Friday, January 28, 2005

Rolling Towards a Takeover?
Tootsie Roll Industries
Ticker: TR (A shares), TROLB (B shares)
Price: $31.95(A)
Market Cap: $1789.3
Avg Daily Volume: 60,000 (A)
9 (B)
Dividend Yield: .88%

First off, the subject of this weeks report has nothing to do with real estate, nor does it trade below its net current asset value. But it may be ripe for a take-over and in that context, may offer compelling value, and is worth a column.

Tootsie Roll Industries is not an exciting company. Your editor has followed it for several years, but has never owned the shares. I’ve downed my share of Charleston Chews, Tootsie Rolls, (the fruity variety, as well as the original) Blow Pops, and other sweets made by the company, though. And that is often the start of my research into a company…”like the product, do the research.”

The company has been around nearly a century, went public in 1922, as the Sweets Company of America. It was renamed Tootsie Roll Industries in the mid 1960’s. Several acquisitions later, the latest being Dubble Bubble brands from Concord Confections in 2004, the company “Rolls” on.

In recent years, though, growth has been weak. Sales have been flat for years. Fiscal year 2003 sales of $392.6 million were down slightly from 2002 sales of $393.19 million. And that’s up just 4.5 percent from 1997 sales of $375.59 million. The earnings story is similar. Not a very convincing argument so far? Read on.

Although growth has been anemic, this is an extremely profitable business. Profit margins (net income/sales) have averaged over 17 percent for the past five years. By comparison, candy giant Hershey Foods has averaged just over half that, at 9 percent, while gum maker Wrigley has averaged just under 15 percent. (Actually, 15 percent is quite amazing in and of itself)

While Tootsie Roll currently trades at a seemingly expensive 25 times earnings, that is well within it’s historic P/E range. The company commands a higher multiple than one might expect for two reasons. First of all, its high profit margins. Companies with consistent, higher than average profit margins can command higher P/E multiples. Secondly, this company has historically maintained relatively high balances of cash and marketable securities, along with little or no debt. This “margin of safety”, helps investors justify paying more per dollar of earnings than they otherwise might, all else being equal. Overall, the combination of high profit margins and a strong, cash-rich balance sheet is a powerful one.

While the recent Dubble Bubble acquisition lowered cash and short term investment balances, the company still has $60 million (down from $139 million). (The company also assumed $105 million in long-term notes payable to pay for Dubble Bubble.) On the non-current asset side of the balance sheet, the company has $107 million in long term investments (mainly municipal bonds), and another $76 million listed as split dollar life insurance and other assets (we are assuming the bulk of that is split dollar life insurance). With 52.275 million shares out, that equates to $3.19 per share in cash and marketable securities. Add in the split dollar life insurance, and that’s $4.65 per share.

You probably aren’t yet convinced that Tootsie Roll is a takeover candidate. I don’t blame you. High profit margins, a strong brand name, and solid balance sheet don’t necessarily translate into a takeover. But aging owners complete this picture.

The Gordons
That’s Melvin and Ellen Gordon. Melvin, at age 85, is Chairman of the Board and CEO. His wife Ellen, age 73, is President and Chief Operating Officer. Melvin has been a director of the company since 1952 and Chairman of the Board since 1962. Ellen has been a director since 1969, and President since 1978. That’s a lot of history, and a lot of time to acquire a major piece of the company. And acquire the Gordon’s have. They currently own, or control more than 79% of Tootsie Roll’s Class B shares (there are 17.6 million outstanding)-that’s the class with most of the voting rights-and 40 % of the class A shares (34.7 million outstanding). The total market value of the Gordon shares is $980 million, or 55 percent of the company’s total equity market value. Ultimately, one would imagine, the Gordon’s will either want out, or want to convert at least some of their shares into cash. Estate planning sometimes necessitates changes in ownership. When you add this piece to the puzzle, the takeover scenario becomes much more viable.

A 12/20/04 article in Crain’s Business Daily suggested that Wrigley might be interested in acquiring Tootsie Roll. That’s an acquisition that could make a lot of sense for Wrigley (I do own shares in this company), on the heals of its 11/15/04 acquisition of Life Savers, Altoids, and other brands from Kraft Foods. Cleary, Wrigley is attempting to move beyond gum, and acquiring a highly profitable well-know brand such as Tootsie Roll would be a next logical step. However, you can’t rule out Hershey as an acquirer, either.

Tootsie Roll shares reacted favorably to the Crain’s story, jumping $2.00 in the week following the story. The stock has since settled back down to the pre-Crain story price range. The real question is, do the Gordon’s want to sell, and at what price? They hold the keys. Stay tuned.

*The author does not have a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Friday, January 21, 2005

Real Estate: Part 3
PICO Holdings:
Mini-Berkshire Hathaway?

What do you get when you cross water, land, medical liability insurance, property and casualty insurance, software, and various other investments? A business with no identity and a lack of focus? No, you get PICO Holdings (NASDAQ, ticker: PICO) a small, La Jolla, California based holding company, which just happens to operate in all the aforementioned businesses. It also bears a resemblance, however small, to Berkshire Hathaway.

PICO caught my attention 2 years ago, when my research indicated that the company was the largest private landholder in the state of Nevada, with some 1.2 million acres at the time. Now, by this time, I’d already become a land baron in Florida with my holdings in St. Joe’s Corp and in California, with my handful of JG Boswell shares, and was looking to expand my real estate "empire" (See archives for those reports). PICO’s market cap at the time was around $150 million, and that in itself was compelling, considering that market cap divided by acres owned was $125! That calculation placed all of the value on the land, and excluded any other assets, including water rights, insurance segments, cash and securities. Mind you, that is an extremely unsophisticated calculation, and just a starting point, but $125 per acre seemed cheap for land. (The EV/acre calculation we’ve used in past real estate articles came out to about $35 per acre, but this is not meaningful in this case, more on that later). Keep in mind, though, that this is Nevada land, much of it former railroad land. I t is not the same quality as what St. Joes holds, nor what JG Boswell holds. Its uses are fewer, it is not located near a coast, and is located in some relatively unpopulated areas. Nonetheless, it seemed appropriate to further research this company, (and I ultimately purchased shares in July, 2003, at about $13.00 per share.)

What I found was a somewhat odd assortment of businesses. Well, for me, it was the insurance businesses that were odd, but that is mainly because I don’t have a great understanding of how that industry operates. Furthermore, land and water seemed to be a good fit, but insurance?

That question answered itself. In March of 2003, PICO sold its last “active” insurance company, Sequoia. Its other insurance companies, Physicians Insurance, and Citation Insurance are in “run-off”. Insurance companies in “run-off” no longer write new policies, but operate to satisfy claims on existing policies. For instance, in Physicians case, the company reports that claims on current policies can be reported until 2017.

To satisfy claims for each of the companies in “run-off”, PICO has investment assets, which are in place to cover claims. PICO benefits from any excess income generated by these investments over and above claims. (This is an over-simplification, I know.) But ultimately, PICO should be out of the insurance business, once time runs out on possible claims. In Fiscal year 2003, the insurance operations generated $3.2 million, about 10 percent of total revenue

Other Businesses: Summary (See the company’s 10K for more detail)
Vidler Water is the largest private holder of water rights in Arizona and Nevada. For fiscal year 2003, it represented 51 percent ($16.8 million) of Pico’s revenue. Among Vidler’s assets is 49,500 acre-feet of ground water in the Harquahala valley, near Phoenix. Much of Vidler’s revenue ($11.4 million in 2003) is generated from the sale of water rights and land.

Nevada Land Resource Company is the largest private landholder in Nevada, which currently owns about 1.1 million acres. In 2003, this segment generated $5.9 million, or 18 percent of revenue. At the company’s current market cap of $263 million, that’s about $239 per acre (market cap/acres). As mentioned above, the EV/acre calculation is not meaningful in this case, because much of the company’s marketable securities, which are backed out in order to calculate EV, are tied to the insurance operations in run-off. The company is actively selling land, but as was previously mentioned, this land is not as valuable as some held by other companies we’ve previously discussed. For instance, in 2003, PICO sold 75,131 acres for $4.1 million. That’s equivalent to $54.58 per acre.

The Business Acquisitions and Financing segment generated $5.6 million, or 17 percent of revenue in 2003. This segment holds a portfolio of equity securities, mainly European companies, but does not disclose all of the actual holdings. The company does disclose that the largest holding is its 23 % ownership of a Swiss railway company, Jungfraubahn Holding AG, followed by Raetia Energy AG.

Hyperfeed Technologies, develops and provides software, ticker plant technologies, and managed services to the financial markets industry. Hyperfeed, 51% owned by PICO, is a publicly traded company (ticker:HYPD).

While PICO has not had a profitable quarter since June, 2003, that’s not the story here. The story is the land, water, cash and marketable securities. Cash and marketable securities totaled $182 million as of the last reported quarter (Sept, 2004). The company has no long term debt, and at the current price of $20.95, has a market cap of $259 million.

Finally, you are probably wondering how your editor has the audacity to compare this tiny company to Berkshire Hathaway. Its simply that the management team has assembled an interesting assortment of businesses and valuable assets, much like Warren Buffet has, and has seemingly done so at low cost. The managers claim to buy undervalued businesses based on Graham and Dodd principles, and it appears that this philosophy has paid off. It certainly has for your editor.

A company like PICO is somewhat difficult to evaluate. You can’t base valuation on earnings, you’ve got to dig deeper to try and value the individual business units, or assets. The company offers an excellent company profile on their website, which does a great job of describing the businesses, and company philosophy. There are no analysts currently covering this company, and you aren’t likely to find much information outside of SEC filings. But that’s where the fun begins.

*The author has a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Wednesday, January 12, 2005

GIII Apparel: Trading below Net Current Asset Value
We've been off on a real estate tangent, but some of you have been asking for more research on the 5 NCAV companies we wrote about on December 10th. Here is the first of those reports.

GIII Apparel
Ticker: GIII
Current Price: $7.82
Market Cap: $56.47 million
Net Current Asset Value: $61.9
2004 sales: $224 million
2004 net income: $8.4 million
P/E: 78
Book value per share: $9.59

The Company
G-III Apparel Group Ltd, is a small, New York based manufacturer, importer and marketer of outerwear and sportswear. The company has licenses to produce products under several well-known fashion labels, including Kenneth Cole New York, Jones New York, Timberland, and Blass to name a few. The company also has a license with the National Football League. There are two business segments, licensed apparel, and non-licensed apparel. In 2004, licensed products represented 78 percent of revenue.

The Industry
The apparel business is highly competitive, and is affected by fashion trends, style, price and quality. The company itself is subject to the expiration of licensing agreements. This company is a small fish in a big sea.

Recent Financial Results
The company earned $8.38 million in fiscal year 2004 (ended in Jan, 2004), or $1.14 per share, on sales of $224 million, for a net profit margin of 3.7 percent. Third quarter 2005 sales, (ended 10/04) were down 9.2 percent to $114.9 million, from $125.5 million from the same period last year. Sales of licensed apparel fell $25 million to $71.4 million, while sales of non-licensed apparel increased $14.3 million to $43.5 million. Net income fell 15 percent to $9.9 million or $1.33 per share, from $11.38 million, and $1.50.

The stock currently trades at 78 times trailing 12 month earnings. The company has been lowering earnings guidance, expecting anywhere from $.18-$.23 for the year ended January, 2005. At the low end of guidance, this implies a P/E of 43, or 34 at the high end. There is no analyst coverage for this company, but some institutional ownership.

What is interesting about this company is that it currently trades below its net current asset value. Finding a profitable company these days that does is a rarity.

The NCAV story (mkt cap as of tk, all other data as of latest reported quarter)
Market Cap
Current Assets: 130.2
Current liab: 67.9
Long term liab: .4
NCAV: 61.9
Market Cap 56.5
Mkt Cap/NCAV: .91

Quality of Assets
The company has $3 million in cash, but the bulk of current assets is comprised of accounts receivable ($81.7) and inventories ($37.1). The quality of current assets is not great, however, given the companies business, that’s to be expected. When we speak of quality in the context of NCAV companies, we are not judging the actual assets themselves, but rather the composition of current assets. For NCAV companies, cash and marketable securities are preferable to inventories and receivables. The former has a fixed value, the latter accounts don’t. Inventories may be worth cents on the dollar, and are expensive to store, while receivables need to be collected in order to be converted into cash, and there are no guarantees that can be done.

The company has no long-term debt, but $36.2 million in short term debt (in the form of a working capital line of credit), which is how the company funds operations. There are no other material long term liabilities.

As of 9/30/04, insiders controlled 3.805 million, or 52.7 percent of shares. Co-Chairman/CEO Morris Goldfarb owned nearly 38 percent of shares, while Co-Chairman Aron Goldfarb owned about 13 percent. The most recently reported insider transactions were acquisitions, the result of option exercises.

While the company has been lowering guidance, and operates in a tremendously competitive marketplace where the majority of sales(and profit)is booked in one quarter, the fact remains that shares are cheap. The company is trading well below its NCAV, and trades at less than 5 times cashflow. On an earnings basis, the story is much less compelling. This company would make an interesting acquisition candidate, and perhaps that is how shareholder value will eventually be unlocked. Of course, given their relative stakes in the company, that decision is up to the Goldfarb’s.

*The author does not have a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Saturday, January 08, 2005

Real Estate part 2
The Pink Sheets:
Searching For Value In No-Man’s Land
JG Boswell Company (Ticker:BWEL)

Ever considered buying real estate exposure on the pink sheets? Me either. I never really considered buying anything on the pink sheets. That’s as “over the counter” as over the counter gets. A virtual dumping ground for has-been companies, right? Not necessarily. My second investment in the wonderful world of publicly traded real estate was in a tiny pink sheet company that I’d never heard of (this will be a recurring theme as we explore my real estate adventures), JG Boswell Co (Ticker: BWEL). Boswell, headquartered in Pasadena, CA, is primarily a cotton grower, with other agricultural operations, but we’ll get into that later.

I found out about this company at the New Orleans Investment Conference , in November, 2002. I was attending the conference as a presenter, representing the personal finance magazine I wrote and edited for at the time. (I f you have never attended this annual conference, I highly recommend it.) I attended several of the breakout sessions at the conference, and one of the best was given by Rick Rule, of Global Resource Investments.

Rule’s presentation highlighted several, unheard of, pink sheet companies, sitting on undervalued assets. These companies had few shareholders, traded very infrequently, and all traded at high ($300 and above) stock prices. One of Rule’s points was that you can find tremendous value in essentially semi-private pink sheet companies. You just have to do a lot of digging, because most are not required file financial statements with the SEC (having so few shareholders), so information is hard to find. Furthermore, trading is extremely infrequent.

Among the companies Rule discussed: Crowley Maritime (CWLM, last traded at $1160), a marine transportation company (they do file with the SEC), Laaco Ltd, (LAACZ, $534.25) owner of the Los Angeles Athletic Club, California Yacht club, self storage facilities and other real estate, Farmer’s Merchant Bank of Long Beach CA (FMBL, $5600) a commercial bank, and, of course Boswell (BWEL, $600).

I was intrigued most by the JG Boswell story. Here was a semi-private company, sitting on thousands of acres of California land, some of which had water sitting under it. Ah, land and water. It does not get any better than that.

JG Boswell was interesting, but I started my research efforts with one hand tied behind my back. There simply was little information available. What little I could find was numerous mentions in newspapers. Then I stumbled upon Standard Investment Chartered Inc., a small investment house that specializes in these situations: semi-private, but asset rich pink sheet companies. There were several research reports on the site; the one for Boswell was a few years old, but with that, and a more recent update, I had at least something to add to Rick Rule’s analysis.

What I found was a profitable, albeit mysterious little company. The company founder JG Boswell, being somewhat of a legend. (In fact, there is now a biography available about him: The King of California: J. G. Boswell and the Making of a Secret American Empire by Mark Arax, Rick Wartzman, you can find it on Amazon.) In any event, based on the mosaic of information I was able to generate, I purchased a handful of shares in early 2003. The stock was trading at $300 per share at the time, and based on the extremely low trading volume (71 shares per day in 2004, for example), I was lucky to get my hands on any.

A few months later, I tried to buy more, placing a limit order, but there were no sellers. In a situation like this you never want to place a market order because you are liable to get hammered on price. The stock traded sideways for many months, and I collected the nice 3 plus percent dividend.

The stock started to move in February 2004, when the company initiated a tender offer to purchase up to 150,000 shares at $325 per share. I was initially tempted by the offer, afterall, I had held the shares a year, and the price had barely moved. I was getting impatient, as a beginner in the world of thinly traded pink sheet companies.

The tender offer documentation and financial statements I received in the mail changed my mind. This was my first look at somewhat recent financial statements, and the numbers I saw were impressive.

For instance, in 2003, the company had net revenue of $395 million, and net income of $35 million, or $36.11 per diluted share. Based on the tender offer price, that was a P/E of just 9, and a very healthy net profit margin of 8.9 percent. Book Value per share was $343.83 based on stockholders equity of $321 million, and 933,855 shares outstanding. That translated to a price to book ratio of .94. I know, book values can be misleading, based on the quality (or lack thereof) of the underlying assets. But that’s where it got better.

Total land holdings for the company were approximately 172,000 acres, 142,000 in California, and 30,000 in Australia. Current use of the land along with acreage figures, was as follows:

Use Acres
Pima Cotton 79856
Tomatoes 17938
Alfalfa 20109
Wheat 12101
Garbanzo Beans 3397
Other Crops 3703
Fallow 5000
Eastlake real estate ?
Cotton 30000
Office park 52

(As for water, company documents mentioned a supply of groundwater under owned land, used to water the crops. But there were no specifics about the supply.)

As I mentioned in my last piece, one metric I like to calculate for companies with land holdings is Enterprise Value Per Acre. In Boswell’s case, Enterprise value at the time was calculated as follows: (in millions)

Market Cap $303.5
Total Debt $170.8
Min Int. .6

EV: $472.3 million
Acres: 172 thousand

EV/Acre: $2745.9

The above figures were as of the tender offer. It is difficult to calculate the current EV per acre, because much of the data is not available. However, based on the doubling of share price, a perceived reduction in shares because of the tender offer and assuming levels of debt and cash are similar:

Current EV/Acre: Estimate: $4000-5000

Boswell is a nice story. Good, profitable operating business perhaps undervalued land, and a growing dividend ($3.25 per share quarterly, up from $3 last year and $2.75 the year before). The stock most recently traded at $600 per share. The downside to a story like this is the lack of information. The company is not required to file with the SEC, so even for shareholders, financial statements are scarce. The only ones I’ve seen since becoming a shareholder were those pertaining to the tender offer. Still, I’ve doubled my money, and will continue to hang on to these shares. It’s all about the land for me….