Friday, August 31, 2007

Two GPT's Report Earnings: Avoca (AVOA) and Bactolac Pharmaceutical (BTCP)

It's back to off-the-beaten path research this week, the kind that has made this site either very original, or painfully irrelevant depending on your point of view. (We won't be mentioning the Fed, Bernanke, subprime, commercial paper conduits, or any of the other more common themes currently being beaten to death in the financial media these days.)

We will disclose recent earnings for two pink sheet companies Avoca, and Bactolac Pharmaceutical (formerly Advanced Neutraceuticals). In recent years, both of these companies went through the process of reducing their shareholder roles below 300 through a reverse stock split. This allowed them to delist, avoid SEC filing and Sarbanes Oxley, eliminating the prohibitive costs associated with each.

Before we go any further it is important for readers to understand that Avoca and Bactolac are not liquid, in fact they rarely trade. As a result of the reverse splits, each company has less than 9,000 shares outstanding, and very wide bid/ask spreads:

So why write about them? We have followed these companies since before they delisted,(please search the site for previous research) and find the notion of companies effectively going "dark", yet still trading, to be fascinating. We believe that some of these situations can offer opportunity and may have a place in certain investor's portfolios. We took positions in both companies prior to their reverse splits, when liquidity was greater, and spreads were not as wide.

Keep in mind that despite the fact that neither of these companies is required to file financials with the SEC, both continue to update their shareholders; Avoca on a quarterly basis, and Bactolac less frequently.

Bactolac Pharmaceutical (BTCP)
Shares Out: 8613
Bid/Ask: $1350/$1700
Mkt Cap(bid): $11.6 million
Book Value/share: $2478
Tangible Book Value/share: $1600

For the six months ended 3/31/07 (they did not isolate quarterly results) sales rose 26% to $15.6 million. However costs rose as well, and operating margins dropped from 15.8% to 10.4%. The company cited higher material and production costs, higher quality control expenses, and customer resistance to price increases for the margin pressure. Net income was $835,000 or $96.95 per share, down from $117.79. Net margins fell from 8.2% to 5.3%.

One of the more inteesting facets of this report was management's discussion
of stock repurchases. The companies credit agreement does allow for limited stock repurchases from shareholders(as long as covenants are not violated), and they also occasionally purchase shares on the open market.

Of note, the company plans to expand, and will build a production facility on land it currently owns. The project is expected to be completed in the Fall of 2008, will cost $7,000,000, and will be debt financed.

Avoca (AVOA)
Shares Out: 8059
Bid/Ask: $6250/$6850
Mkt Cap(bid): $50.3 million
Book Value/share: $981
Tangible Book Value/share: $981

Royalty Trust Avoca, owner of 16,000 acre Avoca island, reported revenues of $1.45 million for the second quarter, down 51% from the same period last year. Net income
fell to $952,000, or $118 per share from $1.754 million, or $218 per share.

Revenue fell primarily due to the loss of production from one of the companies gas wells, Avoca No. 6-1, which expectedly went off production. Although the price of natural gas increased 1%, five of the six remaining wells saw declines in production. Natural gas production represented 80% of revenue in the quarter.

The balance sheet remains strong, with $465 per share in cash and short term investments, and $434 per share in long-term debt and equity investments. The company has no debt.

*The author has a positions in Avoca and Bactolac This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Tuesday, August 21, 2007

Levitt Corp(LEV): More Than Meets the Eye, or a Sinking Ship?

We are not big fans of home builders in the best of times (perhaps we are not smart enough to understand the business), and certainly not now given current market conditions. Many of these companies are down 50% or more year to date, and while the carnage can always get worse, we've got to believe there is some value in some of the names in the sector. But, in general, we'll leave that analysis to those that really understand the home building business and instead focus on one interesting story in the sector, that ultimately has little to do with homebuilding.

Levitt Corp (LEV)is a Fort Lauderdale, FL based homebuilder and real estate company that operates in the Southeast (Florida, North Carolina, South Carolina, Georgia). As of 12/31/06, the company had an inventory of 11,700 acres, 6900 of which were considered saleable (4100 in Florida, 2800 in South Carolina). The company's market cap is just north of $50 million, but a rather heavy debt load brings the enterprise value to about $650 million.

Like most homebuilders, Levitt has been crushed lately; from a 52 week high of $15.44, down to its current price $2.72. This company has truly taken a drubbing, as housing sector woes have worsened. Levitt reported a second quarter loss of $58.1 million, including a $63 million hiomebuilding inventory impairment charge.
It was an ugly quarter, as evidenced by these company reported "lowlights":

Second Quarter, 2007 Compared to Second Quarter, 2006
Total revenues of $127.8 million vs. $133.2 million
Net loss of $58.1 million vs. $737,000
Diluted loss per share of $2.93 vs. $0.04 per diluted share
SG&A as a percent of total revenue was 26.3% vs. 23.3%
Homes delivered (units) of 379 vs. 392
Gross orders (units) of 478 vs. 423
Gross orders (value) of $122.4 million vs. $119.6 million
Cancellations (units) of 187 vs. 91
Net orders (units) of 291 vs. 332
Homebuilding Division backlog (units) of 957 vs. 1,799
Homebuilding Division backlog (value) of $297.8 million vs. $609.2 million
Land Division third party backlog (value) of $29.0 million vs. $15.4 million

To add insult to injury, the January 2007 announced merger with BFC Corp was terminated last week, sending Levitt shares down 21%. Can it get any worse? Of course it can.

Bluegreen Corp (BXG)
But there is another side to this story. Levitt happens to own a 31% stake in resort and timeshare company Bluegreen Corp (BXG). At its currect market cap of $281 million, that values Levitt's BXG stake at $87 million, at a time when Levitt's market cap is just over $50 million. Granted, an ownership stake this large would no doubt command a discount if Levitt decided to unload it. But if BXG's price can hold up, this might just put a support level beneath Levitt shares.

Proceed with caution here, though, Levitt has a relatively heavy debt load, and is operating in an industry given up for dead.

*The author does not have a position in Levitt or Bluegreen. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Friday, August 17, 2007

Thanks, Uncle Ben

The markets got a shot in the arm today courtesy of the Federal Reserve's decision to lower the discount rate by .5%. Investors will rejoice today, because finally, the Fed heard their cries to open the discount window.

We are, of course, skeptical. We want the markets to go up. But we also believe that the Fed stepping in is:

A. An acknowledgement that this may get much worse before it gets better and
B. A band-aid that may stop a little of the short term pain, but will ultimately slow the process of the market working out built-in excesses.

So, today may be a good day for investors, but it's naive to believe this situation will abate because of the Fed's actions.

Wednesday, August 15, 2007

"Stay Calm, Relax, The Markets Always Come Back"

Does our title sound familiar? Perhaps not to avid Cheap Stocks readers, because we rarely, if ever, comment on the markets. You can get that anywhere. But tonight, as much as it goes against our grain, we are going to make a few comments.

Like it our not, what is currently happening in the financial markets is unprecidented. As much as pundits like to compare to the Long Term Capital Management debacle, the Asian crisis, (or insert your favorite era of market upheaval here), it is not the same. That does not mean that this won't ultimately pass, but is a reminder that we are always looking for comparisons, often fooling ourselves in the process. Makes us feel better as we watch our account balances shrink. We may be able to weather a downturn--if we aren't overleveraged, and forced to become panic sellers in the meantime, as long as we believe the return of the bull is just around the corner.

As investors, we have difficulty with down markets, (that's behavioral finance at work) difficulty with uncertainty, and we want downtrends to reverse: quickly. This time, maybe it will turn next week, or maybe it won't. We don't know. Anyone who claims they do, and ends up being right, is probably just very lucky. And, afterall, even a stopped clock is right twice a day.

The bottom line is that the markets, whether fixed income or equity, still run on a very basic principle, supply and demand. The highest quality piece of debt, or equity can languish if no one is buying--as value investors, this is something we know all too well. On the flip side, even a "dog with fleas", to quote Michael Douglas from Wall Street, can appreciate quickly if investors are buying- thats what we saw happen frequently during the tech bubble.

As asset backed securities (or ABS) continue to get crushed (more sellers than buyers)--even those of the highest credit quality that likely have little chance of default, as trouble in the hedge fund world continues, as some "quant" managers see their models failing, and as a small number of funds close their doors to redemptions, it is not surprising that volatilty has returned to equity land. Yes, it will ultimately end. But when? We don't know.

So what's the point of this diatribe? Just a venue for your Cheap Stocks editor to rant...albeit somewhat incoherrently. In all honesty, as painful as it may be, excesses in the markets need to be washed out from time to time, and that's exactly what we are in the midst of.

In all seriousness, if you are not a forced seller, and if you have some cash on the sidelines, folow the quality names you've had your eye on, or already may have a position in. You just might get your chance to buy some high quality names on sale. For what it's worth, in general, equities are not overpriced at this point. After today's action, the S&P trades at less than 15 times forward earnings.

Friday, August 10, 2007

Tootsie Roll Gets Smoked

Its been a wild ride the past few weeks as the markets once again wash out some of the built up excesses, (which however painful, is also very healthy) this time due to the "subprime" event (can we please wipe that word clear from our vocabulary....enough already) and the spectre of a credit crunch. Given the path that under-the-radar Tootsie Roll has taken the past few days, you would have thought it was a BBB rated ABS tranche.

The stock was down 14% today on four times normal volume, on the heels of a disappointing quarter. After hitting a 6 month high of $32.43 yesterday, the stock closed regular trading today at $26.48, for a $6 or 19% swing over just two trading days.

Margins Fall

Second quarter sales were up 7% to $101.9 million, from the same quarter last year. However, cost of goods sold rose substantially, lowering gross margins to 34.2% from 40.1%. The company cited rising ingredient and packaging costs for the margin pressure. Still, the company managed a healthy net margin of 10.2%, although that's down from 11.2%.

On the bright side, the balance sheet remains very healthy with cash and short term investments of $60 million, LT investments of $59 million, and split dollar life insurance of $75 million. LT Debt is negligible at $7.5 million; there is also $13.2 million in post retirment healthcare liabilities.

We've certainly not been happy with Tootsie Roll's performance since we've owned the stock. After considering cash and stock dividends, we are flat after 3 years. We are not rushing for the exits, because we still believe there is value in this very strong brand. However, we believe this company needs to be sold in order for the value to be unlocked.

Previous Cheap Stocks Tootsie Roll Research:

*The author has a position in Tootsie Roll Industries. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Tuesday, August 07, 2007

David Einhorn of Greenlight Capital Responds to our Latest St Joe's Post

We were happy to hear from David Einhorn regarding our recent St. Joes (JOE) piece. David thought we were incomplete in our representation of the analysis he presented at the May Ira Sohn Research Conference. We invited him to lay out his case, which is presented in this post.

While we respectfully disagree with his conclusion, and he obviously disagrees with ours, we find this type of debate very healthy. We happen to be long JOE, while Einhorn's firm, Greenlight Capital has a short position.

David Einhorn, Greenlight Capital on St. Joes Corp.
The per acre analyses used by most St. Joe bulls exclude selling expenses and taxes. I believe that the equivalent gross value to the $9,000 an acre used in your analysis is the equivalent of $18,000 an acre, when taking expenses and taxes into account.

As it was, I did not quantify any amount of swampland at the Ira Sohn conference. I simply noted that some of the land is swampland. The weather is much worse than South Florida (just as hot in the summer and cooler in the winter), there are a lot of mosquitoes, there is not a lot to do, and the demographics are poor. I noted that I thought St. Joe overplayed the value of land within ten miles of the ocean and noted that I thought that vacationers would prefer to be "on the ocean." More than a mile is too far for many families to walk to the beach. Finally, I thought the airport development is the type of story often seen in promotional stocks designed to buy years of time to encourage the market to ignore current financial results. The current airport does not operate near capacity. Airports in Jacksonville an Ft. Myers did not spur a lot of development next to their airports and it is odd the St. Joe seems to believe that a lot of people will want to live near the airport, as if that is a residential attraction.

As I pointed out in my speech, since 2001, St. Joe has sold 268,000 acres at an average price of under $2,000 an acre. Since my speech, St. Joe announced another quarter where they sold over 30,000 additional acres at $1,500 an acre. As such, I don't see that it is very challenging to determine a value for most of St. Joe's land. Assuming they haven't sold the most salable stuff first, it appears that undeveloped land is worth on average sub $2,000 an acre before expenses.

I believe that about 680,000 of the remaining 739,000 acres are similarly undeveloped. Assuming St. Joe has no un-salable tracts of swampland and all the undeveloped land could be sold for $2,000 an acre, it would be worth $1.36 billion gross or about $700 million after selling expenses and taxes.

St Joe has just under 20,000 acres in development (some of which has already been sold). They have an additional 21,000 acres "In Pre-Development", meaning they have land use entitlements, but they are still evaluating the development or need additional permits. They have another 10,000 acres they are planning to entitle.

The developed projects have a book value of $800 million. St. Joe is not making good margins on selling developed property. Residential and commercial land sales have not covered its overhead in any quarter since 2005, when it was still in the homebuilding business. St. Joe is one of very few companies that has spent large amounts on residential development and has not taken any impairment in the current environment. To give St. Joe the benefit of the doubt, let's say the developments could be worth 1.5x book or $1.2 billion.

On that analysis St. Joe is worth $1.9 billion. Subtract $400 million of debt, leaves $1.5 billion of equity or $20 per share. I believe that adding in the time value of money would take this analysis down to the $15 number I used at the conference.


We thank David Einhorn for agreeing to let us publish his response. Why would we agree to have a well-known manager present his views that are contrary to ours in a stock we have a position in? We happen to find the debate refreshing, and even helpful to investors as they seek information.

*The author has a long position in St Joes Corp. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.

Thursday, August 02, 2007

What's Wrong with JOE?

We last featured Florida land giant St. Joes(JOE)this time last year when we compared it to the New Jersey island on which we have a summer cottage. At the time, we surmised, our island was terribly overpriced compared to St. Joe's. If there was a way we could have shorted our beloved little island (without selling our cottage, that is), and used the proceeds to go long St. Joes, we would have. One year later, our little island has slowed down. Some of the same houses that were for sale this time last year still have not moved. We also see more "For Sale" signs, par for the course given the housing slump, yet prices don't seemed to have fallen all that much. Go figure.

Meanwhile, all is not well in St Joes land, at least that's what Mr. Market is telling us. The stock is down nearly 20 percent since last summer, and after hitting more than $60 in February, is off 33%. Certainly trouble in the housing market, and a slowing Florida real estate market are the main contributors, but a skeptical Wall Street has also added to St. Joe's woes.

At a May Ira Sohn Investment Research Conference, Greenlight Capital co-founder David Einhorn painted a bleak picture of JOE, suggesting, among other things, that half of the company's land is swampland, and that on a DCF basis, the company is worth but $15 per share. Since this conference, the stock has tanked. Although Einhorn raised a few eyebrows with his talk--even Jim Cramer mentioned the ST. Joe swampland connection--the pullback has more to do with the asset repricing that many real-estate related firms are currently experiencing in the wake of the housing slowdown, and subprime "event".

While we disagree with Einhorn's assertion about the quality of St Joe's land, lets assume that half of it is actually swampland. Further, for calculation purposes, we'll assume that it is completely worthless.

As of the most recent quarter, St. Joes held 739,000 acres, 331,000 of which were within 10 miles of the Gulf of Mexico. If half of these acres were worthless (which again, we don't believe is the case), and we value the entire company on an enterprise value to acre basis, we get $9,242 per acre:

Market Cap: $3.0 billion
Plus Debt: $428.5 million
Plus minority interest: $7.4 million
Minus Cash: $20.2 million

Enterprise Value: $3.415 billion
Half acreage: 369,500
EV/Acre: $9,242

Florida land for less than $10,000 per acre, given the location, does not seem at all unreasonable. Keep in mind, our EV/acre calculation does consider the company's debt, but places no value on any of the company's other assets, and values half the land at $0.

Einhorn simply views Joe on a much different basis than we do. Discounted Cash Flow analysis can be an extremely valuable tool in order to value a business, and indeed, theoretically, the value of a business is the present value of future cash flows. But any analysis that discounts cashflows is completely dependent on the inputs used in the calculation. A slight change in the inputs can have a drastic influence on the resulting value.

But, in any event, we view JOE as an asset play, one that might ultimately be acquired. We'd view additional weakness in JOE as a buying opportunity.

*The author has a position in St Joes Corp. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.