Saturday, October 27, 2007

Remembering Milton

Today, we take a break from our typical research, in order to pay tribute to a great man, my grandfather Milton, who would have been 100 years old today. This is the follow up to our June 16 piece: Remembering Clyde. Both Clyde and Milton played a large role in my life, and Cheap Stocks is dedicated to their memories: Two extraordinary men who exerted influence they never comprehended. (If anyone still wonders where my pen name Clyde Milton comes from, mystery solved.)

My grandfather was an Englishman, through and through. The son of a potter in Trenton New Jersey, his dry sense of humor, the jokes he told, the scotch he drank, and his calm demeanor-nothing rattled him-all pointed to his English roots. Times were generally tough during his youth-the Great Depression left its mark on nearly everyone who experienced it.

Like many in his generation, he came through it fine. Milton worked hard to put himself through college-The University of Pennsylvania-and graduated at age 25 with a degree in architecture. He was very talented, and had genuine skill as an artist; paintings from his Penn days adorn our walls. (I often wish that his talents had been passed down to yours truly.) He ultimately became President of a well-respected NJ architectural firm, a position he held until forced retirement at age 65.

My grandfather was a quiet man…usually. Other times, he could talk your ear off. But his calm presence was very soothing. I never saw him get mad. Never saw him blue, or down. He whistled constantly, and the trials and tribulations of life never seemed to get to him…(another trait that skipped yours truly!) He dealt with some tough issues, but seemed to always come through it smiling. Although he did not talk about it, his faith was strong.

The Englishman was also stubborn at times. When he built his house in the late 30’s, all the houses on his block were numbered in the 300’s. This made no sense to him given the numbering of houses on parallel streets in the neighborhood. He believed his street should have naturally been the 500 block. So what did he do? He changed the number on his house to 523, while his neigbors houses were all in the 300’s!

Stubborness was one thing, respect was another. While Grandpop liked his scotch, his parents were opposed to drinking. When he learned one day in the late 1950's that his father was heading down to his shore cottage to do some repairs, Milt remembered that there were liquor bottles in a kitchen cabinet. Out of respect for his father, Milton, a 50+ year old successful businessman, ran out of his office like a bat out of hell in order to head his father off, and dispose of the alcohol! All of this, out of respect for his parents and their beliefs.

My grandfather had the foresight in 1956 to do something that has impacted many in my family to this day. It was then that he purchased a small cottage on Long Beach Island, a skinny strip of sand off the NJ coast that is still a huge part of our lives. More than 50 years later, that cottage is still in the family, and has been the site of some amazing family time over the years. We’ve laughed there, we’ve cried there, we’ve forged bonds and strengthened family ties, and been the beneficiaries of a gift that fewer and fewer extended families have these days….we remain close, and genuinely care about one another.

Grandpop would no doubt be proud to know that what was once one house in the family on this little island, has now grown to three. LBI is our home in the summer, and we flock to it like moths to a light. It is our refuge, our place to find peace, to laugh, to love, to enjoy one of God’s beautiful creations. The times we’ve had there, the relationships we’ve built, and the wonderful memories that are continually made are all a result of my grandfather taking a chance more than 50 years ago, and putting $11,000 on the line. He loved that little cottage, that little island, and I’d like to think that the old Englishman would be smiling if he knew how much we loved it as well. He would laugh if he knew that my son is named after (middle name) our little LBI beach town.

I’m sure he would be proud of how his family has blossomed. When he passed away, there were two great-grandchildren. Now there are 13 and 1 more on the way! He would have been proud of how his children have conducted their lives, and how their children have grown up.

I was fortunate to spend a summer with him in that little beach cottage in the summer of 1986. I worked there that summer, kept an eye on him, and made sure he was well fed. Too well fed, I later found out. Grandpop was diabetic, and his blood sugar skyrocketed the summer I spent with him. Thankfully, there was no long-term effect of our "debauchery", and I am fortunate to have experienced a summer with my grandfather.

As grandchildren, we found in him a sense of peace, and of calmness. We have very fond and distinct memories of our grandfather. Long walks on the beach, the daily Grandpop "death float" in the ocean, the little jokes repeated over and over, his presence in our homes, at our ballgames, in our lives. He was Grandpop, we loved him dearly. How I wish he could have been present at his grandchildren's weddings, at the their children's christenings, and all of the other events he truly lived for.

When he passed away at 84, we celebrated his life. This weekend we will celebrate it once again....on Long Beach Island, the place he loved so dearly. We miss you Grandpop. You meant a great deal to all of us, you influenced us all, and we are blessed to have had you in our lives. Happy birthay.

Thursday, October 25, 2007

4Kids Entertainment Finally Rolls Out Chaotic (KDE)

After several delays over the past several months, 4Kids Entertainment unveiled its Chaotic trading card game and website on 10/24.

We were drawn to KDE initially because of its solid balance sheet ($106 million in cash, no debt) and fact that it traded (and still trades) at less than twice net current asset value. We viewed the Chaotic rollout as a major "potential" catalyst; "potential" because of the frequent release delays prior to our initial position. The hope is that Chaotic lives up to its potential as a Webkinz-like phenomemon. Of course, its way to early to tell whether that will be the case.

For more, see our initial 7/4 KDE post.

4Kids Entertainment
Ticker: KDE
Price: $15.94
Cash & S/T Invest: $106 million
Market Cap: $211 million
NCAV: $117 million

*The author has a position in 4Kids Entertainment (KDE). 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, October 19, 2007

(Bizarre)Lazare Kaplan International (LKI): Going Private?

Diamond company and perennial net/net Lazare Kaplan International recently issued its latest proxy. Like most proxies, the items to be voted on at the November 8th annual shareholders meeting are fairly routine. That is, with the exception of the third item.

The company is asking shareholders to vote on the following company sponsored proposal:

“To consider and vote on a proposal to amend the Company’s Certificate of Incorporation to effect a reverse stock split immediately followed by a forward stock split of the Company’s shares of common stock..”
There’s nothing strange about a reverse stock split, it happens fairly often. But what Lazare Kaplan is proposing is a bit different. The company wishes to initiate a 1 for 101 reverse split, buy out any shareholders with less than 1 share post split, followed by an immediate 101 for 1 forward split. Say what?

Lazare says that this will allow the company to buy back stock from any shareholder that currently holds less than 100 shares. The company cites savings of $25,000 per year by eliminating the $11.50 annual fee associated with each company shareholder for transfer agent fees, and printing/postage costs associated with mailing shareholder reports. All this effort for $25,000 in annual savings? We think there’s more to this story.

Setting itself up to go Private?
According to the company, as of September 14th, 2007 there were 1709 shareholders of record, 1644 of which held less than 101 shares, which means that 96% of the registered shareholders own just .045% of the outstanding shares. If Lazare can buy these shareholders out, that will leave just 65 shareholders of record, well below the 300 threshold necessary to de-list, avoid SEC filing and SarBox, while still being able to trade on the Pink Sheets (a situation we’ve covered in several previous posts).

While we believe there are indeed cost savings in eliminating shareholders with small lots, we believe the real reason for the split is to “go dark”. We’re not sure why they just don’t acknowledge that in the proxy. Perhaps they don’t want to draw more interest and attention, and actually increase shareholder roles. We believe that there’s sometimes value to be had in these situations, and Lazare may want to keep its true intentions close to the vest.

For our part, we are still long Lazare Kaplan, and might just have to attend the shareholder meeting and ask the question.

Lazare Kaplan Intl
Ticker: LKI
Price: $7.55
Mkt Cap: $62.4 million
NCAV: $70 million
Mkt Cap/NCAV:1.12
Book Value/Shr: $11.30
Price/Book: .67

*The author has a position in Lazare Kaplan (LKI). 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, October 12, 2007

It's Still Boring in Net/Net Land;The Homebuilders are Clogging our Initial Net/Net Screen

Something strange began happening a few months back when we ran our net/net screen. The list of companies trading below their net current asset value was chock full of homebuilders. It’s not surprising in one sense, due to the troubles in the housing markets, homebuilders have been pounded: 50, 60, even 70% drops. As a company’s market cap falls, and net current assets don’t fall as much, the relationship between net current assets and market cap decreases, increasing the likelihood of trading below NCAV.

But, despite the screens we run, we don’t typically include homebuilders on our net/net list. Why? It’s a data issue. More on this later.

Many readers have inquired over the years as to how we come up with our list of net/nets. It is not as simple as running a stock screen and printing the results, although that is where the process begins. All you need to start here is data, namely the ability to add and subtract the components of the NCAV formula, and compare them to market cap. This is quite easy to do with some of the big name market data providers. The hard part is digging into the data to verify that the companies actually meet your desired screening criteria. (The harder part is trying to distinguish between a "cigar butt", and company with possibilities.)

There are a number of issues that can arise in the initial screening process, we’ll name a couple. First, there can be a lag in the fundamental data. Some data providers don’t get around to crunching the numbers on the micro-caps—typical net/net candidates—until well after the financial statements are actually released. So you can end up with older balance sheet data, compared to current market cap data. This can be very misleading. So, we’ll actually dig into the latest SEC filings, and verify the data manually. Second, data screening tools are not always 100% accurate. We’ve found many cases over the years where screening tools reveal net/nets that upon further inspection don’t actually meet the screening criteria. We’re not sure why this happens, but the bottom line is that stock screening tools are not foolproof.

Back to the Homebuilders
The reason we typically ignore homebuilders is because of the way they classify accounts on their balance sheets. Typically, these companies have “unclassified” balance sheets, which means that they don’t distinguish between current and non-current assets—essential data in the net/net methodology. But in the data standardization process that some equity fundamental data providers employ, homebuilder balance sheets are re-classified into current and non-current assets and liabilities. Given this fact and recent price action, it’s of little surprise that these companies are initially screened as net/nets.

This is no knock on the data providers themselves. One that follows this process is Bloomberg, which probably has the best Equity Fundamental product in the business.

We’re just not comfortable applying the net/net methodology to homebuilders. They are an entirely different animal in terms of valuation and structure. Inventories are typically relatively large relative to total assets; while this account is typically a current asset for companies in most industries, we're not sure this applies to homebuilders--especially now.

In any event, as the markets continue to head upward (at least for now), we're not finding many worthy net/net candidates these days. Stay tuned though, the markets have a unique ability of doing the unexpected.

Friday, October 05, 2007

Trading Illiquid Stocks

By now you know that some of the companies we cover at Cheap Stocks are thinly, or in some cases, rarely traded, and this brings with it a whole host of challenges and risks. These include difficulty in establishing, and exiting positions.

We recently closed a position in such a company, Bactolac Pharmaceuticals BTCP), and thought it would be both interesting and informative to detail the process, and results.

We initially purchased Bactolac(BTCP)when it was known as Advanced Nutraceuticals(ANII), and prior to the company's 1 for 500 split, so liquidity was not an issue in establishing the position. Howewer, post split, there were less than 9000 shares outstanding, and little, if any trading.

When we decided to close the position, the bid/ask was $1400/$1700. (One place to find this information is the Pink Sheets Website; which we recommend checking before you check with your online broker).
Although we were content to exit at $1400/share, we decided to to place a limit order at a higher price. It took 3 days, and 4 different orders to finally close our position:

Day 1: Placed limit order at $1600/share
Result: Order was not filled

Day 2: Placed limit order at $1550/share
Result: Order was not filled

Day 3: Placed limit order at $1500/share
Result: Order was not filled
Changed order to limit $1425
Result: Order was filled at $1450/share

The point is that there are risks in trading illiquid stocks.
1. Be very careful not to place market orders, because you may end up establishing a position at a much higher price than you intend.

2. Don't purchase illiquid stocks unless you can hold for an extended period of time. Being a panic seller here can and will be extremely costly.

3. When you decide to sell, be aware of the bid/ask prices. Don't place market orders, and be aware that if you do place a limit order, there is no guarantee that your entire order will be filled.

4. In general, don't allocate too much of your portfolio to illiquid stocks. We believe there are some great opportunities out there, but you should limit this to a small percentage of your portfolio.

*The author does not have a position in Bactolac Pharmaceuticals. 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, October 02, 2007

JG Boswell Soars (BWEL)

Shares of cotton and farming giant JG Boswell, owner of an estimated 142,000 California acres, and another 30,000 in Australia, soared $73 today to an all-time high of $900 on volume of 251, and you guessed it, no news. We’ve owned BWEL shares for years, have reported on it several times in the past, but the company still remains somewhat of a mystery.

Certainly, the appeal of this company is not in its farming operation, which although impressive in its own right, merely represent the current use of assets which might ultimately be much more valuable used for other purposes. The company continues to develop its Yokohl Ranch project, a master planned community in Tulare County California, but the real gem may lie beneath the land: massive amounts of water that may be worth several billions. "May" being the operative word.

We were fortunate to obtain a copy of the company’s 2006 annual report, which we are embarrassed to admit is the first one we’ve ever seen. (We have seen financial statements from the $325/share company tender offer documents circa 2002-2003)

Here are the Highlights for the year ended June 2006:

Price: $900
Dvd Yield: 1.56%
Revenue: $386.58 million
Net Income: $19.744 million
Diluted EPS/shr: $20.41
Current Assets: $196.741 million
Cash: $5.475 million
Total Assets: $616.957 million
Current Liab: $138.637 million
Short Term Debt: $80.8 million
Long Term Debt: $0
Stockholders Equity: $430.209 million
Shares Out: 956,759
Book Value Per share: $449.55
Market Cap: $861 million
Enterprise Value: $936 million
Enterprise Value/California Acre: $6591

Based on just the California land, we estimate Enterprise Value/Acre to be less than $6600, and that ignores any value in the Australian land. We hope to obtain a 2007 annual report, when available.

*The author has a position in JG Boswell. 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.