, the other LLC members have the option either to buy that member’s interest at the declared valuation, or sell their own interests to the declaring member at the same valuation. So far, no LLC member has exercised this right.

Detroit Legal News is consistently profitable, though profits have declined in tandem with printing revenues. Recently, the company sold off a parking lot it owned several decades for a tidy profit. I don’t expect many more surprises of that magnitude, but I do expect that Detroit Legal’s core operations will continue producing modest profits for many years to come. In 2019, the company earned $540,000, though this figure includes an impairment charge of $191,000 for a software project that has been slow to achieve momentum. Ignoring this impairment and adjusting for minority interest, the company would have earned about $700,000, or $18.50 per share. Revenue for the year was $14.95 million, down substantially from 2018 and down 30% from 2014 levels. Revenue will probably continue to decline at a high single digits rate annually, though a difficult economy is actually beneficial to Detroit Legal as the volume of foreclosure notices and the like rises.

At a share price of $320 and with revenues highly likely to continue rolling off, a price-to-earnings ratio of ~17x is certainly not compelling. However, Detroit Legal’s balance sheet is stuffed with cash and other valuable assets. Adjusted for the dividend paid in January, Detroit Legal News has cash per share of $242. Net current assets per share is ~$281 (ignoring operating lease effects and assuming all non-cash current assets and current liabilities reside at Detroit Legal News Publishing, LLC.) The company’s strong balance sheet offers quite a bit of downside protection. Historically, the company has always maintained a strong cash position while paying out essentially all earnings as dividends.

In my view, shares of Detroit Legal News Company are worth somewhere around $400 per share. Not a stock to own for its incredible return potential, but a lower-risk holding that is backed by an extraordinary balance sheet and a counter-cyclical business model. Or maybe the idea of owning one of the market’s oddities has some appeal. Regardless, Detroit Legal News is quite alone in its niche and fun to watch as it quietly profits year after year.

Alluvial Capital Management, LLC holds shares of Detroit Legal News Co. 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.

Guess who’s back again with another super illiquid, ridiculously high-priced bank stock? Oh, did you think I had run out of them? Naw. Never gonna happen.

Alpine Banks of Colorado is the holding company for Alpine Bank, a $3.9 billion institution founded in 1973. The bank has 40 branches sprawling across the Centennial State from Durango in the southwest to the Denver metro area. Alpine is now the ninth largest bank in Colorado by market share and occupies the number one position in many of its localities. Alpine’s employees are large shareholders of its Class A voting stock. The company recently took steps to allow its non-voting Class B stock to trade over-the-counter.

I’ve had a lot of success in accumulating shares of banks that are newly tradable. Typically, trading volume is very low for some time and the valuation is extremely attractive. (Early sellers are often highly motivated, sometimes having waited years to achieve liquidity.) Eventually, the bank’s results begin to show up in databases and newsfeeds and another cohort of investors begins to buy in. Once the early supply of shares is exhausted, it’s off to the races.

Favorable new listing and liquidity setup aside, I think Alpine Banks is a particularly attractive firm. The bank’s geography is stellar. Colorado is in the midst of a decades-long population boom which makes attracting deposits and making loans all the easier.

Alpine also enjoys an extremely low-cost deposit base thanks to its focus on business and commercial customers. In the quarter ended December 31, 2019, Alpine’s cost of funding was only 11 basis points.

On the lending side, Alpine has a large commercial real estate operation in addition to its more traditional lending activities. The bank is also looking to expand into the commercial & industrial market. Alpine’s asset quality has exceeded its peers since 2015. As of September 30, 2019, Alpine’s balance sheet was in stellar condition with non-performing assets to total assets of only 0.16%.

Alpine also has a wealth management division with rapidly increasing assets under management. The bank’s has improved its operating efficiency in recent years and the efficiency ratio has reached the low 60s, an impressive figure for a bank with a far-flung branch network.

The bank’s strong net interest margin and good efficiency have allowed Alpine to operate very profitably. For the year just ended, the bank produced a return on assets of 1.54% and a return on equity of 18.2%.

Alpine is strongly capitalized, with a Tier 1 capital ratio of 13.1% and a common equity ratio of 10.8%. Given Alpine’s focus on slightly riskier loans, it makes sense for the bank to run a fairly conservative capital structure. Alpine’s loan book has performed quite well, but it makes sense to prepare for any storms ahead.

At the last trading price of $4,950 (not a typo) Alpine trades for 8.9x earnings and a price/tangible book value ratio of 1.65. Alpine’s good geography, stellar deposit base, strong loan book, efficient operations and strong growth outlook make it a bank worth examining.

For those wanting to investigate, Alpine is very communicative and publishes shareholder letters and quarterly presentations. Have fun!

Alluvial Capital Management, LLC holds shares of Alpine Banks of Colorado 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.

The Société Fermière du Casino Municipal de Cannes (or henceforth, SFdCM) is quite possibly the world’s cheapest luxury company. The group owns three world-class hotels, two on the French Riviera at Cannes and the other in St. Bart’s. SFdCM also operates two Cannes casinos and several restaurants.

It is difficult to overstate the quality and reputation of these properties, particularly the Hôtel Majestic.

Hôtel Barrière Le Majestic

Built in 1926, the Majestic is a five-star Art Deco masterpiece. The hotel is popular with film festival attendees. The hotel offers a private beach, several restaurants and nearly every imaginable amenity. Presently, the Majestic has 257 rooms and 92 suites.

Hôtel Barrière Le Gray d’Albion

Le Gray d’Albion is a four-star property located next door to the Majestic. This 200 room property employs more modern design, but nearly the same luxuries.

Hôtel Barrière Le Carl Gustaf Saint-Barth

Finally, SFdCM owns a hotel in a favorite Caribbean destination for well-heeled travelers, St. Barts. Le Carl Gustaf is a boutique with 23 rooms and suites. The hotel was built in 1991 and acquired by SFdCM a few years back. After a top-to-bottom renovation and a hurricane-related delay, the hotel is now open for business. The property’s chef formerly ran an establishment with 3 Michelin stars. Fancy! The company put out a glossy press kit in preparation for Le Carl Gustaf’s grand re-opening.

The Casino Barrière Croisette and the Casino Barrière Les Princes

These casinos offer 340 slot machines and 38 gaming tables, plus dining and entertainment. The properties are just half a mile apart and within easy walking distance of the Majestic and Le Gray d’Albion. SFdCM operates the casinos under long-term concessions from Cannes.

Valuation

In 2018, SFdCM brought in revenue of €145.9 million and earned operating profit of €25.9 million. After taxes and minority interests, profit was €21.1. As I type, the company has a market capitalization of €296.1 million. The company has essentially zero debt and net cash of €35.8 million for an enterprise value of €260.3 million. That works out to a very undemanding multiple of 10.1x operating income and a P/E of 12.3, net of excess cash.

And yet, I believe these financial ratios do a poor job of capturing the value of SFdCM’s unique assets. I think a lot of value investors get caught up in the dollars (or euros) and cents and fail to recognize the enormous public relations benefits and cachet that owning a trophy asset like an historic, high-end hotel brings. For the most part, nobody buys these trophy assets hoping for a financial bonanza. Yes, they hope to at least recoup their investment over time, but the most significant benefits to ownership do not show up on the profit-and-loss report. The signaling involved is far more important than the financial details. China’s Anbang Insurance did not buy the Waldorf-Astoria for a whopping $1.4 million per key because it was the best deal around, they did it to assert their claim to membership in the world’s largest and most prestigious financial companies. A consortium of Japanese corporations were playing the same angle when they bought the Pebble Beach Company in 1990. (Interestingly, these transactions marked a peak for the acquirers with each falling upon difficulties not long after.) LVMH’s 2018 buyout of Belmond also springs to mind. In this case, the world’s premiere luxury brand burnished its existing suite of products and services by adding Belmond’s extraordinary hotels and travel offerings.

I think a superior means of valuing SFdCM is by looking at each asset. The Hôtel Majestic is the crown jewel. The Majestic by itself could fetch €1 million per key. Jaw-dropping? Maybe, but we are talking about an architectural icon in one of the world’s most sought-after locations. That would value the hotel at €349 million. Le Gray d’Albion is smaller and less prestigious, but it benefits strongly from its proximity and association with the Majestic, not to mention its access to the Majestic’s private beach. Valuing Le Gray d’Albion at €600,000 per key for a total €120 million is not out of the question. That yields a value of €469 million for the Cannes properties.

It’s more difficult to place a value on Le Carl Gustaf. The hotel opened only recently and doesn’t have an operating history or a decades-long reputation for excellence. On the other hand, it does enjoy an incredible location and no expense was spared in its renovation or staffing. Being conservative we can value the hotel at the cost of its renovation, €19 million. That yields a value of €488 million for SFdCM’s trio of hotels.

The company’s casinos are difficult to value apart from the associated Cannes hotels. Neither casino produces a consistent profit, but they do have significant strategic value as a conduit funneling guests to the Majestic and Le Gray d’Albion. Gambling appears to be in long-term decline in the region as more gamblers opt for internet competitors. For these reasons, I don’t think the casinos have much independent value and I won’t provide them with such in my estimates.

Including net cash, I estimate SFdCM’s value to be at least €523 million, or €2,990 per share. Just as a reality check, that works out to €853,000 per key. Again, high! But SFdCM’s assets are singularly attractive. And it’s not as if this valuation is indefensible on an earnings basis, either. 23x trailing earnings is a very fair value for the company’s trailing income stream, especially because Le Carl Gustaf will begin contributing to results in 2020. Let’s hope for fine weather in the Caribbean!

So, Why Is It Cheap?

If the company’s assets are really so irreplaceable and prestigious, then why do shares trade at a 43% discount to my estimate of fair value? The answer, like many of the companies profiled on this blog, is illiquidity and obscurity. Despite its €296.1 million market capitalization, the value of free-floating shares is less than €20 million. The Desseigne-Barrière family owns 60% of shares, Fimalac Développement holds another 10%, and a Qatari investor, Casinvest, holds 23%. The remaining shares trade sporadically on the Euronext. I doubt the vast majority of investors even realize the company is public. SFdCM is very much a family-controlled enterprise. Major shareholder affiliate Groupe Lucien Barrière essentially acts as external manager for SFdCM, handling operations and advertising the Majestic, Le Carl Gustaf, and Le Gray d’Albion alongside the many other fine Barrière hotels in France and elsewhere. As always, investors must maintain skepticism when it comes to family-controlled companies. Many do not respect the rights of minority investors or deal fairly with the company. In SFdCM’s case, these risks are reduced by the presence of extremely deep-pocketed Fimalac Développement and Casinvest.

I don’t think investors in SFdCM should expect its ownership structure to change dramatically in the short term. I do think it’s highly likely that the majority owners eventually make an offer to minority holders to take the company private. Why deal with the hassle of a public listing when there is minimal trading activity and a depressed valuation? The Desseigne-Barrières, Fimalac, and Casinvest certainly don’t care about the price at which a few dozen shares changed hands, nor does the company need access to public equity markets in order to raise capital. If an offer does materialize, shareholders should not expect to receive full value for their shares. But at a discount of this magnitude, I think shareholders will do rather well regardless of whether or not an offer materializes.

Alluvial Capital Management, LLC holds shares of Société Fermière du Casino Municipal de Cannes 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.

Today’s company is bait for a certain type of value investor. By that I mean the investor who loves boring, low-profile companies in stodgy but essential industries. Bonus points if the company is located somewhere deeply unfashionable and has a fantastic logo that was clearly designed in the early or middle 20th century.

OK….this is me. The investor I am talking about is me. The company I am talking about is Monarch Cement.

Value investors have long touted the virtues of cement producers. They exhibit a number of characteristics that may enable them to earn out-sized returns. Cement itself is low-value, but heavy and bulky, making shipping it beyond a certain distance from the plant uneconomical. This limits competition and ensures a captive market for the local producer(s). Cement producers also make bad neighbors. There is dust, noise, and frequent heavy truck traffic, so securing approval to build a new facility can be a difficult proposition. The cement industry is certainly not “low-tech” but advancements do tend to happen slowly, limiting the need for expensive R&D to maintain competitiveness. While there have been innovations, the cement being mixed to form the floor of a modern warehouse is fundamentally the same as that used to build the roof of the Roman Pantheon.

On the other hand, cement producers are capital intensive and experience deep cyclicality. Producers must invest in expensive and specialized equipment. Unable to ship their product over great distances, producers are exposed to the strength of the local economy surrounding their plants. It is not as if cement can be shipped from Kansas to Florida or Maine if the Kansas economy is in the doldrums.

Monarch Cement is a Kansas-based producer of Portland and masonry cements. The company has operated for 110 years and has facilities in Kansas, Iowa, Missouri, and Arkansas. The Wulf family has lead the company nearly since its founding. Walter H. Wulf passed in 2001 at the age of 101, having worked at Monarch for over 80 years. Today, Walter H. Wulf, Jr. serves as CEO and chairman of the board. Monarch Cement deregistered its stock in 2014, but continues to provide quarterly and annual statements. The Wulf family controls the company via super-voting Class B shares, but ordinary capital stock trades over-the-counter in small volumes.

Times have been good for Monarch. A look at the company’s results shows consistent profitability and healthy free cash flow generation. Monarch maintains a large investment portfolio which causes reported net income to fluctuate dramatically, but the underlying operations have been profitable each of the last several years. Monarch has built a substantial net cash and securities position, paying off nearly all debt and paring its pension and retirement obligation to a very, very manageable figure.

Monarch is behaving exactly as a cyclical business should, building its cash position and paying down debt when times are flush, all the while maintaining its capital assets and making strategic investments. Monarch is extremely well-situated for the downturn in the cement industry, whenever that may arrive. And when those bad times arrive, just how bad are they? As it turns out, not terrible! Monarch maintained profitability throughout the financial crisis. It helps that Monarch’s geography never really felt the effects of the housing bubble. If Monarch’s plants were located in Florida and Arizona, the company would likely have had a much more difficult time.

Monarch Cement trades at a fraction of the valuation its larger peers receive. Some discount is warranted. After all, a small, regional producer faces risks and inefficiencies that cement giants with global footprints can avoid. But while behemoths CRH Plc and LafargeHolcim trade at >10x EBITDA, Monarch Cement trades right around 4.4x. I doubt the valuation gap will narrow organically. Monarch Cement is simply too small and its shares too illiquid to attract much attention. A much more likely outcome is an eventual buyout. I am always skeptical of a thesis that depends on a family-controlled company deciding to turn over the keys, but it does happen. Just last year another family-controlled cement producer, Ash Grove, sold out to CRH at a low teens multiple of trailing EBITDA. Ash Grove was substantially larger than Monarch, but valuing Monarch at even 9x trailing EBITDA would value shares at north of $105.

As with any company like Monarch, shareholders must be prepared to wait a long, long time for an eventual catalyst. That necessitates trustworthy, capable management that will cause the company’s value to increase at a reasonable rate until that liquidity event. I think Monarch fits the bill. Management is reasonably compensated and highly motivated to steward the company well. Balance sheet strength is a priority, but the company is not afraid to make small acquisitions to round out its product offerings or access new territory. A bigger question mark is how the company will handle its large securities portfolio, which is invested primarily in shares of other cement and building products companies. This portfolio has performed exceptionally well this year, leading me to wonder if the company will choose to realize some gains as it did in 2018. The value of the securities portfolio has risen to $12 per share before tax, or 20% of market capitalization. Despite the uncertainty, I don’t view the outlook for the securities portfolio as a major concern when the company’s operations are being valued at a 60% discount to competitors and are extremely cheap on an absolute basis.

Alluvial Capital Management, LLC holds shares of Monarch Cement 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.

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.

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.

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.

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.

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!

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.

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.