Real Estate Value Strategy:
Looking For Acreage

My current portfolio and many of the recent additions to it bear witness to the fact that I am enamored with real estate. Now, I am not talking about REIT’s, although I believe they can play an important role in a portfolio, but just plain old fashioned land. There are a lot of publicly traded companies out there, some real estate operating companies, many others not, that have vast land holdings, carried on their balance sheets at cost. Much of this land was acquired many years ago, and is now worth significantly more than its carrying value. I like nothing more than to discover these companies, how much land they hold, and where the tracts are located.

It’s no secret that in the past few years, land values have skyrocketed. I don’t need to look any further than the small patch of Long Beach Island (New Jersey) my wife and I purchased in 1998. It’s actually a standard (47 X 100) lot, with a small, original cape cod, built in 1949. A small, cozy cottage, equidistant (250 steps, yes, I actually counted) to the bay and beach, on a beautiful, fairly quiet island.

It was a scary purchase at the time. One Hundred Sixty Thousand dollars, another mortgage, these were heady times. But when the little old lady who owned it approached us, we couldn’t say no. One sixty for our own piece of paradise seemed a no-brainer. And so far, aside from some frozen pipes, it’s been the best purchase we ever made. That little slice of heaven that is part of our family, a refuge, a place where memories have been built, is now worth more than three times what we paid for it less than seven years ago.

That’s just ridiculous. True, we bought it under market value, and demand for second homes is rising, but to me, this still smacks of the 1999 era tech bubble. It really hit home the day I was standing on my property line; a line which had been wrongly surveyed as we were buying it. The surveyors incorrectly placed the stakes five feet closer to our house than they should have. It looked natural at the time. But the seller of the house was nice enough to tell us that the surveyors got it wrong. When they re-surveyed, it showed that our actual property line was less than two feet from the neighbor’s house. I guess the zoning laws were different in the late 1940’s. Since then, it’s always bothered me how close our line is to their house. Just does not give them much room. So I decided to calculate how much that little strip of land would be worth, just in case they wanted to buy it. The answer shocked me. Based on a $475,000 value on the property (excluding the house), that little 5 x 100 strip of sand and gravel is worth: $50,531.91! That, my friends, is $10,106.38 for a 1 X 100 foot strip. Or, if you like, $842.29 for a 1 inch by 100 foot sliver. Per acre you ask? $4 million. That’s insane.

If you think I’m jumping for joy over this, I’m not. Our little cottage, on a quiet street, with the worlds greatest neighbors, people we love, is filled with the laughter of 3 children, memories of sun-soaked summer days, and the hope that, God willing, there will be many more to come. It may look nice on a balance sheet, but it’s not for sale.

What is for sale though, on a daily basis, are the dozens of publicly traded companies sitting on acres and acres of land. Most you have probably never heard of. Some are not even in the real estate business.

My first venture into publicly traded real estate was about 3 years ago, when I bought shares in The St. Joe Company (NYSE, ticker: JOE, $63.85). At the time, shares traded in the $25 range, and I remember being blown away by a presentation given by the company at the Third Avenue Funds conference in New York, back in October, 2001. (Rule # 1 is never be blown away by a companies own presentation, they are always positive, but in this case, my optimism was warranted, after all, if Marty Whitman of Third Avenue is bullish……)

The company, whose main revenue source is from community development, owns approximately 850,000 acres, mostly in Northwest Florida. A substantial portion of this land is gulf, lake, or riverfront. One fact that impressed me at the time was that they have timber operations, a good business in itself, that clears the land until it is designated for development. Still, in the scheme of things, timber is a small part ($36.6 million in 2003, or about 5 percent of revenue).

More impressive to a real estate junkie, such as myself, is the shear size and location of their land holdings. The following is from the company’s 2003 10K:

JOE is one of Florida’s largest real estate operating companies and the largest private landowner in the State of Florida. The majority of our land is located in Northwest Florida. We own approximately 850,000 acres, which is approximately 2.4% of the land area of the State of Florida. Our acreage includes hundreds of miles of frontage on the Gulf of Mexico, bays, rivers and waterways, with nearly 40 miles of Gulf of Mexico coastline, including 5 miles of beachfront. Approximately 387,000 acres of our land are within ten miles of the coast.

To put the 850,000 acres into perspective, 640 acres is a full section, or 1 square mile. JOE’s holdings are 1328 square miles, or an area of roughly 36 by 36 miles! And nearly half within ten miles of the coast!

Valuation wise, St. Joe’s looks expensive, based on its price earnings ratio, which is currently 55. But, P/E’s are not the be all and end all for a company sitting on a huge and valuable portfolio of land.

One way I value companies with land holdings is to calculate their enterprise value per acre. Enterprise value is simply a company’s equity market cap plus their total debt, preferred stock and minority interests if applicable, minus cash. It’s simply a more accurate way to view a company’s perceived value in the marketplace, then just considering equity. In St. Joe’s case, using a recent enterprise value of $5.089 billion, we get an EV/acre of $5,608. In theory, purchasing St. Joes at the current price is like buying Florida real estate for about $5,600 an acre. Compare that to $4 million for an acre on Long Beach Island. (This is not a recommendation to buy or sell the stock, merely an illustration.)

Now, the stock has been on quite a run recently, up nearly 70 percent in 2004. Whenever I start thinking about taking profits, I look at the EV/acre calculation, and the Long Beach Island calculation. I am still holding the stock. But, again, I am a real estate junkie. I am addicted to acreage. I can’t help myself. Stay tuned for more…

12/22/04

As this newest research report indicates, we are expanding our scope here at Cheap Stocks. We'll continue publishing our research on companies trading below their NCAV's, but we'll also report on other value investing techniques, and topics.
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Off The Beaten Path
Micro-Cap Value Strategy
Going Private: Getting Around Filing with the SEC and Avoiding Sarbanes-Oxley in the Process


There is an interesting phenomenon happening in the markets these days in the micro-cap arena. Many of these tiny companies, which tend to have a small number of shareholders, are recognizing the growing costs of being publicly traded. It is relatively expensive for smaller companies to follow the reporting requirements under the Securities Exchange Act of 1934: add to that the additional costs associated with Sarbanes-Oxley. For some of these companies, $100,000 in expenses related to filing, mailing shareholders reports and proxy’s, and paying accountants to help them comply with Sarbanes, may be the difference between a profitable and unprofitable year. And now some are opting out.

How is that possible? Well, the Securities Exchange Act of 1934 allows companies with fewer than 300 shareholders to terminate reporting obligations. This also effectively ends their need to pay up for Sarbanes-Oxley. The trick is to get below the magic 300 level. That takes effort, but may not be as hard as you might think.

One way to get below the proverbial shareholder “Mendoza Line” is to initiate a reverse stock split, say 1 for 100, where shareholders owning less than 100 shares receive cash, in lieu of fractional shares. In essence, these odd-lot shareholders are paid in cash for surrendering their shares, thus reducing shareholder rolls. Everyone else gets 1 share for every 100 held, and the price of the stock adjusts accordingly. For a variety of reasons many of the companies who are candidates for this action have a large number of odd-lot shareholders, so it’s not difficult to dramatically reduce the number of shareholders.

Typically, reverse stock splits are undertaken by companies that are near death; their stock price having fallen below the magic $1.00 mark. It usually is not time to celebrate in this situation: the reverse split may be the last breath of a former high flying company seeking to stay exchange listed. The phenomenon of companies utilizing a reverse split solely to reduce the number of registered shareholders puts the notion of a reverse split in an entirely new light.

There may be as additional motivation, aside from cost-cutting, for companies to go this route: the company itself may be sitting on some valuable assets, and reducing the number of shareholders essentially is a step toward taking the company private, or at least giving large insiders a bigger piece of the pie, and more control. The act of buying back shares from odd lot holders requires company cash, but in return, remaining shareholders own a proportionately larger stake.

Such a transaction, however, will lower a company’s liquidity in the trading markets, liquidity which was probably already on the low side. Volume which was light on a daily basis before the reverse stock split, will now be light on a weekly, monthly, or even quarterly basis. It is not inconceivable that the stock will trade just a few times a year. Bid/Ask spreads will be huge, so new investors wanting to get in will have to pay dearly, assuming they can even find a seller. Furthermore, not having to file with the SEC will lower a company’s profile, so access to capital markets will be limited. This all sounds negative, but, from the perspective of current owners, who may realize their company’s true value, this is not so bad.

How do you tell the difference between motivations for initiating a reverse split? You can first identify those splitting because their stock price needs to meet a minimum in order to stay listed. While this information can be inferred from a very low stock price (typically below $1.00), companies will also disclose (in their proxy statements) their reasons for splitting. (Reverse splits typically need shareholder approval.) Likewise, companies wishing to initiate a reverse seemingly to cut costs and avoid Sarbanes-Oxley, will also state this in their proxy, often in great detail.

Recent Examples: Splitting to Reduce Number of shareholders
This was the approach taken this past May by Winter Sports Inc (ticker WSPO, market cap $20 million), operator of a ski resort in Whitefish, Montana. The company initiated a 1 for 150 reverse stock split, where shareholders owning less than 150 pre-split shares were paid in cash. The purpose of and reasons for the split were best described in the company’s 2004 proxy statement: (Schedule 14A)

Purpose. The primary purpose of the Reverse Split is to reduce our number of shareholders of record to fewer than 300, thereby allowing us to terminate our reporting obligations under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Sarbanes-Oxley Act of 2002. In the event that there are fewer than 300 shareholders following the transaction and Winter Sports is eligible to file to deregister its common stock, Winter Sports intends to file a notice of termination of registration with the Securities and Exchange Commission to deregister its common stock under federal securities laws. As a result, Winter Sports would no longer be subject to the costly and time-intensive annual and periodic reporting and related requirements under the federal securities laws that are applicable to public companies…

Reasons. We are considering the Reverse Split, and the board of directors has recommended that you approve the Reverse Split, as a means to eliminate various expenses associated with remaining a “public company,” by which we mean a company whose stock is registered under, and which files reports in accordance with, the Exchange Act. In addition to direct financial savings, we expect that the going private transaction will free substantial management time and attention that currently is devoted to Exchange Act compliance, allowing management to focus more closely on Winter Sports’ core business operations. An ancillary benefit is that the Reverse Split would allow us to reduce costs by reducing the number of shareholders with whom we communicate. Because administrative and mailing costs accrue on a per-shareholder basis, those costs are disproportionately high for shareholders who hold only a limited number of our shares when considering their stake in Winter Sports. In the aggregate, we expect these cost reductions to reach approximately $200,000 in the first full fiscal year following the Reverse Split. We also believe the Reverse Split will provide liquidity to shareholders who hold fewer than 150 pre-split.

To put Winter Sports estimated cost savings ($200,000, before tax) into perspective, the company reported a net loss of $570,000 in 2003, and net income of $1,600,000 in 2002, so $200,000 is material. Once shareholders approved the reverse split, the company’s next move was to file a Form 15-12G, which essentially serves as notice to the SEC that they will no longer file reports, having met the number of shareholders criteria. In Winter Sports case, the number of shareholders was reduced to 167, as stated in this filing.

Since the Split
The company now has less than 7000 shares outstanding, shares which rarely trade. The last trade (12/1/04) priced the shares at $3000, up nearly 15 percent since the reverse split. The most recent bid/ask however, was 2000/3200, representing a huge spread. Any potential buyers of this stock will pay handsomely (if they are fortunate to even find a seller); while sellers risk getting crushed if they place a market order. For holders, this situation represents the ultimate long-term play. The value may be in the 900 acres the company owns near and around the base of the ski-resort it operates. Only time will tell.

Avoca Inc
The latest example, Avoca Inc , a royalty trust, (ticker AVOA, $23 million market cap) owns and manages 16,000 acres, which comprise the bulk of Avoca island, situated 90 miles west of New Orleans. The company’s main source of income is royalties from oil and gas leases. Avoca currently yields about 10.3 percent, based on the 2004 annual dividend.

The company’s story is very similar to Winter Sport’s. Avoca declared a 1 for 100 reverse split on 12/1/04, and filed its 15-12G on 12/16/04. The company has yet to trade since the split, but traded in the $28.00 range prior to the split, and odd lot shareholders were paid $28.00 for their shares.

Besides estimated cost savings of $50,000 from no longer having to file, why would management have made such a move? Could it be that the natural gas reserves under the island are not adequately valued? Does the land (16000 acres, of which 2/3 are actually under water) have some potential future use not yet disclosed? Or, is it that the current yield will increase once the 2005 dividend is declared, pushing the valuation higher? Maybe a combination of all three?

Whatever the story, it was compelling enough for the author to purchase 100 pre split shares. I now own 1 of 8000 or fewer shares outstanding (exact figures are unavailable). This strategy is not without great risk. There is virtually no liquidity in the stock, but I believe the assets are far undervalued, which may ultimately lead to the company going private. In the meantime, I am happy to collect a nice fat dividend.

Finding other candidates
First, find out which companies have declared, or are seeking shareholder approval for a reverse stock split. For those with very low stock prices, look no further, they are probably splitting because they want to stay listed. If there’s any doubt, read the company’s Proxy statement (DEF 14A) to determine whether the split is an attempt to reduce the number of shareholders. Once you find an interesting candidate, find out all you can about the company. Proceed with caution: once you get in, it will be tough to get out. If you find a company you want to buy, purchase shares before the reverse split, and buy enough (in Avoca’s case it was 100, Winter Sports, 150) so that you are not one of the shareholders whose shares are converted into cash.

To find out which companies have filed form 15-12G (companies who will no longer file reports with the SEC), check the SEC
website.

Final Thought
It may be a coincidence that both example companies main assets are real estate related…but don’t bet on it.


Postcript
Avoca Inc. finally declared their annual dividend on 12/16 (that was the declared date, but was not disclosed until 12/22), payable on 1/31/05.....the amount? $350.00 per share. That raises the current yield based on the last trade to 12.5 percent. Stay tuned.

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UDATE

It certainly didn't take long for Dominion Homes to tick up above its net current asset value. The stock closed yesterday at $21.31, up slightly (1%) since we highlighted this company last week. Here is how the other four fared:

Cellstar (CLST) $4.75 (up 4.2%)
G III Apparel (GIII) $6.55 (up 4.0%)
Boss Holdings (BSHI) $7.00 (unchanged)
Electro-Sensors (ELSE) $3.83 (up 1.9%)

Not a bad week for these companies. We'll continue to search for other NCAV companies, and post as we can.

Last but not least, we posted research on Duckwall-Alco recently, and since then the stock is up 2.9% (to $17.50). The company still trades below its NCAV. We'll continue to follow this interesting story. Merry Christmas to all from the research staff at CHEAP STOCKS.

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Five Profitable Companies Trading Below Net Current Asset Value

These five companies all trade below NCAV as of 12/10/04. All have a trailing 12 month profit. Please e-mail cheapstocks@earthlink.net if you'd like more analysis on each posted on this site.

Company Ticker Mkt cap(mln) NCAV(mln) Price(12/10/04)
Dominion Homes DHOM 171.19 176.31 20.64

Cellstar Corp CLST 95.93 131.26 4.56

G III Apparel GIII 44.67 52.41 6.30

Boss Holdings BSHI 13.56 15.64 7.00

Electro Sensors ELSE 12.1 13.29 3.76

Company Report: 12/3/04
DUCKWALL-ALCO STORES
Ticker: DUCK
Exchange: NASDAQ
Price: $17.00 (12/3/04 close)
Market Cap: $74 million
P/E Ratio: 12.5
Shares Outstanding: 4.38 million
2003 sales: $423.5 million
Net Income: $6.3 million
Book Value per share:$25.23

THE COMPANY
First of all, I’ve got to admit that I had never heard of this company either. Headquartered in Kansas, the company is a regional discount retailer operating in 21 states in central U.S. It is comprised of two segments, ALCO Stores (185 total) which account for 92 % of company sales, and Duckwall Stores (80 total), accounting for 8 percent of sales. (Sales Data as of 2nd quarter, 2005).
The retail business is one of the most competitive, so how can a small-time chain such as this compete with the big boys? It doesn’t try to. As stated in the company’s 2nd quarter 2005 10Q report:

“The Company’s overall business strategy involves identifying, and opening stores in towns that currently have no direct competition from another larger national or regional full-line discount retailer. The Company’s business activities include operation of ALCO discount stores in towns with populations which are typically less than 5,000 not served by other regional or national full-line discount chains and Duckwall variety stores that offer a more limited selection of merchandise which are primarily located in communities of less than 2,500 residents”

THE NCAV STORY (Data as of 3rd quarter 2005)
Current Assets: $157.9 million
Current Liabilities: $53 million
LT Debt: $18 million
Other LT Liabilities: $4 million
NCAV: 82.9 million
Market Cap: 74 million
NCAV/MKT Cap: 1.12

Composition of current assets:
Cash: $3 million
Receivables: $ 2 million
Prepaid expenses and other: $3.4 million
Inventory: $149.2 million

The quality of current assets is not outstanding, but typical for a retailer. The company has $3 million in cash, but the bulk of current assets, $149 million, is inventory. (As students of NCAV investing know, cash is the most valuable current asset.) Still, the company is trading below its net current asset value. Remember also, that NCAV calculations completely ignore long-term assets. In Duckwall’s case, we are ignoring nearly $27 million in net property and equipment, and $4 million in other assets. These values represent book value; it is difficult to estimate their true value.

Institutional Ownership
One interesting facet to this company is that there is institutional ownership; quite rare for a company of this size. As of 9/04, Heartland Advisors, Franklin Resources, Dimensional Fund Advisors, and Royce Associates (to name a few) owned a combined 28 percent.

Conclusion
If nothing else, this is an interesting story to follow. The risks are obvious: it’s difficult for any retailer to prosper given the competitive environment. However, the company’s strategy makes sense: go to the towns no one else will. The company has been profitable for years, yet still trades below its NCAV. Just keep in mind how rare that is. Finally, with the company trading at just over 4 times cashflow, and 2/3 book, deep value investors may want to dig further.

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