Friday, June 10, 2005

Silverleaf(SVLF): Part II

First of all, let’s get one thing straight. We here at Cheap Stocks are not seers, we can’t see into the future, and we don’t believe in short-term trading (or maybe we’re just not good at it). The fact that Silverleaf is up 13 percent (to $1.50) since last weeks report is a coincidence. Now that we have that out of the way, here is Part II of last weeks report.

Recent Events
• In June, 2004, the company exchanged nearly $25 million of its 6% senior subordinated debt maturing in 2007, for the same amount of 8% senior subordinated debt due in 2010, and a cash payment of $271 thousand. Conceivably, this buys the company some time to get its house in order, but if it does not, it simply delays bankruptcy.
• In July 2004, the company purchased 500 acres of land on route 7 in Berkshire County, Massachusetts. This land was formerly the Brodie Mountain ski resort, and is within 25 miles of the company’s Oak N’Spruce resort in South Lee Mass. The company estimated future development of the site would allow for up to 324 units, or the equivalent of 16,848 one-week vacations.
• Restructured loan facility in July, 2004, reducing amount from $35 million to $25 million, while extending due date to March, 2009. In same transaction, paid off $5.4 million term loan, and added $10 million revolving loan.
• In October 2004, acquired 48 two and three bedroom units on 4.8 acres in Davenport, Florida, (near Orlando, Disney World) for $6 million. Received approval from the state to sell 16 of those units.
• In March, 2005, sold the water distribution rights and waste water treatment facilities for eight of their resorts for $13.2 million.
The company has obviously been very aggressive in its efforts to restructure debt, divest of some assets, while attempting to further the core business.

The NCAV Story (in millions)
Current Assets: $324.8
Current Liabilities:$11.5
Long Term Liabilities: $230
NCAV: 83.3
Market Cap: 55
NCAV/Mkt cap:1.5x

Balance Sheet Quality
While the company currently has $8.3 million in cash, the bulk of current assets is comprised of accounts receivable ($194 million) and inventory ($113 million). On the liability, side notes payable ($195 million) and Senior subordinated notes ($35 million) represent the majority. This is not a great balance sheet. In fact, in some respects, its downright scary. Why? As we’ve stated before, we prefer current assets of NCAV companies to have relatively large components of cash, and to be a little lighter on the receivable and inventory side. Receivables need to be collected in order to have true value, and inventories need to be sold. There are no guarantees either of this can be done, so we discount the stated value. On the liability side, the company is carrying a lot of debt, and as well all know, debt eventually needs to be repaid. One interesting feature of Silverleaf’s debt, however is that is “backed” by receivables from customers.

That’s right, the company offers financing to buyers of its timeshares. As of 12/31/04, the company held promissory notes from more than 34,000 customers, in the principal amount of $250 million. That portfolio of notes had an average yield of 15.1 percent, and a weighted average cost of 6.8 percent. Hence, the company makes money by borrowing money, then loaning it to customers. In 2004, the company generated $37.8 million in interest income and $17.6 million in interest expense. The company essentially backs its loans with receivables from customers. This can be risky business. Despite the fact that there is a large spread between what the company pays its lenders, and what it’s customers pay the company in terms of interest rates, this situation can go awry. Lenders have covenants on loans that companies must adhere to, and loans to customers are virtually worthless if customers can’t or won’t pay.

In 2004, the company had an allowance for doubtful accounts of 21.1 percent of the amount receivable (up from 20 percent in 2003). Essentially, that means the company expects to collect only 4 out 5 dollars it loans to customers. There is a lot of risk here, much of it driven by the fact that Silverleaf does not verify customer credit history. This explains why the average yield on the portfolio notes is 15.1 percent.

Off Balance Sheet
Silverleaf also has a wholly owned, off balance sheet subsidiary Silverleaf Finance, which had notes receivable of $84.5 million at year end 2004.

No doubt there is a great deal of risk here. Silverleaf is highly leveraged, and dependent on the ability to keep its lenders happy, while collecting loan payments from customers who may have terrible credit. On the positive side, the company has taken strides improve its balance sheet by restructuring debt, continues to build its core business through the acquisition of additional properties, and has been profitable for five straight quarters. First quarter 2005 sales were up 30 percent to $42.1 million from the same quarter last year, while net income was up slightly to $2.52 million from $2.34 million. I would caution readers to read the company’s most recent 10K and 10Q reports before buying shares in this company. We at Cheap Stocks are cautious on this one, but intrigued just the same. We’ll continue to follow this story.

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