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Opportunity Missed? (EPAX)

On July 13 Ambassador Group announced a plan to cease operations by year-end and liquidate the business, returning capital to shareholders. The day after the announcement the stock took a wild ride down to $1.50 a share from the previous day’s closing of $2.40, ending the day at $1.78. On the surface of things this kind of made sense since the book value as of the end of Q1 was $1.83 a share. But EPAX is (was?) in a very seasonal business where cash is received upfront as a deposit and recognized only when the trip takes place, so it behooved anyone interested in the underlying value of the liquidation to look a bit deeper. In fact, on July 16 the company issued another press release updating the amount of ‘cash available to shareholders’ at the end of 2Q; it had increased to $45.3 million from the $31.7 million on the balance sheet at the end of Q1. The stock rebounded the next day to the $2.20-2.40 per share level and has remained there since. What can I say? I was on ‘vacation’ at the seashore and missed the wild swing in the share price when the liquidation announcement was made. The lesson here is that you have to have done your analysis beforehand and be ready when Mr. Market acts so foolishly! Well, what now, you’re asking. Are shares still trading at a discount to liquidation value? For that, we needed some estimate of shutdown costs which the company has, as of today, kindly provided ($2.3 to $4.5 million). Still, the analysis is not straight forward; the company will be recognizing cash received as deposits over the balance of the year as well as prepaid and other expenses incurred or to be incurred. Assuming all sales & marketing efforts ceased as of the end of Q2, a quick and dirty liquidation analysis might look something like this:

Cash on balance sheet as of 6/30/15 (millions) $71.0
adjusted for:
  prepaid expenses $12.2
  payment of A/P ($4.4)
  deposits ($33.5)
Cash available for shareholders as of 6/30 $45.3
Balance of year cash expenses:
  Est. G&A expenses 3Q & 4Q ($4.6)
  Shutdown expense (avg of high and low) ($3.4)
Net cash available to shareholders after shutdown $37.3
shares outstanding 17.284 million
per share cash available for distribution $2.16

Now that’s not a very enticing proposition! You can pay $2.25 to buy a share today and get back $2.16 sometime over the next two years! But, as in any liquidation, there are some upsides to company projections. Do the PP&E assets have any value? Those assets are primarily depreciated computer equipment and software so I wouldn’t hold out much hope here; the company notes that this item will be written off entirely in the 2Q financials. (Remember the company has already sold its headquarters building last year). G&A expense for the balance of the year could be lower; I was using the 1Q run rate of $2.3 million but the company announced it will begin laying off staff in August. And of course, shutdown expenses could be lower. All in all, however, I don’t see that much upside. But maybe that’s just my shortsightedness. If you see the magic bunny that could be pulled out of the hat please let me know!

Edit: Sold my entire position at $2.40 today as I think there are situations with greater upside out there.

Parking Meter

Last August/September I had some extra cash just kicking around and decided to ‘park’ it somewhere that I expected would provide a small return but would be pretty safe for my principal. I posted two ‘parking’ ideas, Diversified Real Asset Income Fund (DRA) and Firsthand Technology Value Fund (SVVC). So how did the two ideas work out? The first, pretty much as expected, the other less well.

Diversified Real Asset Income Fund (DRA)
In a post last September I wrote about my rationale for ‘parking’ some funds in DRA. Part of my rationale was the prospect of participating in potentially 3 tender offers at or close to Net Asset Value each for 10% of outstanding shares. So how has the investment fared? After 9 months, 2 of the 3 tender offers have been completed, and despite a sell off in fixed income securities over the past 2-3 months, I have still come out ahead. Both the first and second tenders bought back about 15% of tendered shares as they were significantly oversubscribed. So, as you might imagine, with a significant investor like Bulldog trying to unload their position – but not being fully able to – the discount has not really narrowed significantly. It still stands at over 10%. I did purchase some additional fund shares in February, before the second tender offer, which turned out to be not a particularly propitious moment to increase my holdings, but overall, notwithstanding the negative developments in the bond market over the past couple of months, my IRR for this investment is just over 10%. Had I elected to sell just before the second tender offer my return would have been almost twice that. However, I still believe the fixed income market has over-reacted recently and that rates will once again subside when it become clear that the Fed will not be raising discount rates on the currently anticipated schedule. Clearly I am in the minority on this subject and, unlike most everyone else, remain in the deflationary camp. And therefore, yes, I’m holding my current position in DRA in the belief that the Greek problem (or perhaps the Italian, Spanish or Portuguese problem?) will eventually rattle the European financial infrastructure (and investors’ confidence), there will be a flight to the dollar and that will continue to put downward pressure on interest rates(perhaps even putting equity markets into a tailspin). But of course things will probably work out quite differently than I imagine, so I’m not beholden to my macro view. In the meantime, fund management has boosted the dividend, I believe mostly to reduce the discount (and thus make the 3rd tender unnecessary – its will only be done if the discount remains over 10%), which supports the price somewhat, and I’m getting a near 10% current yield on my investment.

Firsthand Technology Value Fund (SVVC)
Another Bulldog investment! Shares were selling at about a 20% discount to NAV when I bought last August (read about it here). My theory was that the agreement between management and Bulldog Investors would act as a catalyst to narrow the discount. The agreement was for SVVC management to sell their two largest positions, Facebook and Twitter, and distribute the profits to shareholders by a date certain, as well as repurchase up to 10% of shares outstanding. Well, the sales took place as agreed. The distributions to shareholders took place as agreed. The repurchase also took place as agreed. But guess what, the discount to NAV didn’t narrow, it WIDENED and significantly! Yep, that’s right, the 20% discount to NAV when I purchased has gotten BIGGER. At a recent price of $13.80 the shares are now trading at over a 45% discount! So much for my theory about the discount  Anyway let’s see where I stand. I purchased shares at $21.66/share and received 2 dividend payouts totaling $5.86/share in Nov./Dec. Then I was able to sell back 17% of the shares I held for 95% of NAV ($23.27/share) in January. With all of that, despite the widening discount, I’m still off only 6% on this investment, and as of now I plan to continue holding; a fund trading at 45% discount to NAV can only have good things happen (or can it?). With this kind of discount I believe the investment risks are overstated. If just one of the top fund holdings were to IPO I think the discount would narrow significantly. Also because Bulldog still holds a substantial investment in the fund, some 9.7%, I think there could be a repricing either when the Bulldog overhang is reduced (because they sell off their shares) or because there is another liquidity event.

Any thoughts from readers on these investments are welcome! As always, my meanderings are not meant to constitute investment advice; You should always do your own analysis before investing.

Steel Parners: Still selling at a substantial discount

Management at Steel Partners continues to try and simplify the LP structure, or rationalize the holdings, as they say. Two minority holdings have been fully acquired; API has been substantially purchased, and this past week HNH acquired JPS. Unfortunately, management’s efforts have not yet been rewarded in terms of a narrowing of the discount to NAV. On the contrary, the unit price continues to languish slightly above last year’s tender offer price, while the NAV continues to increase.

This is a quick post to simply point readers to the shareholder letter released in May that shows management’s (I believe conservative) estimate of the partnership’s NAV. You can view it here. Most holdings are valued at their public market prices, which I believe are substantially undervalued due to a ‘control’ discount. Also note that Webank is estimated at book value though it achieves outsize returns. With all of this the discount to management’s estimate of NAV is over 30%. What’s next? Another tender offer? I wouldn’t mind! My only fear here continues to be the creeping takeover of the company as management rewards itself with units.

Update on GYRO: Rights offering

Gyrodyne Corporation of America (GYRO) is a company in liquidation, or rather, it wants to liquidate. I won’t go through the history of the company, you can read my earlier posts on the company here and here. Since I closed out my earlier investment in 2012 a number of things have happened. The Company paid a large dividend then entered into a plan of liquidation. However, the plan of liquidation, in order to minimize the tax impact, provided that the company be divided into two separate entities, an operating entity (listed) and an ownership entity (non-listed and non transferable), as well as for the issuance of a dividend in the form of non-transferable notes. Unfortunately, this strategy has caused an unforeseen problem as the liquidation plan requires the corporate ‘pieces’ be remerged before the liquidation can be completed.  This ‘remerger’ requires a 2/3 majority favorable shareholder vote which has yet to be achieved despite 3 scheduled shareholder meetings; each had to be cancelled due to insufficient shareholder participation. The lack of shareholder voting has been ascribed by the company to the makeup of the current shareholder base. So we come to the rights offering. It was first hinted at after the last scheduled-then-postponed shareholder vote in December 2014. An initial S-1 was filed March 6, 2015 and a revised S-1 filed April 10. On April 28 the company announced that the record date for receiving the subscription rights would be May 6 as well as publishing updated liquidation ownership percentages (GYRO, GSD and dividend notes) for the remerged entity. The purpose of the rights offering is to get shares of GYRO into ‘friendly’ shareholder hands that will participate in a shareholder vote and approve the liquidation. Remember, the clock is running on the liquidation. Management has 2 years from the liquidation announcement on September 13, 2013, (thus, September 13, 2015) to effect the liquidation, otherwise the plan will have to be adjusted. If this latter happens there could be adverse tax effects for current AND prior shareholders, I believe in the form of tax recategorization of prior distributions.

The mechanics of the rights offering are straightforward. For each share of Gyrodyne (GYRO) owned as of May 6 the shareholder will receive 1.5 rights allowing him/her to purchase 1.5 shares of GYRO for $2.75 per share (one right, one share). Thus the number of shares outstanding will increase from 1.483 million shares currently to 3.707 million if all the rights are exercised. The rights are non-transferable and there is a provision for oversubscription if all the rights are NOT exercised. This is the key. Presumably those shareholders who did not participate in the last 3 shareholder votes will not exercise their rights, allowing those who participate to oversubscribe, become larger owners of GYRO and, if all goes well, provide the necessary 2/3 favorable shareholder vote to remerge the entities and thus provide a path to liquidation within the stipulated timeframe.

Let’s look at the value proposition for an investor. In the revised plan of liquidation of December 19, 2013 the book value of GYRO (post dividends) was $5.70 per share. As of year-end 2014 the book value had declined to about $5.16 per share. Given that the company was officially in liquidation as of September 2013, these book values should equate to (conservatively) estimated liquidation value. But the liquidation payout of each security (the public company, GYRO, the ownership entity dividend, GSD, and the dividend notes and their PIK interest) is ultimately defined as a percentage of the recombined entity. Those percentages were originally set in December 2013 (GYRO – 15.2%, GSD 55.6% and the dividend notes 29.2%) THOUGH THEY CAN BE CHANGED AT THE DISCRETION OF THE GYRO entities’ boards. As the subscription rights plan provides for an injection of an additional $5.6 million into the GYRO (and thence the combined) entity it certainly wouldn’t be attractive for rightsholders to exercise unless the liquidation payout percentages were adjusted. And that’s what the April 27th press release addresses. The revised ownership percentages now are: GYRO shareholders, 22.6%, GSD shareholders, 47.4% and dividend note holders 30%. Assuming that the revised percentage ownership in the recombined entity post-rights exercise reflects relative liquidation values and using the 12/31/14 book values we can conclude that the recombined entity currently has a liquidation value of about $58.7 million vs the $55.3 estimated at 12/31/13. Taking into account the $5.6 million capital inflow from the rights offering this would mean the estimated liquidation value has decreased by $2.2 million over the past 18 months.  On a per-share basis, the estimated liquidation proceeds per GYRO share will be reduced from about $5.16 to $3.58 if all rights are exercised. For an individual obviously the more shares purchased at the rights exercise price, the lower the average cost and the greater the potential gain at liquidation. Based on my average cost of $4.18, if I exercise only my subscription rights, my new average cost would be $3.28, so my upside to liquidation value is only 8%! (vs. the 23% under a non-rights scenario).  Hardly a great investment or even very enticing. To say the least I find this subscription rights offering structure quite disappointing! Clearly I can increase my upside by purchasing additional shares under the oversubscription facility, if they are available; the more shares I can get my hands on at the $2.75 rights exercise price, the lower my average price will be. But as the number of oversubscription shares is not linked to current share ownership, and it is unclear that ANY shares will be available for those oversubscribing, this is of small consolation. Making the situation even less appealing, any upside, in the case of liquidation proceeds exceeding the company’s initial estimate (not uncommon) is limited by the ownership structure because of reverse leverage. Since the GYRO shareholders will receive only 22.6% of the liquidation proceeds, they will only share in the upside to this extent, with GSD and dividend note holders receiving the balance. So with limited potential upside and significant downside (if the remerging of the entities cannot be achieved), I will be holding my position and possibly even pruning it if Mr. Market becomes exuberant, rather than increasing my exposure, even though, at the current share price of $3.07, there is a 16% upside to the implied liquidation value.

A time to reflect

My four plus month hiatus from blogging has been a time of reflection. Yes, I could have continued to focus on the micro aspect of investing (stock selection, if you must) following some kind of modified Graham discipline. And, yes, in time, I’m sure this kind of approach would have produced respectable investment results. Instead I’ve been reflecting on the overall equity market and why my portfolio has underperformed the S&P 500 for the past 3 years, possible causes and possible solutions. My conclusion regarding the latter, perhaps delusional, is that my underperformance is structural in nature, due in large part to the fact that we are in the middle of an artificially protracted cycle, a bull market that is being kept alive by a fiscal respirator. I am hoping that during the waning parts of the cycle my portfolio will finally pull its weight. What do I mean by the ‘artificially protracted’ cycle? Consider the US equity market. Over time it tends to move gradually upward in waves, with troughs and peaks along the way. The current wave has been unusually long; the market has been trending upwards without much backtracking since March 2009, over 6 years, first rebounding from the liquidity panic and earnings compression of 2008/2009 then levitating further, fueled by interest rates artificially depressed through Quantitative Easing. And the effects of QE have certainly been more P/E expansion than revenue growth! Nothing new here. I think most market observers would agree. The question is, can multiple expansion continue? I think not, at least not in the long run. Again, I think most market observers would agree. Yet strangely, the equity markets continue climbing higher. I can only ascribe this to market participants’ fear of missing yet more P/E expansion, addicted as they have bec0me to valuation inflation. In short, I think the market is where it is right now because of GREED! And we know what a powerful force that can be even in the face of hard facts. Greed renders us delusional! That’s where I think we are right now, in the delusional phase. A recent example from another ‘market’ might help to put today’s equity markets in perspective. Remember last year at this time when oil was hovering around $100 a barrel? Then suddenly the price began to drop? It started slowly, then continued dropping and then dropped further! Now its bumping around the $50-$60 mark and who knows whether this is the bottom. Given the benefit of retrospect everybody seems to agree this price drop was inevitable, brought on by oversupply from additional shale oil production. But the shale oil revolution began well over 5 years ago, and we all had a pretty good idea as early as a couple of years ago what the impact was going to be. So why the big drop in oil prices only last year? I think it was because nobody WANTED the price of oil to drop, so it didn’t….. until the storage tanks were full, until traders began hiring tankers to just sit offshore and hold the surplus oil until prices began rising, etc. So the price stayed high… until it didn’t, then it fell hard and fast! I think that’s where we are with the stock market now. Greed and inertia keep most investors in the market and keep valuations high … and it will stay like this until the market starts going down. Then all hell will break loose!

Enough prognosticating! I don’t know when the market will begin its descent, though I know it will eventually (but maybe I’ll be dead by then!). For me, as the averages creep higher and higher I feel like I have to hold more and more cash, or at least move into investments that are less market correlated, special situations and such.

When last I posted I had just sold 1/4 of my largest position, AIG, and reinvested the proceeds into a number of special situations; three spin offs (COVS, RYAM and CVEO) a net-net (EPAX), two liquidations (FUR and GYRO) and a classic Fisher investment, (ZINC). The results have been less than spectacular. Actually, for the 1st quarter the results were horrendous, but recently there has been a bit of a turnaround in the shares of these companies, although overall they are still lagging the market. I did make a few changes to my portfolio during the first quarter that I didn’t note here (adding to my ZINC and GYRO positions, opening a new position in BFCF and closing out my Liberty Media positions). However, these were all part of the strategy to move funds into special situation investments, away from positions closely correlated with market moves into more market-uncorrelated positions. I have just now sold another half of my remaining AIG position, which I plan to partially reinvest in a liquidation situation (that will remain nameless until I have made the investment).

I look forward to posting more regularly about my positions in the near future.

Four new positions.. or trying to get there…

Over the past month I’ve added three new names to my portfolio and an old one, none of which have I mentioned here yet primarily because I hadn’t bought a full position. I don’t really think my blog has enough readers to move the price of any stock, but a couple are pretty small so just in case I’ve waited until now.

Anyway, at this point I’ve either already purchased a full position or resigned myself to an orphan position in these stocks. What do I mean by ‘orphan’? I think I mentioned before that I always find myself in a quandry when buying a new position. I like to buy into a position gradually, most times in thirds. The problem arises because I hate to purchase the second third at a price higher than my first third. Likewise my final third with respect to the prior two. On reflection this appears rather stupid as I end up only purchasing a full position in stocks that are on a downward trajectory! Stocks that are moving up only allow me to get an initial position. Thus the orphan positions. I realize I need to change this approach, but in the meantime….it is what it is.

I felt guilty about holding positions without blogging about them. No, not guilty because I haven’t let you in on my investing secrets (you’d probably be better off without my naming them, by the way) but rather because I haven’t put pencil to paper and laid out my investment theses for these stocks for myself. So I’m listing the four previously undisclosed positions with their investment theses in abbreviated form. Three of them are recent spinoffs and the fourth, smaller position is a special situation. The three spinoffs are Covisint (COVS), a microcap cloud storage company that was recently spun out of Compuware Corporation, Rayonier Advanced Materials (RYAM), spun out of Rayonier in the middle of 2014, and a stock I held earlier this year, Civeo Corp. (CVEO), spun out of Oil States International last June. All three spinoffs, I believe, have come under selling pressure related to the spinoff (there are also other reasons for the sell-off in these shares) which has been amplified as year-end portfolio rebalancing takes place. The fourth stock Aviat Networks (AVNW), is a microcap special situation where Steel Partners (SPLP et al) has taken an activist position. I’m not going to dive into the fundamentals of these companies in this post. Rather I’m going to outline the reasons that these are Greenblatt-like situations.

Covisint (COVS) has a number of factors that make it an attractive spin-off investment. Until November, 20% of COVS equity was publicly traded, with the remaining 80% held by Compuware (Compuware IPOed 20% of COVS in Sept. 2013). In November Compuware spun off this 80% to holders of Compuware common stock via a distribution that gave Compuware shareholders 0.14025466 shares of COVS for each share of Compuware stock held. Compuware shares were trading at $9.70 just before the distribution (ex date of October 16) and COVS shares were trading at $2.68 (down from mid $4 range a month before the distribution). This meant that COVS represented less than 4% of the value of each Compuware share at distribution. In fact, it appears that Compuware owners considered that the Covisint business had a negative value, as on the ex distribution date Compuware shares actually increased in value rather than decreasing the amount of the COVS spun out equity. Why? Possibly because Compuware pays out a dividend of close to 5% and shareholders might be more interested in free cash flow being distributed to shareholders rather than invested in Covisint’s cash negative cloud computing business. So my thesis was simple: Most Compuware shareholders would not be interested in owning the Covisint shares distributed to them and would be dump them before year-end. The shares would be artificially depressed because of this, providing an interesting investment opportunity. There are also fundamental issues that favor COVS, primarily the recent change in executive management and the freedom its new public status will provide the company. Hopefully I can address these in a future post. I was only able to purchase my first third plus 1/2 of my second at around the $2.30 level before the stock went up about 20%. So I’ve got a semi orphan position here, but still enough to make it worthwhile.

Rayonier Advanced Materials (RYAM) was spun off from Rayonier at the end of June, 2014. At spinoff the stock was trading around $40. Since then, operational results have been, to say the least, miserable. Shares have dropped 45% to the $22-$25 range. Part of the drop is clearly because of the operating results, however part, I believe, is because the owners of Rayonier, a forest and pulp products company, are not the natural owners of RYAM; like the situation with Compuware/Covisint, Rayonier pays a significant dividend while RYAM will not be paying any dividend. Thus, a temporary depression in the price of RYAM until ownership arrives at a new equilibrium. I’m 2/3 of the way into a full position and will try to pick up my final third if the shares fall to the $21 range.

Civeo was spun off from Oil States International (OIS) in June 2014. I had purchased OIS back in May 2014 as a short-term play on the spinoff. The Civeo shares I received from spinoff were sold in July at approx.  $28/share for a 35% gain. Not bad for a couple of months! Since then, the shares of Civeo have declined substantially; 3rd quarter operating results were disappointing resulting in a share price drop of close to 50%, then recent oil price declines impacted the price of all oil service companies, with CVEO shares dropping into the $7-$9 range. I think the price drop has been overdone, perhaps exacerbated by year-end selling related to the spinoff. I’ve picked up a small position at $8/share (my timing is, as always, is not perfect) and perhaps will add to this position if the shares fall further, back to $7 or under. Did I forget to mention there is an activist here, Einhorn, whose average cost is far above the present share price?

Lastly there is Aviat Networks (AVNW) a small networking and microwave equipment company that is currently undergoing some difficult times. I’m coat-tailing on this one. Steel Partners has taken an 13% position in the shares over the past couple of months. Their modus operandi is to take a significant position, perhaps eventually a control position, and help management build back up the company. I missed my chance with ModusLink, another small company that Steel Partners took a position in, which subsequently ran up 50% or more. This is a small position for me as I haven’t done a deep enough dive into the financials. Furthermore the company is losing money, though it is trading at less than book value and about half of my purchase price ($1.34/share) is in cash. It also has an impressive list of value investors as owners (Royce, Schneider, etc.).

As always, this is not a recommendation to buy any of the securities mentioned; the post is destined for your entertainment only!

Ambassadors Group (EPAX)

As I noted in my last post about restructuring my portfolio, I’ve been adding shares of small ‘special situation’ companies. The next one up here is Ambassadors Group (EPAX)

The company describes itself as ” a leading provider of educational travel experiences and online education research materials primarily engaged in organizing and promoting worldwide educational travel programs for students through a direct to consumer revenue model”, but I view it as a soon-to-be positive operating income net-net. Revenue has been declining for the past 5 years, dropping from $69 million in 2009 to $51 million in 2013. In 2014 the annual running rate based on the first 3 quarters is about $39 million. With revenue dropping, earnings dropped too, from $1.05 per share in 2010 to a loss of $.42 per share in 2013. So why would I be interested in such a company? For one thing the company had a book value of $2.78 per share as of Sept. 30, 2014, and all of that is in CASH (or equivalents, obviously). Oh, did I forget to mention NO DEBT! Furthermore, the company seems to have turned the corner operationally, earning $.11/share last quarter. In addition they have recently sold off the smaller of their two operating segments, BookRags, and monetized their headquarters building. This is all a result of a change in strategic direction the company went through in 2013 brought about by activists Bandera Partners and Lane Five Capital Management, owners of respectively 18% and 7% of the outstanding shares. Since 2012/2013 both of these firms  have had representation on the board. A management change was effected during the first quarter of 2013 (or, more accurately, I should note that ‘old’ management was allowed to resign) and a restructuring plan was devised to rationalize and shrink the company back to profitability. I think we are seeing the fruits of these efforts with the latest quarter’s results.

What’s not to like? Well, we obviously need to see a leveling off of the drop in revenue as well as continued positive net income. In other words, the plan still needs to be proved out. In the meantime we can purchase the shares at $2.15, or less than 80% of net cash. If the company could just continue to earn 11 cents per quarter (so $.44 annually) as it did last quarter what might it be worth? Let’s look at it on a per share basis; first, the cash they don’t need for operations (most of it, so I’ll estimate that conservatively at 80% of the cash equivalents on the balance sheet), about $2.22, plus the operating business at 6 times net income (have to be conservative as they aren’t paying any taxes currently), so $2.64, for a total of $4.86, some 126% above the current share price. Now that’s a really back-of-the envelope calculation which doesn’t take into account the company’s true earnings potential or taxes or any of the other subtleties we really need to factor into a thorough valuation.

I’ve been following the company for a couple of years now but it never quite got cheap enough for me to buy… that is, until now (my opinion only…. do your own analysis!) so I’ve added shares to my portfolio as I think that end-of-year tax loss selling has severely mispriced these shares.