Steel Partners Holdings, LP

Steel Partners Holdings, LP (“SPH”) offers a rare opportunity to invest in a leading activist investor’s portfolio at a significant discount to net asset value. There’s even a catalyst on the horizon.

Steel Partners Holdings is run by activist investor Warren Lichtenstein. According to the Financial Times, the partnership produced gross annual returns of 22% from its 1990 inception to 2007. SPH typically engaged in different forms of investor activism, pushing companies to improve operations or seek a sale and often taking a seat on company boards. Steel Partners also had a pioneering role in activist investing in Japan, with mixed success.

SPH ran into trouble in 2008, when the financial crisis caused the value of many of its holdings to drop precipitously. Facing huge requests for redemption, but believing many of its holdings to be too under-valued or illiquid to sell without doing harm to continuing investors, Steel Partners Holdings hit upon a novel solution: going public. Many investors objected to this plan and pressed for a full liquidation, but Lichtenstein prevailed in court. Steel Partners executed a reverse merger into WebFinancial, a tiny pink sheets-traded financial concern operating in Utah, and then distributed the newly-created units to investors in the Steel Partners partnership. The LP now trades under the ticker SPNHU on the pinks. Many objecting shareholders opted to receive cash and in-kind securities instead, so the total assets of the partnership are much smaller than in 2007, when the partnership had $1.2 billion in assets.

Since listing publicly, SPH has remained extremely active. The company succeeded in taking control of Adaptec, renaming it “Steel Excel” and seeking acquisition candidates for the shell. The company’s BNS Holding Corp. has expanded into the oil and gas equipment and services market in North Dakota, buying Sun Well Services. The company continues to hold active stakes in many other public companies, including GenCorp, Handy & Harman, SL Industries and others.

As of today, Steel Partners Holdings, LP units are changing hands for around $12.55. However, the partnership held net assets of $18.02 per unit as of January 31, 2012. The S&P 500 Index had a total return of 4.32% in February. If we assume conservatively that the partnership’s holdings advanced half as much,¬† current net asset value is somewhere around $18.41. The current trading price represents a discount of 31.8% from net asset value.

If Warren Lichtenstein can achieve returns close to the historical performance of Steel Partners Holdings, investors in SPH will experience magnificent returns. If not, investors can still benefit from a narrowing of the market value/net asset value gap over time plus the market return on the fund’s assets.

A narrowing of the large market value/net asset value gap is likely because on December 15, 2011, SPH filed a registration for its units to trade on a major exchange. An uplisting will provide a much greater level of attention and publicity for SPH, as well as enable a much greater cross-section of investors to buy in. Even the worst-performing closed-end funds rarely trade at a 30%+ discount to asset value, much less the investment vehicle of a successful activist manager. Once the market becomes aware of this huge discount, I expect it to evaporate quickly.

Here are a few links with some more information and history:

Steel Partners Holdings, LP website and financial statements

Steel Partners Holdings, LP registration statement

Financial Times story on conversion to publicly-traded entity

No position.

Alaska Power & Telephone

Alaska Power & Telephone Company (APTL) has been scratching out an existence in the Frozen North since 1957. The company’s business model is simple: generating electrical power and providing telecommunications services to many small communities on the Pacific coast of Southeast Alaska and the interior. The company is largely employee-owned and has deep ties with the communities it serves.

Though electric generation and telecom services are hardly growth business, APTL has been aggressive in driving change and improving service. APTL’s power generation assets are nearly all hydroelectric, a big change from just a decade ago. While the traditional wireline business is eroding, the company has added broadband services and is continually upgrading its network to add to the non-regulated broadband business.

In order to understand APTL’s structure and behavior in recent years, a quick history lesson is in order. In the years prior to 2001, APTL had been a frequent acquirer of small communications and energy companies in Alaska. These acquisitions were funded mainly by debt, eventually leading the company to be 78% liability-financed at the end of fiscal 2000. At that point, attractive acquisitions were nearly exhausted and the company’s large dividend put pressure on the company to find new and diversified revenue sources. Rather than exercising discipline by slowing growth, cutting the dividend and devoting cash flow to debt reduction, the company spent millions to purchase a firm with hydroelectric operating in South America and purchased a minority stake in Summit Alaska, a civil construction firm.

In nearly no time at all, Summit Alaska went bankrupt. This caused APTL to violate its debt covenants with its primary lender, sending APTL itself into Chapter 11. Amazingly, the company exited bankruptcy proceedings a short while later with the equity completely intact. APTL’s profitable electric and telecom subsidiaries were its saving grace. The company agreed to make periodic payments to its bankruptcy claimants from available cash flow until 2013. APTL recently paid off the last of these claims two years earlier than planned.

In the wake of the bankruptcy, the company undertook positive corporate governance changes, separating the CEO and chairman roles and installing a new board. Since then, the company has focused on streamlining operations and deleveraging, with an ultimate equity target of 40% of capital.

Here’s a look at Alaska Power & Telephone’s historical results:

Growth has been slow but steady at around 4.4% annually. Annual net income has roughly doubled in the last decade, but is hardly consistent. The harsh climate and unforgiving environment in which APTL operates makes maintenance expenses highly unpredictable. The company explains that the Alaskan economic environment has been poor which makes it all the more impressive that the company has managed to grow. Any turnaround could improve the company’s operating results.

Consistent profitability has resulted in an improving balance sheet:

Since bottoming in 2002 in the wake of bankruptcy, the company has more than doubled book value per share to $22.93 at quarter’s end, an annual growth rate of 9.1%. Unspectacular, to be sure, but it should be remembered that the company has been burdened by its unprofitable HydroWest subsidiary (South American hydroelectricity, now spun off to investors) and its broadband segment has only recently approached profitability after years of capital investment. The company has more than doubled the equity proportion of its capital and is well on the way to achieving its deleveraging goal.

One interesting balance sheet component to note is the company’s investment in its primary lender, CoBank. CoBank is a private, cooperative bank that is part of the Farm Credit system, created by the government to encourage lending to farms and rural infrastructure projects. CoBank’s earnings are distributed to its borrowers, based on their loan balances. In the past twelve months, APTL earned $529,000 in dividend income from CoBank. Part of this is paid in cash and part shows up as ownership in CoBank. I have no idea what would happen to this ownership in a sale or liquidation of APTL, but this income from CoBank is real and material to APTL’s earnings, providing a nice offset to interest paid on borrowings.

Another important consideration is APTL’s recent spin-off of HydroWest. Due to a disagreement with CoBank, APTL was forced to divest HydroWest. The company did so by distributing common stock to investors, while retaining HydroWest’s newly-created preferred stock. Frankly, the divestiture should have happened long earlier. HydroWest never produced a dime of operating profit for APTL, and offered no synergies at all. Its existence was a legacy from APTL’s ill-fated diversification efforts of a decade ago. APTL’s profits and and leverage will improve going forward in HydroWest’s absence.

APTL stock’s current bid/ask midpoint is $17.55.

With an earnings yield of 12.2%, even a modest earnings growth assumption of 2.2% (half of historical revenue growth) implies an annual return of 14.4%. APTL’s valuation is very low for a stable regulated utility/telecom company. The company’s gradual deleveraging is wise and will likely continue until the company reaches a stable capital structure. At that point, I expect the company will reinstate its dividend and trade more in line with peers. This process could take several years, but in the meantime I expect the company’s slow but steady growth to continue. The recent completion of the company’s Southeast Alaska Microwave Network (SAMN) broadband data project could provide a kick for telecom growth and profits as well.

At the current valuation, I think Alaska Power & Telephone represents a low-risk opportunity with above-average return potential.

No position.

 

 

Webco Industries

And now we go back to steel.

Webco Industries manufactures and distributes carbon steel, stainless steel and other tubular steel products. The company is based in Oklahoma and was founded in 1959.

Quote: WEBC.PK

Website

Webco Industries is, in many ways, your typical pink sheets manufacturer. The company has a long, profitable operating history and lots of tangible assets to back up the share price.

At present, the company trades (infrequently) at a sharp discount to book value and at severely depressed multiples compared to competitors.

Webco’s track record of growing sales and profits is solid. Since 2002, revenues have grown at 13.2% annually. Even in the worst 0f the economic crisis, the company remained EBITDA positive. Revenues for the twelve trailing months sit at an all-time high for the company. Still, the economics of the steel industry are not stellar. The manufacturing process is capital-intensive and foreign competition is a real threat. Even in strong years, Webco has struggled to achieve NOPAT/Invested Capital of much over 10%.

Webco has increased book value significantly through the last decade. The company does employ a significant amount of debt, but not materially more than its competitors.

 

With a P/E of 3.63 and an EV/EBITDA of 4.00, Webco looks cheap on an absolute basis. The company also looks cheap when compared to a group of steel manufacturers with enterprise values under $1 billion. Webco has a superior gross margin, EBITDA margin and net margin to most others, yet trades at less than half the valuation.

The average EV/EBITDA for these competitors is 8.59. It’s unlikely that Webco will ever trade at that level, due to its small size and obscurity. However, if Webco would trade up to just 80% of its competitors’ valuation (EV/EBITDA of 6.87) then equity value would rise by 150%!

The biggest mark against Webco Industries is its lack of free cash flow. The steel industry is mature and true growth opportunities are scarce, yet the company directs all of its operating cash flow year after year to capital expenditures. The company itself is confident in its ability to create growth through capital spending, with the CEO saying “We are progressing with the development of additional facilities and new product offerings. It is our intention to continuously deploy capital in pursuit of organic growth opportunities that are consistent with our long-term niche strategy” in the most recent quarterly report.

Time will tell.

At 68% of book value and 3.63 times trailing earnings, Webco Industries looks like a great value for patient investors. If management can grow the company in a disciplined manner, acquirers may come calling.

Disclosure: An account I manage holds Webco Industries.

 

 

 

McRae Industries

McRae Industries manufactures boots. Combats boots, work boots and Western boots. The company has been in business since 1959 and is still run (and controlled) by the McRae family.

Quote: MRINA.PK/MRINB.PK

Website

McRae Industries is a stable, profitable manufacturer of necessary goods with a significantly overcapitalized balance sheet, trading at a very modest valuation. The company has had operating losses in only two of the past 25 years. Within the past several years, the company exited an unprofitable bar code reading business and now concentrates  solely on boots. The company pays a dividend and consistently repurchases stock. First, a look at recent operating results.

Revenues and income have been relatively flat over the last five years, which in itself can be considered an accomplishment. In 2009, the company’s sales of its higher margin Western fashion boots faltered, leading the company to a modest loss. However, the company’s fortunes have recovered and the twelve trailing months period shows the highest revenues and income since fiscal 2008.

On the negative side, return on capital continually comes in at an anemic 8% or so. A large part of the reason for this is the company’s extremely conservative balance sheet.

To say McRae has excess capital is an understatement. The company has no debt and minimal liabilities, yet it continues to hold 1.4 times its total liabilities in cash alone. If the company were willing to reduce net working capital or take on modest debt and return the excess to shareholders through a special dividend or share tender offer, the value for shareholders could be substantial.

Assuming current revenues and costs are maintained, any recapitalization strategy would lead to improved returns on capital, which could lead the market to assign a higher multiple to McRae’s earnings.

Unfortunately, none of these events are likely. The McRaes are firmly in control (owning over 40% of class A shares and over 60% of the super-voting class Bs) and have held excess cash for many, many years. On the plus side, holding this excess capital provides an additional buffer against economic downturns.

Investors shouldn’t expect massive returns from McRae, but a 12.3% earnings yield, significantly overcapitalized balance sheet and ongoing dividend and share buybacks make McRae Industries a very strong candidate for conservative equity investors.

No position.

Schuff International Inc

Schuff International fabricates and installs steel structures. The company operates mainly in the American South and Southwestern regions and has been run by the Schuff family since its founding in 1976.

Quote: SHFK.PK

Website

First, a look at the company’s historical performance.

Steel construction is a tremendously cyclical industry. Schuff rode the great housing boom of the early and mid 2000s, more than quadrupling revenues from fiscal 2003 to fiscal 2007. From there, revenues fell off quickly, bottoming in 2010. Since then, revenues have rebounded 16.7% in the twelve trailing month period.

At cycle peaks, Schuff records massive profits and impressive returns on assets and equity. At troughs, the company operates at roughly breakeven. For cyclical companies, any particular year’s earnings may not be representative of long-term earnings power, so it helps to normalize earnings by averaging the results of several years, including at least one full economic cycle. Over the last ten full fiscal years, the company has produced an after-tax return on invested capital averaging an impressive 14.5%. (I calculate this as operating profit less 35% tax, divided by the sum of book equity and interest-bearing obligations. Note, I am excluding a one-time accounting charge that reduced net income in 2002.)

The company used its last decade’s profits to fund expansion and to deleverage the balance sheet. As of the last quarter’s end, the company had zero net debt and strong liquidity.

Schuff took on a large amount of debt in the late 90s. This debt was nearly extinguished at the end of September, 2011. The company was successful in creating value for shareholders, compounding book value per share at 10.7% annually over the period. This figure does not include the $56 million dollar dividend the company paid to shareholders in 2009. If the dividend had been retained, annual book value growth would have been over 30%.

With 9.76 million shares outstanding as of quarter’s end and a bid/ask mid-point of $10.86, the company’s market cap would be $106 million. (It isn’t, but I’ll explain why in just a bit.) Short of another historically unprecedented housing and construction boom, I don’t expect the company to repeat its 14.5% after-tax ROIC decade. I think a handicap of 30% is reasonable, down to 10.13%. Pre-tax, that is 15.58%. Given the quarter’s end capital structure, here’s how that looks:

That is not to say that Schuff will earn $17.54 million this year, or probably even next. They will likely earn far less until the cycle turns, then far more. 6.0 times normalized earnings is a reasonable price for a strongly-capitalized company with a history of success. However, the story doesn’t end there.

Schuff recently announced the repurchase of 5.6 million shares from majority shareholders D. E. Shaw and Plainfield Direct LLC. The repurchase leaves 4.1 million shares outstanding, a reduction of an astounding 57.7%. Schuff is serious. President and CEO Scott A. Schuff had this to say:

“By completing this transaction, we are taking advantage of a unique opportunity to enhance stockholder value while demonstrating confidence in the long-term outlook for our business…Every Schuff International stockholder now owns a greater percentage of the company by a factor of nearly 2.5. The reduction of the total outstanding shares as a result of this repurchase implies a greater share value for the holdings of our stockholders. We believe that the commercial construction market is at or near the bottom, and we are confident that our strategic vision and the disciplined cost controls we instituted nearly two years ago are allowing us to capitalize more quickly on new projects we see in the pipeline.”

To finance the repurchase, Schuff used cash on hand, a $30 million mezzanine financing from GB Merchant parters, its Wells Fargo line of credit and an unsecured loan from Mr. Scott A. Schuff in the amount of $1.4 million.

I used a few assumptions to make the projection below. I assumed that Schuff spent its cash down to $20 million and drew $30. 34 million from its line of credit. For the mezzanine debt, I used the same interest rate as the existing long-term debt, 10.5%. The interest on Schuff’s line of credit is prime minus 1 percent, so I assumed a long-term average of 5%. For the unsecured loan, I used an interest rate of 15%.

Based on my projections, Schuff’s debt-financed recapitalization adds tons of value for shareholders. Previously trading at 6.0 times normalized earnings, the company now trades for only 3.4x. Projected interest expense is much higher, of course, but income per share increases dramatically. The debt is easily serviceable, given the company’s liquidity and recent cash flow.

Of course, Mr. Schuff could be wrong and the commercial construction industry could remain sluggish for years to come. In that case, Schuff would be dead in the water, operating at near break-even for a long period to come. However, I am inclined to trust management’s judgement, especially considering how much of the Schuffs’ own money is at stake. After the repurchase, the Schuff family owns 60.8% of shares outstanding. That in itself introduces the risk that minority shareholders will not be treated fairly. Shareholders should keep both eyes open.

I will be adding Schuff International Inc. to the Idea Tracker page soon.

No position.

 

 

QEP Company

QEP Company manufactures and distributes flooring products such as hardwood floor materials and installation tools.

Quote: QEPC.PK

Website

Despite operating in an absolutely horrid housing market, the company is firing on all cylinders. Revenues, earnings and EBITDA are all at record highs. The balance sheet is solid and improving. Even with all of these positive factors, the company trades at a depressed multiple and could reward investors handsomely once the market eventually recognizes the company’s success.

First, a look at the company’s recent income and cash flow trends:

Beginning in 2007, the company was hit hard by declining sales, resulting in losses and goodwill writedowns. The company responded with vigorous efforts to cut costs and reduce debt, resulting in greatly improved margins and profits. Net income and revenue over the trailing four quarters are the highest in company history! Free cash flow has soared as well.

Improving profitability and cash flow has gone hand in hand with a strengthening balance sheet:

QEP Company’s share price was hammered during the financial crisis as investors fretted over the company’s excessive leverage and poor liquidity. Since then, the company has succeeded in nearly doubling its current ratio and has cut total liabilities by 37.1%. By gradually paying down liabilities and retaining earnings, the company has increased equity to greater than 50% of assets, more than double 2007’s figure. By any measure, the company’s present balance sheet is less levered and more flexible than at any time in recent history.

At a recent bid/ask midpoint of $17.73, the company’s market cap is $60.18 million. Enterprise value is $65.76 million. Trailing earnings of $11.57 million give a P/E of just 5.20, while EV/EBITDA comes in at only 3.14. Trailing free cash flow yield is 17.02%.

QEP’s process of deleveraging by using free cash flow to reduce debt is coming to an end. Future free cash flows can be used to make acquisitions, reinvest in the existing business or distribute to shareholders via dividends or repurchases. At some point, the market will recognize QEP company’s earnings power, growth potential and balance sheet strength and reward it with a higher earnings multiple. A normalized housing market would only provide an additional tailwind for the company.

QEP does face risks. A stronger US dollar would reduce the value of the earnings of the company’s foreign operations. Another US recession could cause decreased revenue and pinch margins. Most significantly, Home Depot accounted for 63% of sales in fiscal 2011. The impact of losing Home Depot’s business would be devastating. However, the company’s relationship with Home Depot goes back to 1983 and QEP works very hard to maintain the partnership, even offering support to the Home Depot customers who buy QEP Company products.

I’ll be adding QEP Company to the Idea Tracker page tomorrow. In my view, QEP offers a chance to buy a good business with improving finances at a large discount to earnings power.

No position.

Hello!

And welcome! Somehow, amidst the endless chaos that comprises the internet, you’ve found yourself here. My task on OTC Adventures is to find and profile the most intriguing investment opportunities I can find among the ranks of the market’s most neglected and suspected companies: OTCBB and pink sheets stocks.

Most of the companies trading in these markets are worthless, or even fraudulent. However, the patient and diligent investor can still find hundreds of profitable, reputable companies worth examining.

Please check back soon for commentary and investment ideas.