David Winters, CEO of Wintergreen Advisers, has now written two letters in the past six weeks to Consolidated-Tomoka’s board of directors. The first letter was relatively tame and requested a shareholder vote at the 2016 annual meeting to put the company up for sale. Winters feels the market is not accurately valuing CTO (spoiler alert: I agree) and some combination of a sale and/or liquidation would maximize shareholder value. Winters’ second letter to the board made some serious claims: “we believe that CTO management, led by John Albright, is actively trying to deceive shareholders with filings, investor presentations and disclosures that obfuscate, confuse and hide what is really going on at CTO.” Not surprisingly, the stock dropped around 10% that day and has since recovered about half that. I want to go through that second letter point by point and give my opinions on the issues it brings to light.
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Author: Travis Wiedower
A Unique Win-Win Scenario for Investors
My original write-up on Consolidated-Tomoka (CTO) was titled “No Downside, Unknown Upside.” The situation has improved dramatically since then, we have a better sense of what NAV may be (that unknown upside is becoming more known), and yet the stock is only up 5.3% since my first post (now trading at $56.08). I have been adding to my position as of late. If you’re not familiar with the CTO story, I recommend reading my initial write-up prior to the below update.
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GlobalSCAPE Inc and Why SaaS Kicks Ass
I’ve been looking at several SaaS (software-as-a-service) companies as of late. In laymen’s terms, SaaS is software that is hosted by the providing company and the customer pays a regular subscription fee to use it (as opposed to purchasing the software up front for a one-time fee and hosting the software themselves). If you were to write down a list of characteristics you seek in investments, I bet the typical SaaS company checks off most items on your list. GlobalSCAPE Inc (GSB, $4.10) is one such company that possesses the following:
- 95% gross margins
- Free cash flow margins around 15%
- Over 100% returns on capital
- Over 50% of revenue is recurring
- Good visibility into future revenue
- Little to no customer concentration (no one over 10% of revenues)
Napco Security Technologies (NSSC)
Napco Security Technologies (NSSC, $5.56) is one of the companies I met with at the MicroCap Conference two weeks ago. At a quick glance, Napco appears to be a typical manufacturer with no competitive advantage and low margins, but there may be more to the story. They manufacture security products such as alarms, door locks and surveillance systems that are sold through a distributor network with schools being the major end user. They occasionally get large one-off projects like the $1.7 million dollar sale to Pepperdine University as part of the school’s larger security overhaul. As school shootings have become more common, schools will continue to beef up security. Just in 2015 there have been 52 school shootings (though six were suicides) with three of these considered mass shootings (four or more people shot). This provides a decent tailwind for Napco’s products.
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A Better Way to Understand What You Read
“If you go home with somebody, and they don’t have books, don’t fuck em!”
— John Waters
Have you ever read a book and a week later you can barely recall any details of what you read? A couple months go by and I’m lucky if I remember the one or two main ideas. I can’t tell you how many hours I’ve wasted trying to find something that I know was in a certain book I read six months ago, only to give up and wonder why I read the book in the first place if this is what I have to show for it. There must be a better way. Earlier this year I completely changed the way I read books and the results have been very pleasing. I think there are a few different ways to read a book.
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Macro Enterprises Update
I only wrote about Macro Enterprises (MCR.V) six weeks ago but there has been quite a bit of news (both good and bad) related to the company since then. So far, Mr. Market has responded to this news by pushing the stock down to C$1.80 (so -16.3% since I posted the idea). They don’t report third quarter earnings until the end of this month, but I wanted to review what’s been going on.
A major focus of my initial write-up was the potential catalyst of an LNG export terminal on British Columbia’s west coast. This would massively increase pipeline construction where Macro operates and would almost certainly lead to a lot of business for them. As a reminder, the LNG terminal closest to coming to fruition is from Petronas. The others are probably at least a year from a final investment decision and some of them have been pushing that decision farther to the right thanks to the oil collapse.
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How Should I Be Paid?
For my more up-to-date views about industry pay, see my blog post from February 2018: How to Better Align Money Managers With Their Clients.
Over the past couple months I have written and talked about management compensation quite a bit. This has led to me thinking about my own compensation recently, and just like with CEOs, I’m not sure if any fee structure is perfect. Non-qualified investors can’t legally be charged performance-based fees so those clients are easy—2% of assets under management (AUM) is what I charge which is pretty standard. More discrepancies come into play with qualified investors ($2 million net worth excluding primary residence) who can legally be charged a percentage of profits that the money manager earns.
The industry standard for hedge funds is 2 & 20. That is, the money manager earns 2% of AUM (the management fee) plus 20% of net profits (the performance-based fee). Thus, if a manager returns 32% one year, the client pays him 2% of assets plus 20% of the net profits, which is 20% of 30%, or 6%. Altogether the money manager gets paid 8% of that client’s AUM that year, and most people would say it was well deserved for such large returns. But what if the overall market gained 35%—does the manager still deserve to be paid so well even though they underperformed the broader market?
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Oriental Watch: Deep Value at its Finest
Oriental Watch is a luxury watch retailer that owns stores in China, Hong Kong, Macau and Taiwan. The company’s stock is currently selling for HK$1.05 and my estimate of liquidation value is around HK$2.50-$3.00. Any company selling for 35-40% of liquidation value is bound to have its fair share of problems and Oriental Watch is no different. They were profitable as recently as 2014 but there are significant headwinds facing the Asian luxury watch segment. Thankfully the management team has already been making moves to cut expenses and return to profitability.
One note: they are listed on the Hong Kong Stock Exchange (symbol: 0398) and on the American pink sheets (ORWHF). Unless otherwise stated, all numbers in this write-up will be in Hong Kong Dollars (HK$). The conversion is currently HK$1.00 to US$0.13.
Business overview
While the majority of their stores are in China (68 out of 87), these stores are smaller and less important to the story than the thirteen locations in Hong Kong. The company’s two operating segments are Hong Kong and then China, Taiwan and Macau combined as one. For simplicity I’m going to refer to this second segment as China since only six stores total exist in Taiwan and Macau and they are all through joint ventures. The thirteen Hong Kong stores make up around 70% of revenue and are still profitable as opposed to the China stores dragging down the results.
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Check Out My Interview on the Micro Cap Investing Podcast
Fred Rockwell, founder of Tarsier Capital Management, and Nate Tobik, founder of Complete Bank Data, run an investing podcast that I was fortunate enough to be featured on. During the episode I discuss the recent volatility in the market, management compensation, how poker has affected my investing career and the stock I’ve been buying most recently: Consolidated-Tomoka. You can listen to the episode by clicking here or by searching iTunes for the Micro Cap Investing podcast and choosing episode 21.
In addition to the podcast, Fred and Nate are organizing a microcap conference in Philadelphia in November which I’ll be attending. Should be a great opportunity to have 1 on 1s with small companies and meet some other like-minded investors. If interested, you can click here to learn more and register for the event. If you plan on attending, do let me know. I always enjoy meeting other passionate investors.
Macro Enterprises: Below Liquidation Value and Profitable
Macro Enterprises is profitable, selling for below liquidation value, still run by its founder who has significant stock ownership and there is an impending catalyst that could significantly increase revenue. Macro is based in Canada and its main listing is the TSX Venture Exchange under the symbol MCR (C$2.15); they’re also listed on the American pink sheets under MCESF ($1.60). Unless noted, all numbers in this write-up are in Canadian dollars.
Business overview
Macro builds and maintains pipelines for the oil and gas industry in Western Canada. Not surprisingly due to the oil collapse, very few (if any) new pipelines are being built today. Their revenue has declined from a high of C$212 million in 2013 to a projected C$130-140 million for full year 2015. Because no new pipelines are being constructed, almost all of their current revenue is maintenance and integrity work on existing pipelines under master service agreements (MSAs). The silver lining here is that maintenance work is required by law on active pipelines which means they’re able to maintain pricing power even during a downturn. As proof of this, towards yearend 2014 one of their MSAs came to an end and was extended for three years at similar terms. Management has stated they expect gross margins to remain fairly close to where they were in 2012/13 (~22% vs 26% at the peak). This has been proven true through the first several quarters of the downturn.
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Travis Wiedower 