The investment manifesto (1½/2)

You can read the first part of The investment manifesto (1/2) here.

The exclusion process

In the previous post on the investment manifesto I ended with a presentation of my margin of safety definition. The purpose of that definition is to sort out those companies that I won’t allow myself to invest in. In a sense, I use my margin of safety definition as a exclusion process. In other words, the exclusion process is a negative screen to sort out companies that I don’t think I can satisfactorily determine their downside protection. Those companies get excluded and automatically put in my too-hard-pile. Thinking about investing, at least initially, as a negative art, what you don’t want to own, is an underappreciated approach in my opinion. This is based on a belief that risk- (i.e. permanent loss of capital) control should be the main emphasis for all investors. A quote that reminds me of the importance of controlling risk is this one:

“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” – W. Buffett

However, a quote that in my opinion best explains the reason for the importance of risk control is this one:

Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep on average. Margin for error gives you staying power and gets you through  the low spots. – H. Marks

Or as one of my favorite authors stated in his newly published book Skin in the Game:

“In order to succeed, you must first survive.” – N. Taleb

The statements and thinking above goes back to my belief that only after one has established a population of ideas with solid downside protection should one move on and start to think about their upside potential. In conclusion so far, downside protection (survival) is more important than upside potential (returns) as one starts to think about which companies to invest in. As you will see in this post, I won’t go as far as; Focus on the Downside, and Let the Upside Take Care of Itself, but almost…

The inclusion process

The population of companies that have survived the exclusion process I termed; The Liquidation Oxymoron’s in the last post. If you haven’t already figured out my reasoning for choosing this name I’ll make sure to explain it now. The companies that have survived the exclusion process all fit under the following oxymoronic statement;

They are going concerns selling below their liquidation value.

My belief is that the population of liquidation oxymoron’s creates a powerful starting point of companies to potentially invest in. The basis for that belief is that the oxymoronic statement establish that there exists a fundamental difference between consensus and value for these companies. In a recent post you can read about why I consider this difference to be the most important thing to establish and take into consideration if one strives to be a successful investor: Consensus is what you pay; the relationship between consensus and value determines what you get.

But now, let’s move on from the margin of safety and downside protection argument and take a look at my inclusion process. The positive screen if you like. I will divide the presentation for this process under three headings; 1) upside potential, 2) catalysts and 3) other factors and characteristics. Remember, the companies I look at during the inclusion process (the companies that have survived my exclusion process) are all potential investment ideas that I would be willing to invest in. More specifically, the inclusion process is about determining if I’m going to invest in company A, B or C at a certain point in time. I will come back to my reasoning for this approach of picking stocks when I present my thoughts for the buying- and selling process for the Liquidation Oxymoron portfolio.

Upside potential

As you would expect, most companies get excluded as a result of the first criteria in my margin of safety definition. That is: Selling below liquidation value (i.e. price below readily ascertainable net asset value = raNAV). The reason why I have put this criterion first is because I think the valuation aspect as it relates to downside protection is the most important one, independent of how one defines “value”, to take into consideration as an investor. Furthermore, I think the same holds true about the valuation aspect from an upside potential perspective. Again, if you are interested in my reasoning for these statements you can read more about that topic in the following post: Consensus is what you pay; the relationship between consensus and value determines what you get. 

However, the valuation aspect is far from what describes the complete picture regarding the upside potential of companies. Unlike the margin of safety definition that should be developed individually, the definition for upside potential is an universal one I would argue. The best way, in my opinion, to think about upside potential is to think of a return formula with three components. One should note that I’m by no means the inventor of this formula. For this I would like to give credit to Fred Lui at Hayden Capital and more specifically his Investor presentation and Calculating Incremental ROIC’s presentation but also John Huber at the Base Hit Investing blog and all posts on ROIIC.

What the two investors just mentioned have concluded is that the upside potential (i.e. future returns) is to be determined by the following three components (some minor adjustments done by me). I have termed this the return formula:

1. Intrinsic value compounding yield (ROIC × reinvestment rate = earnings growth)
2. Shareholder yield (stock buybacks / issuance + dividends + net borrowings)
3. Valuation yield (valuation multiple expansion / contraction)

= upside potential (i.e. future returns)

Although the return formula might seem like a manageable calculation exercise one should not be fooled into a sense security or precision. In investing, should happen ≠ will happen. Therefore, I would again like to stress the importance to only engage with the return formula once one is done with the exclusion process. Furthermore, I would like to point out that one should not cry oneself to sleep if one struggles with all the components of the return formula. For some investment ideas, the calculation of intrinsic value compounding yield will almost be impossible to calculate. Or it might be almost impossible to determine what a fair valuation multiple is for a specific investment idea. Nonetheless, those statements begs the question: Should one stay away from companies for which you can’t calculate their upside potential?

My opinion is; no, companies whose upside potential that is hard to determine should not per definition be avoided. Rather, the important aspect is the certainty of the fundamental difference between consensus and value of the company for which you are trying to calculate upside potential. For me personally, this goes back to my thinking and reasoning for the name of the Liquidation Oxymoron’s and what that name implies. Or explained in a more colorful way with the help of one of my favorite quotes in investing:

“You don’t have to know a man’s exact weight to know that he’s fat.” – B. Graham

In conclusion, I will always try to calculate upside potential based on the return formula stated above. For some investment ideas this calculation exercise will be quite thorough and detailed (e.g. HEL:SAGCV, analysis not published). For some investment ideas (e.g. NASDAQ:GIGM, analysis not published) I will more or less fall back on my assessment that the company is a Liquidation Oxymoron (i.e. makes it through the exclusion process) with high certainty in regards to the current fundamental difference between consensus and value. In conclusion, I will not exclude or rank the Liquidation Oxymoron’s population based on the outcome of their return formula calculations. Rather, I will rank the investment ideas in terms of my conviction for their upside potential, i.e. most probable upside potentialIn order to make such an assessment I have to take into consideration potential catalysts and other factors and characteristics for the Liquidation Oxymoron’s.


The circumstances for what a posteriori is determined as the catalysts is hard to determine and arrive at a priori. I’m not the first one to make this unsatisfactory conclusion as the following statement from 1955 will show:

Skärmavbild 2018-03-04 kl. 16.24.09
p. 544

Related to the statement above is his famous quote:

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” – B. Graham

Although I ascribe to the belief that value is its own catalyst there are nonetheless some circumstances and signs that I keep my eyes open for when I’m to determine my conviction for the Liquidation Oxymoron’s upside potential. Furthermore, the reason why catalysts, other than the mentioned realisation of value from Mr. Market over time, are important to take into consideration has to do with the time factor of investing. Specifically, these catalysts have the potential to unlock value in a direct and fast manner. I would argue that the time factor is an important component if one, like myself, think in terms of CAGR.

For the Liquidation Oxymoron’s I will specifically evaluate and take into consideration any signs of:

  • shareholder activism.
  • major asset sales, spinoffs or mergers plans.
  • acquisition and/or expansion plans.
  • dividend and/or share buyback plans.
  • buyout or takeover plans.
  • changes in management.

Note that what I have stated above is not to be considered an exhaustive list of catalysts. Rather, the evaluation of potential catalysts and their respective probabilities has to be done on an idea per idea basis since they will be highly individual and context dependent.

Other factors and characteristics

The factors and characteristics I will mention below are not to be considered “make it or break it” components for the investment ideas of the Liquidation Oxymoron population. Rather, they are factors and characteristics that have the potential to improve both the upside potential and the probability of upside potential. As you will see, non of these are original or special in any way but should in my opinion nevertheless be taken into consideration during the stock picking process:

  • Small market capitalisation (preferably nano or micro cap).
  • The trading of the company shares is illiquid.
  • Large insider ownership and/or insider are recent net-buyers of company shares.
  • Reasonable insider pay.
  • Famous deep value investors on the shareholder list and/or they are recent net-buyers of company shares.
  • Company has improving fundamentals (e.g. high F-score).
  • Low-level of debt or high level of debt but the company is aggressively paying down debt.
  • Company has historically paid dividends.
  • Company has historically been net-buyers of company shares.
  • Company conducts business in a stable and/or boring industry.
  • Company has been active for some time (preferably more than ten years).
  • Company shares are currently trading near historical lows.
  • The company is not a perennial Liquidation Oxymoron (i.e. the company has historically trade above raNAV).
  • A big portion of raNAV consists of cash and cash equivalents.
  • Company has hidden/undervalued asset values not reflected on the balance sheet.
  • Positive or low raNAV burn-rate.
  • Low valuation compared to operating earnings and/or free cash flow.

Again, the list above is not to be considered an exhaustive list of factors and characteristics that should be taken into consideration during the inclusion process. The ones mentioned above I usually consider but I might retract and/or add factors and characteristics to the list in the future.

The buying- and selling process

Similar to the situation for the first post on the Investment Manifesto, this one became longer than I had expected. As a result, I will save my thoughts and ideas about the selling- and buying process for the Liquidation Oxymoron portfolio for yet another post. I promise, this will be the last part in my series of post related to the Investment Manifesto.

The investment manifesto (1/2)

It’s been a while since I last posted anything here on the blog. I’m sure that this isn’t the last time I zoom out and remain silent for a while. In the end, although I’m always interested in hearing your thoughts and getting your feedback, I write for an audience of one, me. If that selfish audience is not keen on or have the time to listen the blog will be a quiet one from time to time. I hope you understand.

Nonetheless, after a long break I will try to distill the mess of thoughts that have accumulated in my head and in this case present the reason why I haven’t posted anything “portfolio related” since the mid of July.

A clean sweep

Although I haven’t posted anything you might have noticed, if you had a look at the Portfolio-page, that I sold all previous holdings during the last couple of months. In order to understand the why-question for my reason to do so I would like to start with a underappreciated Warren Buffett quote from the 1998 Berkshire shareholder letter:

Once we knew that the General Re merger would definitely take place, we asked the company to dispose of the equities that it held. (As mentioned earlier, we do not manage the Cologne Re portfolio, which includes many equities.) General Re subsequently eliminated its positions in about 250 common stocks, incurring $935 million of taxes in the process. This “clean sweep” approach reflects a basic principle that Charlie and I employ in business and investing: We don’t back into decisions. Berkshire Hathaway Shareholder letter 1998

What caused me to do a clean sweep of my previous portfolio holdings was that I came to develop a new investment manifesto. Rather than retrospectively trying to fit my previous investment decisions into the new manifesto I decided that the approach applied by Buffett and Munger would be a good and reasonable one for me as well.

One could question the rationality behind the clean sweep since the approach I had used up on till that point in time had worked out fairly well. On that note, I would like to stress that the development of a new manifesto is not a reach for more alpha or that I was dissatisfied with the track record that I had produced up on till that point in time. To the contrary, I realize that the new manifesto could possibly produce a worse outcome than a simple quant based approach. Especially in the short-term. However, at the core of my investing foundation is a firm belief if one is to be a long-term successful investor one should always focus on improving the process applied not the outcome. In other words, focus on what you can control. Over periods of time I will therefore be more than happy to look like a fool and have an audience that questions the rationality of my decisions as long as I believe that the process I apply is the correct one for me. Note that I in the previous sentence say the correct one for me not the correct one in some form of absolute sense. We will come back to this almost egocentric view of investing and its importance several times during the presentation of the manifesto.

The seeds to a new manifesto

Before presenting the process behind my new investment manifesto I would like to share the story and the circumstances that lead to its development.

At the start of the summer I decided that it was time for me to read all the Berkshire Shareholder Letters since I haven’t done so previously (you can find my extracts of wisdom from all the letters here). Defining oneself as a value investor, not having read the Berkshire letters is like being a Christian not having read the Bible. The same could be said about not having read Poor Charlie’s Almanack which I read and then re-read during the period I was reading the Berkshire letters. Having read all the Berkshire letters and Poor Charlie’s Almanack twice I could honestly say that I was on the brink of leaving the classic value investing school for the more modern value investing school. Still to this day I agree on almost all of Buffett and Munger’s points of argument as it relates to the advantages of the modern value investing school and their rational for leaving the classic school of value investing. But after countless of days thinking about a possible change I still came to the conclusion that the modern approach would be too hard for me to implement successfully.

Both Buffett and Munger are famous for the too-hard-pile analogy as it relates to individual investment ideas. I would argue that the concept can equally be applied to investment philosophies in general and their implementation. Placing an investment idea in the too-hard-pile will be a personal dependent evaluation and the same should be true for the investment philosophy too-hard-pile. I would argue, in the same way as one has to have conviction in the ideas that one invests in one has to have an even larger conviction in the philosophy that one applies. This off course has to do with the ability to “stick to your knitting” in both the good and the bad times. Not having conviction in your philosophy and your ability to successfully implement it will bring out the worst enemy of them all, you.

The investor’s chief problem – and even his worst enemy – is likely to be himself. – Benjamin Graham

Even though I was not “transformed” in the same way that Buffett once was by Munger I will without hesitation say that reading the Berkshire Shareholder Letters and Poor Charlie’s Almanack is by far the best “investments” I have made in my “investing life”. As you will see in the investment manifesto below, there are now principles at the core of it inspired by Buffett and Munger that did not exist before. These where the seeds to the new manifesto and has since then evolved into its absolute foundation. As many others do, I owe them a lot of gratitude.

Four investment principles

Sound investment principles produce generally sound investment results – Benjamin Graham

As it relates to Benjamin Graham’s quote above I would like to use the famous Munger expression:

I have nothing to add. – Charlie Munger

Therefore, I thought I would go straight to the point of presenting the four core principles of my investment manifesto (if you have read Poor Charlie’s Almanack you will recognize them):

1. Preparation. Continuously work on investment idea generation and the accumulation of mental models and worldly wisdom.

Opportunity meeting the prepared mind: that’s the game. – Charlie Munger

2. Discipline. Stay within the boundaries of the investment manifesto.

You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital. – Warren Buffett

3. Patience. Be selective and cautious in the buying- and selling process.

Resist the natural human bias to act. – Charlie Munger

4. Decisiveness. Believe in the investment manifesto and execute accordingly.

When proper circumstances present themselves, act with decisiveness and conviction. – Poor Charlie’s Almanack

Margin of safety

Beyond the four principles, but still at the heart of the manifesto, lies a focus on the concept of margin of safety, i.e. downside protection. By focus I mean that only after one has established a population of ideas with an adequate margin of safety one should move on and start to think and rank the ideas remaining in terms their possible return opportunities, i.e. upside potential.

The concept of margin of safety was first developed (as far as I know) by Benjamin Graham and David Dodd in the classic value investing book Security Analysis that was first published in 1934. However, I think most investors that are familiar with the concept relate it to the 1949 book by Graham, The Intelligent Investor, and more specifically the last chapter in that book called “Margin of safety as the Central Concept of Investment”. As most of you will know, “the margin of safety” is a wide concept and one that has been defined in a variety of ways by both Graham himself and many others since the books first publications. In my opinion, there is nothing wrong with that. To the contrary, I would say that it is both natural and needed considering the variety of investing philosophies in existence and more specifically how one defines the concepts of value and risk. However, I would argue that the margin of safety purpose is a universal one that all can ascribe to (?). In my opinion that purpose was best defined in the original text of The Intelligent Investor:

It’s available for absorbing the effect of miscalculations or worse-than-average luck. – Benjamin Graham

Based on the definition for the margin of safety purpose and with the help of little inversion we can narrow in on my definition of margin of safety. Again, note that what I present below is my definition of margin of safety not a universal one. I would strongly suggest that one goes through the same process as I present below in order to come up with a definition that is your own.

In order to make the starting point of the margin of safety definition process a little bit less vague consider the following excerpt from Poor Charlie’s Almanack:

Why should we want to play a competitive game in a field where no advantage – maybe a disadvantage – instead of in a field where we have a clear advantage?

We’ve never eliminated the difficulty of that problem. And ninety-eight percent of the time, out attitude toward the market is … [that] we’re agnostics. We don’t know. […]

We’re always looking for something where we think we have an insight which gives us a big statistical advantage. And sometimes it comes from psychology, but often it comes from something else. And we only find a few – maybe one or two a year. We have no system for having automatic good judgement on all investment decisions that can be made. Ours is totally different system.

We just look for no-brainer decisions. As Buffett and I say over and over again, we don’t leap seven-foot fences. Instead, we look for one-foot fences with big rewards on the other side. So we’ve succeeded by making the world easy for ourselves, not by solving hard problems. – Charlie Munger

In other words, your margin of safety definition process should start by focusing on what you define as “no-brainer decisions” or “one-foot fences” to hurdle over and where you believe that you have a “big statistical advantage”. The outcome of that evaluation will allow you to invest in ideas where the purpose of the margin of safety concept will likley be fulfilled. I won’t, since I can’t, go into details about the specifics of the evaluation process for me personally. This is something that has taken years to develop and where the number of inputs now are numberless. Therefore, note that what I will present below is only the end product of a long evaluation process.

My margin of safety definition

Based on my investment beliefs and my accumulated investing knowledge I have developed my margin of safety definition. The population of companies that fit into this definition I call The Liquidation Oxymorons. These will constitute the population of companies that I’m allowed to invest in, i.e. they have an adequate margin of safety:

1) Selling below liquidation value (i.e. price below readily ascertainable net asset value)

2) Proven business model (i.e. historically profitable)

3) Sound financial position (i.e. low risk of bankruptcy)

4) Shareholder friendly management (i.e non-fraudulent management with a thoughtful capital allocation track record)

If you are an old reader of the blog you will find similarities in the above definition to the investing checklist I have previously used (see for example this post about PFIN). That is true. Whats has changed is that evaluation process for each of the four criteria is now qualitative rather than quantitative. Again, if that is a rational and wise move, especially from a return perspective, remains to be seen.

Since the post became longer than I first thought I will split it up into two parts. In the next post I will present the stock picking process for which companies from the Liquidation Oxymoron population to invest in, i.e. the evaluation of upside potential and catalysts. I will also present the guidelines for the manifesto’s portfolio construction and the selling process.

Follow-up and portfolio update

1kr50öreIt has been a while since I published anything. Therefore I thought it would be a good idea to sum-up what has happened in the portfolio over the last couple of months before I move on to post new stuff on the blog. The attentive reader will notice that two companies in the portfolio (IndigoVision Group plc and AG&E Holdings, Inc.) have “expired” follow-up dates but are not included in this follow-up and portfolio update post. I will get back to these two companies in the future.


Hargreaves Services plc (sold 2017-05-17) was one of those net-nets with favourable going-concern characteristics but was nevertheless valued well below liquidation value by Mr Market (see checklist analysis in Swedish). The fact that the company is/was a coal-producing and -distribution company most certainly had something to do with the valuation. However, as with most net-nets the pessimism and negative factors are often well priced into the market valuation. Small improvements can therefore have huge upside effects. In the case of Hargreaves the future started to look a little bit brighter during my holding period. For example, the company experienced increase in both price and demand of coal and substantial assets on the balance sheet proved to be more valuable than their current stated book value. Over my thirteen month holding period the stock went from 166 GBX to 328 GBX and from a valuation perspective the company went from a net-net to selling just below its tangible book value. I concluded on the follow-up date that the margin of safety no longer was in place as a result of the increased share price in relation and that I should sell my position. The return after tax, currency effects and brokerage fees for Hargreaves amounted to 93%.

Arden Partners plc (sold 2017-05-26) shared many similarities with the Hargreaves when bought. It is/was a British company with good going concern characteristics while simultaneously selling well below liquidation value (see checklist analysis in Swedish). Also, similar to Hargreaves the company was conducting its business in an unloved industry. Arden is/was a small in this case a stockbroker that provides a range of financial services to corporate and institutional clients. However, unlike Haregreaves the outlook and corporate fundamentals for the company didn’t improve during my holding period. To the contrary, the liquidation value eroded and the company’s operating losses increased. Right on time to my follow-up date the company announced that it intended to issue new shares worth approximately £5.0 million. For a company with a market value of £13 million that would result in a pretty hefty dilution. For me this was the final nail in the coffin and I decided to sell my position on the follow-up date. However, with a large portion of luck, the return for my Arden position was more positive than what the above description seems to suggest. The return after tax, currency effects and brokerage fees for Arden amounted to 27,5%. Should I have held my shares the outcome would have been even more positive as the issuance of new ordinary shares was done at a price of 40 GBX. This was well above the price which the stock was trading at and the price I sold my shares at (33 GBX).

McCoy Global Inc (sold 2017-06-06) and the position I initiated in the company in May 2016 was largely driven by the same rational as with my position in Hargreaves and Arden (see checklist analysis in Swedish). Unlike the two early candidates McCoy is/was a Canadian company in the business of oil and gas, more specifically the company provides equipment and technologies used for making up threaded connections in the global oil and gas industry. Initially it looked that I had made a really bad call as the price went south and the stock traded as low as 1,41 CAD in November. However, as oil prices started to once again rise and an improved backlog was announced in the Q4 report the price moved back up to the level of my initial buying price. Although there were some positive signs in the Q4 report the margin of safety had disappeared and a sale was inevitable at the follow-up date. However, once again I got lucky just in time to my follow-up. In May management decided that the company’s shares were undervalued and a 5 % share buyback program was announced. The return after tax, currency effects and brokerage fees for McCoy amounted to 11,3%.

Associated Capital Group Inc (sold 2017-06-08) is the only special situation case included in this post although it could also be described as a deep value case selling below cash value. Associated Capital was a conviction pick of mine with a thesis best described as a free lunch created by the spin-off from Mario Gabellis company Gamco Investors Inc (see the first part of the analysis posted in Swedish, part one). The special situation part of the thesis played out well and in line with my analysis with one exception. I made the mistake of concluding that the valuation multiple the company was trading at that point in time would remain the same and that the market would not place a discount on company’s operations in the future. However, the outcome has been the direct opposite. In other words, the market seem to value Associated Capital to a higher extent as a holding company than an operating business within investment management and research. So, while book value has increased, in line with my thesis and predictions, the non-adjusted price-to-book-multiple has decreased from 1,02x to 0,94x. Based on this outcome and the fact that the company is no longer a new/forgotten spin-off I concluded on the follow-up date that the upside, related to the special situation part, had played out. This was the first part of my rationale for selling Associated Capital on the follow-up date. Again, I could be wrong on this point and one should note that $3,71 per share related to the GAMCO note still remain to adjust book value as of Q1 2017:

ac q1 BV

Unfortunately, I also made a second mistake / wrong prediction. In concluded in my second part of the analysis (see the second part of the analysis posted in Swedish,  part two) that the profitability levels of Associated Capital in the presence of Mario Gabelli would likely improve. So far that has not been the case, although assets under management (AUM) has grown. Furthermore, Mario Gabelli has stepped down from his position as CEO of Associated Capital which made my conviction regarding future profitability growth for the company to decrease. So although the downside remains intact the upside has unfortunately disappeared in large parts in my opinion. Or to be more specific and sincere, Associate Capital is now placed in my to-hard-to-analyse-pile. This is my second part of my rationale for selling Associated Capital on the follow-up date. The return after tax, currency effects and brokerage fees for Associated Capital amounted to 16,7%.

Sanshin Electronics Co Ltd (sold 2017-07-13) I struggled with quite a bit whether to sell or hold. Sanshin was my first J-net and as with most Japanese net-nets the fundamentals looks to be good to be true when you factor in what they are selling for (see checklist analysis in Swedish). After my thirteen months holding period Sanshin still looked good. The company is still selling below liquidation value, P/NCAV = 0,77x, and the business is still profitable. However, as of today the company is trading well above its historical liquidation multiples and the P/NCAV = 0,43x I bought my position at. This is mostly attributable to the fact that the share price that has increased about 75 % (including dividend) over the last thirteen months. So partially, my rational to sell the Sanshin position was a decreased margin of safety and a current above average historical valuation (both as it relates to assets and earnings). Also, when I bought Sanshin I made two mistakes that a sale of the position would “correct”. The first mistake was to deviate from my focus on small obscure deep value companies. With a market value of 42B JPY Sanshin is not exactly small or obscure. In other words, it is harder for me to justify and hold Sanshin after the hefty increase in both price and valuation multiples than if the company had been a small/nano-cap J-net. The second mistake was my position sizing of Sanshin. In this case the my position size was too small. I will try to not make the two mistakes just mentioned in the future. The return after tax, currency effects and brokerage fees for Sanshin amounted to 64,3%.


Macro Enterprises Inc. (bought 2017-05-12) is a new type of deep value candidate in my portfolio. It’s a raNAV (readily ascertainable net asset value) candidate not a NCAV (net current asset value) candidate. I wrote some sentences about the importance of raNAV and the differences to the classical net-net/NCAV calculation in my latest post about BEBE (see post Lessons about leases and liquidation value: a bebe stores, inc case study).

I probably won’t spend any time putting all my notes, spreadsheets and links about Macro Enterprises into a whole post/analysis. Reason being that it has already been done to perfection by two other people. I recommend you read the Macro Enterprises analysis by Jan Svenda if you have Seeking Alpha pro. If not, I would highly recommend that you read the analysis of Macro Enterprises included in the sample newsletter for On Beyond Investing and that you listen to the episode of The Intelligent Investing podcast were the author of On Beyond Investing Tim Bergin talks about the company and the investing case.


Disclosure: The author is long CVE:MCR when this analysis is published. Also note that CVE:MCR is a nano-cap stock (44 M$ in market capitalization). The trading is illiquid.

Lessons about leases and liquidation value: a bebe stores, inc case study

I got a comment in the BEBE analysis post related to their $186M in operating lease obligation and what my view was as the company announced that they are closing down all their remaining stores. As I started to write an answer in the commentary section I came to realize that this might be a good time to put my view about operating leases into print. Also, as the BEBE situation is currently playing out in real-time it makes it a good live case study for how to view operating leases when it comes to investing in net-nets and companies selling below liquidation value. At least I hope it makes the post about operating leases a bit more interesting.

Off-balance-sheet financing & operating leases

Before diving into the more interesting stuff, lets first remind ourself what we are talking about. First off, what is off-balance sheet financing? Well, in broad terms it refer to assets or liabilities that we can’t find on a company’s balance sheet but nonetheless are forms of assets or liabilities of the company. The reason why I say “forms of” is because there exist some nuances, but for the most part they fit the assets and liabilities definitions. Lets remind ourself of the definitions for asset and liabiliy:

Asset: Resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow the entity.

Liability: Present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefit.

The most common reason for not capitalizing an asset or a liability on to the balance sheet is that it misses on the first part of the above definitions. Resources controlled as it concerns assets and present obligation as it concern liabilities. In other words, the company is not the recognized legal owner of an asset or does not have direct legal responsibility of the liability.

Operating leases is probably the most common type of off-balance sheet financing and it’s also the oldest form of off-balance-sheet financing. In 2014 listed companies using IFRS or US GAAP disclosed almost US$3 trillion of off-balance sheet lease commitments. Yes, that’s trillion with a T. An operating lease is a contract between two companies where one company is allowed to use the asset (lessee), but where the rights of ownership of the asset stays with the other company (lessor).  So an operating lease represents an off-balance sheet financing of an asset, where the leased asset (future benefits) and associated liabilities of future rent payments (outflow of cash) are not capitalized on the balance sheet of the company using the asset. In other words, provided both parties are behaving rationally, the economic substance of this arrangement is that the lessor has made a loan to the lessee that is equal to the capital value of the leased asset. The lease payments will be equivalent to the loan repayments on that loan plus the interest that would have been charged.

So whats the problem?

A distorted view

Since operating leases are found off the balance sheet they distort the view that you would get of a company’s financial position and performance if you were looking through a screener. The same would apply if you were only looking at the financial statements presented in an annual report or 10-K. Primarily, a company with a big operating lease obligation will look a lot slimmer than it actually is. As you can imagine, a number of important key ratios, such as equity ratio and return on total assets, would therefore be quite different if the company decides to put it on or off the balance sheet. However, with a quick search for “operating leases” in the annual report or 10-K you would find the following note:

lease bebe.png

With this note you could be guide in your division for what is to be regarded as current assets and liabilities (< 1 year) and non-current assets and liabilities (>1 year). Therefor it could be argued that it is not rocket science in order to get a more fair view, just add-on the numbers back on the balance sheet. However, both IASB and FASB would argue against me and as I will later demonstrate with the case of BEBE this is not even the whole truth…

New lease standards from IASB (IFRS) & FASB (US GAAP)

About a year ago both IASB and FASB announced that they had issued new lease standards. It was stated that the new standard from IASB will come into play as of 1 January 2019 and the standard from FASB as of 15 december 2018. There are minor differences between the two standards but the main change and effect of the new standard is the same. That is, all leases, except short-term leases (< 1 year), must be capitalised, i.e. put on the balance sheet. As a result, the expense for operating leases will be moved from operating costs and divided into one part depreciation and one part interest, similar to a regular assets and liabilities.

ifrs 16

ifrs 16 incom.png

One should also note following regarding the effect on cash flow stated by the IASB:

Changes in accounting requirements do not change amount of cash transferred between the parties to a lease.

Consequently, IFRS 16 will not have any effect on the total amount of cash flows reported. However, IFRS 16 is expected to have an effect on the presentation of cash flows related to former off balance sheet leases.

IFRS 16 is expected to reduce operating cash outflows, with a corresponding increase in financing cash out flows, compared to the amounts reported applying IAS 17. This is because, applying IAS 17, companies presented cash out flows on former off balance sheet leases as operating activities. In contrast, applying IFRS 16, principal repayments on all lease liabilities are included within financing activities. Interest payments can also be included within financing activities applying IFRS.

The net-net formula and operating leases

If you are still reading at this point give yourself a pat on the back. Now let’s get into the more interesting stuff for how the above relates to investing in companies that are selling below liquidation value.

If you had asked for my opinion about operating leases, as it relates to net-nets, just a few months ago I would have given you a completely different answer than what I will give you today. Back then I would have said something like “all backtesting that I have ever come across doesn’t take operating leases into account and the returns are still awesome”. While this is true I would now argue that I don’t think this is a healthy approach to investing. Also it’s not what Benjamin Graham thought of when he initially stated the approach for how to invest in companies selling below liquidation value:

A good part of our own operations on Wall Street had been concentrated on the purchase of bargain issues easily identified as such by the fact that they were selling at less than their share in the net current assets (working capital) alone, not counting the plant account and other assets, and after deducting all liabilities ahead of the stock. It is clear that these issues were selling at a price well below the value of the enterprise as a private business. No proprietor or majority holder would think of selling what he owned at so ridiculously low a figure. – Benjamin Graham (The intelligent Investor)

Specifically note the bold text related to liabilities and ask yourself: would Graham include off-balance sheet financing in a net-net calculation if he lived today? I’m sure he would. So while the quantitive approach to net-net investing from a balance sheet approach has proven to be a solid strategy for generating alpha it also deviates from the wise words once written by Graham in the Intelligent Investor. On this note one should remember what Graham stressed above all everything else: margin of safety. So what I have come to realize is that you shouldn’t let a backtests sway you away from the true meaning behind the concept of margin of safety as it relates to the liquidation value approach of investing. In other words, just because something doesn’t show up on a screen it doesn’t mean it does not exist and should not be accounted for as a future inflow or outflow of cash, i.e. asset/liability. This epiphany has become even more relevant as of the new lease standards that will soon come into play for both US GAAP and IFRS.

So now you might think that the correct way to calculate the liquidation value for BEBE is just to add the $186M of operating leases into the net-net calculation. Well, unfortunately it’s not that easy if you aim for a fair estimate of a liquidation value. With the help of the current situation in BEBE I will try to demonstrate this. But before I do that I would like to set the stage by presenting two important quotes from two of my favorite investors, Marty Whitman & Seth Klarman.

We do net nets based more on common sense. As, for example, you have an asset, a Class A office building, financed with recourse finance, fully tenanted by credit-worthy tenants, that, for accounting purposes, is classified as a fixed asset, but, given such a building, you pick up the telephone and sell it, and really it’s more current than K-Mart’s inventories, for example, which is classified as a current asset. – Marty Whitman

As long as working capital is not overstated and operations are not rapidly consuming cash, a company could liquidate its assets, extinguish all liabilities, and still distribute proceeds in excess of the market price to investors. Ongoing business losses can, however, quickly erode net-net working capital. Investors must therefore always consider the state of a company’s current operations before buying. Investors should also consider any off-balance sheet or contingent liabilities that might be incurred in the course of an actual liquidation, such as plant closing and environmental laws. – Seth Klarman

Lessons about leases and liquidation value

With the situation in BEBE I will try to demonstrate three lessons that I have acquired via my previous quantitative approach to investing in net-nets. All three could be summarised under the lesson that the quantitative net-net calculation is a strict theoretical valuation method not based on common sense. In recent time I have therefore decided to leave my previous quantitive approach behind me and apply a more semi-rule based approach for investing in companies selling below liquidation value. I will write an additional blog post about this new approach and the implications for other factors than just the valuation aspect some time in the future.

Lesson 1: Operating leases ≠ 100 % future outflow of cash

Remember the $186M in operating leases obligation that BEBE had stated in its note from the latest 10-K? In other words, the same $186M that the new lease standards wants us to put directly on the company’s balance sheet:

lease bebe

Well, it turns out that it’s not a $186M obligation. The actual liability (future outflow of cash) as it relates to the company’s operating leases (leased stores) is more in the ballpark of $60-65M.

The Company has hired a real estate consultant to negotiate with its landlords to terminate existing leases and the Company will have to make payments in order to close all of its retail stores. While the Company does not know the exact amount of such termination payments it believes the payments will be in the range of approximately $60 to $65 million. – Q3 2017

In the table attached above it is important to highlight the word noncancellable leases. Reason being is that this gives us the answer for the difference between the total minimum leases payments that is “noncancellable” (the obligation that the new standards will require the company’s in the future to put on the balance sheet) and the actual liability (actual outflow of cash) as a result of the termination of the company’s leased store contracts. I want you to read with full attention now: It is named noncancellable but it be cancelable. But only when:

A lease which is cancelable (i) only upon the occurrence of some remote contingency, (ii) only with the permission of the lessor, (iii) only if the lessee enters into a new lease with the same less, or *iv) only upon payment by the lessee of a penalty in an amount such that continuation of the lease appears, at inception, reasonably assured.

If significant enough, a penalty for cancellation may result in a conclusion that continuation of the lease appears, at lease commencement, to be reasonably certain. If so, it should be considered noncancelable for any periods in which the penalty exists.

The lesson here is that the actual liability (outflow of cash) as it concerns operating leases is likely to be lower than what is stated in the note and what in the future will be stated in the liability section of the balance sheet. Remember that the company does not have direct legal responsibility (liability) of the leased asset. This will not change even when the new standard comes into play.

While the information about $60-65M was quite recently announced (2017-05-16) I will demonstrate how one could obtain this information already in March 2017. If we take a look at this  8-K the following could be noted:

On March 28, 2017, bebe stores, inc. (the “Company”) committed to close 21 bebe store locations. As a result, the Company will incur an impairment charge related to the closed stores of approximately $2.0 million and will make a termination payment to the landlord of approximately $7.4 million. The Company is continuing to explore options with respect to its remaining stores.

If we use these figures above and apply it to the 151 stores that BEBE had not closed at that point in time we get the following total termination payment:

$7,4M / 21 stores = $352,000 x 151 stores = $53M –> $53M + $7,4M = $60,4M.

This fits perfectly into the ballpark of the $60-65M stated above.

 Lesson 2: Operating leases ≠ asset

The next lesson is a direct outcome of the situation in BEBE. While the new lease standards requires operating leases to be capitalised both on the liability side and the asset side of the balance sheet this is in my opinion not a fair view. Remember why operating leases did not fit the real asset definition? Yes that’s right, the company is not the recognized legal owner (asset). From this we can draw the following conclusion, the liquidation value of operating leased asset is zero. Or really its negative considering the termination payments that the company will incur in a situation similar to BEBE’s. So when calculating a liquidation value you should in my opinion attach no value to the “asset” leased. Reason being that the company will not be able to sell the asset and therefore there is now future inflow of cash. This is especially important to take into consideration when screening for companies in the future since operating leased assets then will be part of the company’s total current asset position.

Lesson 3: The importance of readily ascertainable net asset value (raNAV)

The third lesson relates to the a concept of liquidation value that Marty Whitman has coined. It is explained in the book The Aggressive Conservative Investor but also in the quote I presented earlier in this post. I will try to demonstrate the importance of using raNAV instead of NCAV by presenting the valuations of BEBE from both perspectives as of Q3 2017. BEBE is also a perfect example for the fun side of the equation when it comes to off-balance sheet items. That is, off-balance sheet assets.

If we take a look at the Q3 2017 report from BEBE that has just been published the following net-net calculation would be made from a strict quantitative approach:

‘000 $
Cash  26 755
Recieviables  7 862
Inventory  28 413
Assets held for sale  25 796
Prepaid and other  8 491
Current assets  97 317
Total liabilities -46 482
NCAV  50 835
NCAV per share  6,3

In relation to the share price of $4,82 that would give us a P/NCAV = 0,76x which is pretty good. However, if we dig into the Q3 report and other announcements made there are some interesting facts that should be taken into consideration when trying to get a fair view of BEBE’s liquidation value. So let’s try to get the whole picture sorted out regarding the situation in BEBE. In connection I will also state what conclusions I draw from the facts as these will be built into the valuation for the raNAV calculation that I present below.

1. BEBE has announced that its closing all stores. The cash outflow because of this economic event is by the company stated to be $60-65M. As I have displayed by my earlier calculation of lease termination payments I believe that the final amount will be at the lower end of the stated spectrum ~$60M. This amount has been used in my raNAV calculation below.

The Company has hired a real estate consultant to negotiate with its landlords to terminate existing leases and the Company will have to make payments in order to close all of its retail stores. While the Company does not know the exact amount of such termination payments it believes the payments will be in the range of approximately $60 to $65 million. – Q3 2017

2. As a result of the termination of stores the company has also announced that it will terminate the employment of all store personnel and will therefore incur a termination payment of $7-10M. As I have no further insight into this so I will use the ~$10M as my estimate for employee termination payments in the raNAV calculation.

the Company expects that it will then cease to have any retail operations and will instead manage its investment in the Joint Venture. As a result, the Company expects to terminate the employment of all or substantially all of its employees over the coming months as its operations wind-down and to pay severance, accrued vacation and stay-on bonuses in the range of approximately $7 to $10 million to such employees expected to be paid over the next two fiscal quarters. – Q3 2017

3. BEBE has previously provided information about the value of a joint venture with a company called Bluestar. Also, in the Q3 report the company state what the company intends to do going forward. I regard to the remaining 50 % ownership in the joint venture to have a value of ~$35M since Bluestar paid this amount quite recently, June 2016, but also since BEBE still holds licence for two important markets, USA and Canada.

Strategic partnership. During the fourth quarter of fiscal 2016, we entered into a strategic joint venture arrangement with Bluestar Alliance LLC (Bluestar). Under this partnership, bebe contributed all of its trademarks, trademark license arrangements (described in the next paragraph) and related intellectual property, including certain domain names, to a newly formed joint venture (the Joint Venture) and received just over 50% ownership interest in the joint venture. Bluestar contributed $35 million to the newly formed joint venture that was then paid to bebe and received just under 50% ownership interest in the joint venture. – Q3 2017

In connection with this initiative, bebe retained a royalty-free perpetual license to utilize the bebe brand and trademarks within the United States, including its territories and possessions, and Canada which enables us to continue our existing business. – Q3 2017

The Company also intends to transfer the domain name, its social media accounts and its international wholesale agreements to the Joint Venture. The Joint Venture in turn intends to license them to one or more third parties.  – Q3 2017

4. BEBE has previously announced that a liquidator had been appointed to sell all of the company’s inventory and FF&E. As a result I have applied a 50 % discount on the company’s inventory value in my calculation for raNAV value. I have not done the same for FF&E (included in PP&E on the balance sheet) since the value as of today (Q3 2017) has already been impaired by a large amount taken this into consideration. Therefore I will use the $9,935 stated on the balance sheet as it relates to other assets that the company is going to sell.

On April 18, 2017, bebe stores, inc. (the “Company”) entered into a Consulting Agreement (the “Agreement”) with Great American Group, LLC, an affiliate of B. Riley & Co., the Company’s financial advisor, and Tiger Capital Group, LLC (collectively, “Consultant”), to, among other things, sell (i) all merchandise and inventory owned by the Company and certain of its subsidiaries located in its existing retail stores (the “Stores”) and (ii) certain furnishings, trade fixtures, equipment and improvements to real property with respect to the Stores. We may incur a loss in connection with this sale of our merchandise and inventory, but we cannot estimate such loss at this time. Consultant will be paid $550,000 in consideration for its services, plus reimbursement for certain expenses, and will receive an additional fee of 15% of the gross proceeds generated from the sale of the furnishings, trade fixtures, equipment and improvements to real property.

5. BEBE has also stated that it intends to sell its owned real estate:

The Company intends to sell its real estate holdings consisting of a distribution center in Benicia CA, a design studio and production facility in Los Angeles CA and two condominium units in Los Angeles CA. The Company has decided that it no longer needs these properties because it is shutting down its operations. The Company will use the proceeds from sale of the buildings to fund the costs of wind down including lease termination costs, severance and other costs. The Company does not expect to incur a loss on the sale of its real estate holdings.

The real estate is currently found under the FSLI “held for sale” for current assets at a value of $25,796. One should note the following regarding the valuation method as it concerns held for sale assets: measured at the lower of carrying amount and fair value less costs to sell

From previous 10-K’s and the note “Property and Equipment” I have gathered the following information about these real estate properties:

In December 2008, we acquired two condominium units in Los Angeles, California for use as short-term executive accommodations with approximately 3,400 total square footage.

The purchase price for the two condominium units was $1,705.

We also purchased our 144,000 square foot distribution center in Benicia, California in May 2012.

The purchase price for the distribution center was $18,000.

In fiscal 2004, we acquired a 50,000 square foot design studio and production facility in Los Angeles, California that houses our design, merchandising and production activities.

The purchase price for the design studio and production facility was $10,942.

The total price paid for the owned real estate adds up to $30,647. Naturally this is higher than the held for sale number value because of depreciation (see valuation definition above for held for sale assets). Although there might be some hidden value in the real estate (fair value) I have only assumed that BEBE at least will get the similar amount of money back as they once have paid. Therefor I have used $30,647 in my raNAV calculation.

6. The company has a large amount of net operating losses (NOL’s), $298,600 or $36,9 per share. NOL’s are found off the balance sheet but could be regarded as an asset. Especially by a company that would potentially acquire BEBE. This is because the acquiring company can use the NOL’s to lower their taxes paid. However, the valuation of NOL’s is truly rocket science. It all depends on the potential value of the NOL’s that an acquiring company can use. In other words, since the NOL’s expire over a period of time a more profitable company would assign higher value to the NOL’s than a less profitable company. Therefor I have made four assumptions as it concerns the value of BEBE’s NOL’s. [EDIT: 2017-05-26, see comments regarding NOL’s]

As of July 2, 2016, the Company has federal, state and foreign gross net operating loss carryovers of approximately $169.2 million, $122.1 million and $5.9 million, respectively. If not used, these carry forwards will expire at various dates from fiscal year 2016 to fiscal year 2036. The Company also has foreign tax credit and state tax credit carry forwards of approximately $1.6 million and $0.2 million, respectively, which will be available to offset future taxable income. If not used, the foreign tax credit carry forwards will expire at various dates from 2017 to 2026 and the state tax credit will expire from 2020 to 2022.

  NOL’s Discount
  298600 0%
per share 36,9  
  149300 50%
per share 18,4  
  89580 30%
per share 11,1  
  29860 10%
per share 3,7  

7. Before providing you with my calculation of raNAV based on what I have presented above I should also present my view about the company’s future (you might want to compare this with what the company has stated, see point 3 above).

I don’t think that BEBE will continue as a company under the joint venture. I think the company is going to be sold as there is still value in the brand of BEBE (see point 3 above) but also considering the amount of NOL’s that the company has. This is also based on the fact that the company’s has rushed into the termination of all lease contracts and personal and appointed a liquidator of inventory and FF&E and that have decided to sell all their real estate. Moreover, the CEO Manny Mashouf announced in June 2015 that he intended to sell of his then 59 % position in the company. However, as of today he still holds about 57 % of the shares outstanding. I would argue that he has decided to look for a deal where the whole company gets acquired rather than to sell his position gradually on the market. One final note, a very important one, is that Lloyd Miller III seems to be invest on a similar story. Since this story has evolved he has repeatedly and more aggressively increased his stake in BEBE. He now owns 10 % of the company. But enough speculation, here is the raNAV calculation of BEBE as of Q3 2017:

‘000 $ Comments
Cash  26 755
Receivables  7 862
Inventory  14 207 See point 4.
Assets held for sale  30 647 See point 5.
Prepaid and other  8 491
Adjusted current assets  87 962
Total liabilities -46 482
Adjusted NCAV  41 480
Adjusted NCAV per share  5,1
Lease termination payment -60 400 See point 1
Employee termination payment -10 000 See point 2
PP&E  9 935 See point 4.
50 % JV ownership  35 000 See point 3.
raNAV  16 015
raNAV per share  2,0

On top of the $2 USD per share of raNAV that I have calculated is the value of NOL’s that one must also take into consideration. I find it hard to believe that an acquirer will pay $1 for every $1 of BEBE’s NOL’s. I also think is it is fair to assume that they will likely pay more than 10 cent for every $1 of NOL’s. My guess is that it is likely going to be in the ballpark of 10-30 cent for every dollar of NOL. But my honest answer is I don’t know. However assuming a 10-30 cent for every dollar of NOL on top of the other $2 per share would give us a raNAV value of $5,7 – 13,1 USD per share. Based on the current price of $4,82 that would give us the following multiples of P/raNAV = 0,85x – 0,37x. [EDIT: 2017-05-26, see comments regarding NOL’s]

As of today I have not increased my position in BEBE but will most likely do so if the stock tumbles back below $4. [EDIT: 2017-05-26, as a result of my misstake regarding NOL’s, see comments]

Disclosure: The author is long NASDAQ:BEBE when this analysis is published. Also note that NASDAQ:BEBE is a nano-cap stock (40 M$ in market capitalization). The trading is illiquid.

Follow-up: 11 88 0 Solutions AG (telegate AG)

Q4 2016 – 0,48 € – ETR:TGT

After my thirteen months follow-up I have decided to sell my position in TGT. After brokerage fees and currency effects the return amounted to -51,7 %.

1kr50öre11 88 0 Solutions AG, formerly Telegate AG, is a Germany-based provider of directory assistance and call center services. The Company operates through two segments: Directory Assistance and Digital. The Directory Assistance segment provides services related to inquires made at by phone for information regarding to phone numbers, pre-dial numbers and addresses. The Digital segment receives revenue from advertisements on the Company’s platforms and Websites. The Company also offers online marketing services related to Google AdWords, Google My Business, social media Websites and company profiles on platforms, as well as tools and market analyses, and software for data, address and network management. – Google Finance.

1. The company is currently a net-net with an adequate margin of safety: 

  • P/NCAV < 1x
    • 0,75x ✓ 
      • MoS = 25 %
    • 1,7x (incl. operating leases).

Assessment of margin of safety:

Although the company is still a net-net and makes it through the rest of my checklist I regard the current margin of safety as inadequate. This is based on an assessment of the NCAV-brun rate that is negative for both YoY = -41 % and QoQ = -20 %. In other words, there is a high probability that the NCAV will continue to erode in a quick pace and that the 25 % margin of safety is gone by next follow-up. Also, taking operating leases into consideration the company is no longer to be regarded as a net-net as it is selling at a premium, 1,7x. This is relevant since TGT uses IFRS and the changes to be effective as of 1 January 2019 with IFRS 16 (operating leases are to be capitalized). Based on these notations and that I haven’t found any other value creation catalyst I have decided to sell my position in TGT.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):


  • Debt/Equity < 25 %
    • 0 % 


  • Z-score ≥ 3
    • 0,2 X

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):


  • Positive retained earnings:
    • -28M € X


  • Positive aggregate operating income for the last ten years:
    •   118M € 

3. The company does not have a shareholder unfriendly capital allocation:

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 0 %
    • Net buyback yield TTM = 0 %
      • =  0 % 


Disclosure: The author doesn’t own any shares of ETR:TGT when this analysis is published.

P & F Industries, Inc. – Q4 2016

Q4 2016 – 6,95 $– NASDAQ:PFIN

1kr50öreP&F Industries, Inc. conducts business through its subsidiaries. The Company operates through two segments: tools and other products (Tools), and hardware and accessories (Hardware). It conducts Tools business through a subsidiary, Continental Tool Group, Inc. (Continental), which in turn operates through its subsidiaries, Florida Pneumatic Manufacturing Corporation (Florida Pneumatic) and Hy-Tech Machine, Inc. (Hy-Tech). Florida Pneumatic imports and sells pneumatic hand tools, most of which are of its own design, primarily to the retail, industrial and automotive markets. It conducts the Hardware business through its subsidiary, Countrywide Hardware, Inc. (Countrywide). Countrywide conducts its business operations through its subsidiary, Nationwide Industries, Inc. (Nationwide). Nationwide develops, imports and manufactures fencing hardware, patio products, and door and window accessories, such as rollers, hinges, window operators, sash locks, custom zinc castings and door closers. – Google Finance.

1. The company is currently a net-net with an adequate margin of safety: 

  • P/NCAV < 1x
    • 0,89x ✓ 
      • MoS = 11 %
    • 0,91x (incl. operating leases).

Assessment of margin of safety:

P & F Industries is an American nano-cap company that was incorporated in 1963 and that up until recently had two business segments, tools and hardware. In 2016 it was announced that the company’s Hardware subsidiary Nationwide Industries had been sold for 22,2M $ as well as its real estate property for 3,8M $. The proceeds from the sale was used to pay down almost all of the company’s debt, initiate a quarterly dividend policy of 0,05 $ per share and to pay a one-time special dividend of 0,50 $ per share. Finally, this Thursday it was announced that the company had acquired Jiffy Air Tool, Inc. for 7M $ (another 1M $ is entitled to the seller if certain profitability thresholds are met). Note that I initiated my position before this acquisition was announced and that the figures I present below are not adjusted for this transaction.

Besides the fact that P & F Industries makes it through my checklist there are four other factors that in my opinion makes the company at the current share price a good addition to a diversified portfolio of net-nets:

1. I would argue that even though the absolute level of NCAV margin of safety is only 11 % it is good enough considering that the burn rate is positive for both QoQ and YoY, i.e. the NCAV margin of safety has been growing.

2. Regarding historical profitability. In the picture below I have tried to demonstrate the company’s historical profitability as if Tool was P & F Industries sole business segment. Note that the ‘Adjustment Hardware general corporate expenses‘ is only correct for the 2015 numbers since I haven’t managed to find earlier years figures. However, I have used the same figure for earlier years to get some sense of the historical profitability. As can be observed in the picture the company has on a Tool business level alone been profitable for most years during the las ten year period. Based on the consistency and the fact that the company today is selling below liquidation value this must be a true oxymoron. Or is it?
operating income pfinIf we put the current enterprise value in relation to the average operating income for the last five and ten years that gives us multiples of 15x (5y) and 22x (10y). In other words, the company is not on a Tool’s operating income level what I usually consider cheap. Also, in P & F Industries Q4 conference call it was announced that they have chosen not to renew their Sears agreement which will result in a loss of 1M $ EBITDA going forward. However, in this context it should be noted that the recent announced acquisition of Jiffy Air Tool will probably help the situation a bit. To what degree I don’t know but I note the following positive sentence from the acquisition announcement: “We anticipate that this acquisition will be immediately accretive to earnings.

3. Regarding ownership structure. Insiders definitely have skin in the game when it comes to P & F Industries as they together own 39,7 % of the company. The CEO, Richard. A Horowitz, alone owns 36,1 %. Also, in relation to his total compensation (1,5M $) it seems that the CEO eats his own cooking as his stake in the company is currently worth ~6,x that amount (9,5M $). However, a total compensation of 1,5M $ annually for a CEO of a 25M $ company can also be questioned. One large shareholder (12,9 %) that has addressed the problem with compensation and that also keeps pushing for more shareholder friendly actions such as buyback programs is the activist Lawndale Capital Management (Andrew Shapiro)For those of you that have read my earlier analyses will know that I like having an activist investor involved in the company’s that I invest in.

4. Regarding hidden real estate value. In their latest 13D Lawndale also make an interesting note: “Lawndale believes the public market value of PFIN is undervalued by not adequately reflecting the value of P&F’s business segments and other assets, including certain long-held real estate.” On this note I conclude that the company owns’ a 72,000 square foot plant facility located in Jupiter, Florida and a 51,000 square foot plant facility located in Cranberry Township, Pennsylvania that together is valued at 5M $ on the company’s balance sheet. Also, the company has 1,6M $ worth of land on its books. This is interesting since their 56,250 square foot plant facility located in Tampa was just sold for 3,8M $. Therefore, I finally would argue that the P/TB multiple for P & F Industries of 0,67x shows a better picture of the current margin of safety in the company then what can be observed from a strict net-net point of view.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):


  • Debt/Equity < 25 %
    • 0,2 % 


  • Z-score ≥ 3
    • 4,9 

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):


  • Positive retained earnings:
    • 36M $ 


  • Positive aggregate operating income for the last ten years:
    •   9,9M $ 

3. The company does not have a shareholder unfriendly capital allocation:

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 9 %
    • Net buyback yield TTM = 1 %
      • =  10 % 


Disclosure: The author is long NASDAQ:PFIN when this analysis is published. Also note that NASDAQ:PFIN is a nano-cap stock (25M $ in market capitalization). The trading is illiquid.

Clarius Group Limited – H1 2017

H1 2017 – 0,095 A$– ASX:CND

1kr50öreClarius Group Limited is engaged in the provision of permanent, contract and temporary employment services. The Company operates in two segments: Recruitment Services, which is engaged in the provision of recruitment services (permanent and contract placements), and Information Technology Services, which is engaged in the outsourcing and technical support services. It works with a cross section of employers in Asia Pacific, placing job seekers in contract, temporary and permanent roles at all levels. It helps government and private sector organizations source permanent, temporary and contract workers, placing all levels of seniority in various specialty areas, such as accounting, administration, customer service, engineering, information management, information technology (IT), and sales and marketing. It works with organizations throughout Australia, providing talent for short-term engagements and augmenting user’s in-house programs to execute IT projects. – Google Finance.

1. The company is currently a net-net with an adequate margin of safety: 

  • P/NCAV < 1x
    • 0,49x 
      • MoS = 51 %

Assessment of margin of safety:

Clarius Group is a small Australian net-net that is focused on employment and recruitment services in Australia and China. If you are interested in a good overview of the company and its business operations I recommend looking at the 2016 AGM presentation as I won’t go into any details here. Although I like the typical Graham net-nets, Coventry Group for example, I’m also a big fan of what famous net-net investor Jeroen Bos calls “cyclical service shares” in his book Deep Value Investing. If you want a explanation why these are interesting types of net-nets to look at here is an interview with him on the topic. Besides the fact that I like ‘service net-nets’ and that Clarius Group makes it through my checklist there are three other points that in my opinion makes the company at the current share price a good addition to a diversified portfolio of net-nets:

1. Regarding NCAV margin of safety in relation to NCAV-burn rate. I would argue that there is a good enough spread between Clarius Group NCAV margin of safety of 51 % and the NCAV burn rate for QoQ (-6 %) and YoY (-16%). As a general rule of thumb I like to see that NCAV-margin of safety / NCAV-brun rate > 3x. Clarius Group have the following NCAV MoS/Burn-rate multiples, QoQ = 8,5x and YoY = 3,2x.

2. Regarding historical profitability. Clarius Group have posted negative figures on an operating income level for the three most recent years. However, looking further back in time the company posted positive figures during the period 2013-2007. If we take the average operating income over the last ten years in relation to the current enterprise value that gives us a multiple of 1,4x. In other words, if Clarius Group can get back to some form of historical average operating income profitability level the company is at the current share price a real steal. Also, note that Clarius Group net income (and retained earnings) has been hit hard in recent years as a result of recurring impairments of goodwill. In other words, taking a free cash flow perspective we get a similar picture of Clarius Group profitability as we got with the operating income measurement. The average free cash flow over the last ten years in relation to the current enterprise value gives us a multiple of 2,9x.

3. Regarding ownership structure. One similarity with my most recent addition to the net-net portfolio, Coventry Group, other then the fact that both are Australian companies can be found via their shareholder lists. Both companies are in fact owned by the Australian activist fund Sandon Capital. While it may first seem that Clarius Group is a much smaller position for Sandon (1,5 %) that is not a fair presentation of their entire ownership in the company. According to a statement of ownership Sandon Capital have in fact control of 11,33 % of Clarius Group via different companies. In addition, Sandon Capital is not the only interesting shareholder on the Clarius Group shareholder list. Just recently another value focused fund, Collins St Value Fund, increased their position from 7,25 % to 8,56 %. Also, the largest shareholder of Clarius Group with an 25,3 % ownership through the company Ego PTY Limited is a private investor know as Victor John Plummer. Although he has not made an fantastic investment so far on his position I recommend reading this article from 2012 about him and the big position he has acquired in Clarius Group. Finally, although management doesn’t have any real skin in the game (< 1 % ownership) two directors have recently bought reasonable amounts of shares (Gabrielle Trainor and Garry Sladden) in the company. To summarize and conclude, the current ownership structure of Clarius Group will probably protect minority shareholders interest better than in most companies. On this point it should be noted that the company has recently appointed a new CEO and CFO and there has also been some changes on the board of directors. If this is an effect of activist shareholder pressure I can only speculate.

2. The risk of permanent loss is low:

2.1 The risk of bankruptcy is low (criterion a) or b) must be met):


  • Debt/Equity < 25 %
    • 0,6 % 


  • Z-score ≥ 3
    • 2,8 X

2.2 The company’s business model has historically been profitable (criterion a) or b) must be met):


  • Positive retained earnings:
    • -63,5M A$ X


  • Positive aggregate operating income for the last ten years:
    •   49,9M A$ 

3. The company does not have a shareholder unfriendly capital allocation:

  • Shareholder yield TTM ≥ -2 %
    • Dividend yield TTM = 0 %
    • Net buyback yield TTM = 0 %
      • =  0 % 


Disclosure: The author is long ASX:CND when this analysis is published. Also note that ASX:CND is a nano-cap stock (6,5M $ in market capitalization). The trading is illiquid.