Tuesday, August 5, 2014

ALJ Regional Holdings Annual Meeting Notes

A few weekends ago, I embarked to New York for the ALJ Regional Holdings Annual Meeting of Shareholders. While there were fewer than 20 shareholders in the meeting room, there were more than a few proficient hedge fund managers in attendance: Jeremy Deal of JDP Capital Management, Thomas Braziel of BE Capital Management, Steven Kiel of Arquitos Capital Management, and several others. Whopper Investments would have been there if not for scheduling conflicts. Any company with this type of shareholder base deserves to be studied.

Jess Ravich and the company's board of directors, as well as the heads of Carpets n' More- Steve Chesin and Faneuil- Anna Van Buren, were on one side of a large conference table, with shareholders on the other. The business part of the meeting started a few minutes after 10AM and concluded in fewer than 5 minutes. After which, an hour long discussion about the company’s state of affairs took place. Something that stuck out to me, even a few weeks later, is how competent the management teams at both Faneuil and Carpet’s n’ More Seemed. This can not be overstated enough, as they now have free reign to think for the long term health of the organization (which they stated) and are also compensated well when they preform.

The first topic brought up was how ALJ (and more specifically, Ravich) found Faneuil as an acquisition. Houlihan Lokey had shopped the company to ALJ, which, as it turns out, was not the highest bidder for the company- the seller really liked ALJ, and in turn got 9% of the company, plus board representation (Michael Borofsky). As so much of the ALJ's cash is tied up at the moment, they are not actively looking for deals, though, would buy if the company had the right one come along- think in terms of the Carpet's n' More acquisition, which involved a small amount of debt and share issuance at prices that reflect an attractive purchase.

Since the acquisition, Faneuil's growth has outperformed the company's internal expectations, with the company looking to further present contracts, and expand it's tolling operations of state highways, which the present administration supports. They are also looking to move into federal and foreign contracts, as well as more back office support, in addition to the 3 health contracts that the company recently landed.

Moving along, a shareholder asked if the company was able to quantify the amount of money that it could save the various municipal governments that it serves, or could potentially serve. Interestingly, the company is generally not the lowest bidder on most contracts, but is very competitive, especially when considering the amount of customization that they can offer clients. As such, they can generally show clients how much they can save provided the products are alike. It seemed that Van Buren felt Faneuil had an advantage over it's 2 main competitors- Xerox and Maximus, as they are so large that it is hard for them to veer off of a standard platform that they are accustomed to operating with.

The next question was the one that seems to be on everybody's mind: seasonality of the business...

Originally, there would have been some due to the nature of the healthcare business, though, they planned for this and moved into Medicaid support which "flattened revenues." There were many state exchanges that are looking to turn over to the federal government- that said, Washington state's exchange, which the company is involved in, is very successful. The company is looking to do more back office work, with states such as Tennessee. Ravich stated "there is not seasonality like retail... but we don't forecast..."

There was discussion of how there will, over time be a decline in electronic tolling for roadways, and that states generally have better success with doing manual tolling, due to there being problems with tracking down the people that don't pay. As an example of a contract, Florida's Sun Pass was one that had been held since 2005/6. Due to governance changes in Florida, the company bid for all the agencies in Florida, but ultimately lost to Xerox. With ALJ scoring higher, they decided to appeal the loss and will know the verdict in the next 60 days. The contracts end in 2015 and 2016. The company is committed to replacing and growing any revenues that are lost. While the company wouldn't talk about the bids that it is currently in the middle of, they again stated that the company is looking to win federal contracts. As part of this, they plan to partner with small minority businesses to grow. They have also been looking for new revenue streams outside of the US.

When asked as to how they are able to compete with Xerox, the company does niche work, in the sense that they can custom´service, and will often have members of the organization in management meetings to ensure that things run smoothly. Furthermore, while the company is more expensive than Xerox, they aren't so lofty with their pricing that they are out of the ballpark. In my view, this is a neat niche that has barriers in the sense that Xerox is so big, that they can't change what they do very well, as they are a juggernaut in the industry. Smaller competitors will have  tough time, as this is a niche market, that Faneuil seems uniquely suited for. Management also discussed that over 85% of their growth came from adding services to existing contracts- which to me indicates that the company is pleasing it's customers.

The only point of (albeit, mild) contention in the meeting was when a shareholder expressed that the company should at some point become SEC filing and listed on a major exchange. Certainly, the benefits are numerous- institutional ownership (especially with the recently increased market cap) as well as liquidity, higher pricing of the security, which would aid in issuing stock for acquisitions, and the like. Ravich addressed this by stating that they do keep this on their mind, and at the time, it doesn't make sense to do. Jess was sure to state that given his ownership stake in the company, that he views the company as he would his own.

In terms of deal flow, the company gets roughly 2 calls a month for potential deals, which is less than before it’s recent acquisitions, considering that people know Ravich and team don’t have the cash they did. However, the company is continuing to look, as there are still creative ways to acquire (as was highlighted by the debt and stock issuance for the Carpet's acquisition). Ravich said that if they couldn't generate returns in excess of its shareholders, cash would be returned to the owners of the company, however, he didn't see that happening soon, because the company is in a unique situation where it doesn't have to pay taxes due to it's substantial net operating losses. The company is looking for deals in the $5-$70mm dollar purchase range, as they want to use all of their NOLs, sooner rather than later. Through the meeting, Ravich was very specific in saying that ALJ is trying to be opportunistic buyers and sellers of businesses (which makes a world of sense with the NOLS, and the KES purchase and sale). He also noted that while he generally has a distaste for debt, that the company was paying too much interest in this environment for the Carpets transaction. Given that the company does have some debt which it pays double digit interest rates on, Ravich stated that "it should be paid off" and that it was on the agenda for the board meeting that immediately followed the annual meeting. Personally, he has no debt, even though he sold a lot of it when working at Drexel. It seems that if the amount of debt that the company has is reasonable, they are willing to issue it in an reasonable manner. As an example, he stated that presently, the company more or less has debt that is equal to roughly 1x its annualized cash flow, and that the majority of it is cheap- bearing interest of 5% (emphasis mine).

With this, the devil is in the details: as a thought exercise, this makes sense: if the company has net debt of ~$15mm by year end, which when using Whopper Investment’s analysis, is roughly what using the last 6 months EBITDA numbers would tell you when modestly adjusting for capex. As Whopper points out, these numbers are likely low, especially when you throw a run rate on last quarter, which during the meeting management implied that you could more or less do.

When ALJ’s stake in Bellator was came up for discussion it came out that company views it as sort of a call option. As the number 2 MMA organization in the world, with Viacom now being the majority owner, it's future could be quite bright. Management said that Viacom made UFC into what it is today, and that with Bellator now being on SPIKE! TV, that interesting things could happen.

Steve Chesin was one of the last insiders to speak at the meeting, addressing the subsidiary of ALJ that he manages: Carpets n' More. As a premier provider of carpets, window treatments, and cabinets, the company is in a unique spot, as they serve both commercial, home builders, and homeowners in the Las Vegas area. The housing downturn had taken a toll on their competition and they feel in good position to take advantage of the turning real estate market. One of the unique aspects of the business, is how they market. If a homeowner comes in as a referral from their builder, and buys a lot of one item, they can market based on that (if a new owner doesn't buy rugs, but they bought a lot of hardwood flooring...). The company has exclusive contracts with some homebuilders, which should help them scale out, and is even a preferred vendor for Caesars- recently providing the gambling operator with the tile and stone for a new casino. In the next quarter, this part of the company will still be hard to dissect, but should clear up in the future. They noted that the company was purchased by ALJ for ~1/10th the price that it was valued at, at the peak of the housing bubble- when coupled with the fact that building permits in Las Vegas are up 25-30%, year over year, and there is less competition out there, it seems apparent that ALJ got a heck of a deal on Carpets...

The meeting concluded around 11AM, with Chairman Ravich saying that they look forward to reporting back next year with the progress and as everyone was getting up from the table he said "hopefully, there will good things to come..." then, almost under his breath "which there will be".

I certainly believe that: the previously mentioned discussion and various valuations of the company contend that the company is cheap, even with no growth. I think that there is significant upside, even with the recently bid up share price. ALJ is a company with very manageable debt that can quickly be paid off from cash flow, the company seems to have incredible deal making ability, and a great management team. With the results that I feel are more than reasonable to expect, the company is trading for less than 6x cash flow, which, due to the tax assets and nature of the business, are pretty close to what shareholders will earn for the foreseeable future.

Additionally, the company has a recently acquired business, that seems to be getting better credit conditions, will be profitably expanding, and is guided by a manager that is now incentivized to think for the long term, and as such, could reasonably be (I would say, conservatively) valued at nearly 1/3 the present market cap of ALJ in the next few years. Throw in a call option for Bellator, the potential for growth at Faneuil, and yet another acquisition(s) that would speed up the monetization of the NOLs, giving them more present value, and I think that you have a compelling case for this company still being too cheaply valued by a significant amount.

Disclosure/Disclaimer: I own and represent shares of ALJJ and reserve the right to change that at any time. This is my opinion and not investment advice. Always do a ton of your own research in regard to anything that I say, do, write, or so much as even think about.

Monday, June 23, 2014

Starting Activism at Sitestar (SYTE)

Historically, I have had a very cheery opinion of Sitestar. The company seemed well run and has historically traded at a significant discount to what I believed its liquidation value to be. As a result, I ended up filing a form 13D and buying over 7% of the company. I even did a couple of write-ups on it and the CEO Frank Erhartic, who agreed to give me a board seat about 9 months ago.

Fast forward to today...

In my last post, I alluded to the fact that if things aren't going as they should at a public company, it is the job of the Board of Directors to change management's course. If the board fails to act, then that responsibility falls to shareholders. With Sitestar, if any of problems or disagreements were minor, I could get past them, however, after many months of my being locked out of the board room, operational results lacking, the company making numerous mistakes with their SEC filings, not to mention not filing them or renewing their business registration in Nevada in a timely manner- I believe it time for the shareholders to change Sitestar- and others agree. As such, Steven Kiel of Arquitos Capital, Jeremy Gold and Chris Olin of Alesia Asset Management, and myself formed a 13D group- the first filing of which can be seen here.

Here is a brief history that led to the start of this activist campaign.

Since becoming part of the company's board of directors, I have been to Virginia several times. During this process there were various items that I believed to be important to discuss at the board level:

*deciding what properties needed to be rentals, whole-saled, or flipped, and then to act accordingly, making plans of how to do so
*investigate the return of capital to shareholders either through share repurchases or dividends
*investigate all options for the company, be it acquiring more ISPs or shopping the internet operations to prospective buyers. There are also domain names that could potentially be shopped for interest
*hold an annual meeting, as is required by law, and have the shareholders vote on a reverse share split
*hold regular board meetings, as are required by the company's articles of incorporation

Frank Erhartic who is the CEO, a board member, and large shareholder of the company, made assurances as to many of these items, which gave me hope to work with the company. Yet, as time progressed, it seemed as though none of this was getting taken care of, despite my requests to aid the company in implementation. As such, the real estate operations have not been progressing  at a significant rate and there has certainly not been an annual meeting.

Later, as a board member, I requested cost basis info for the various properties as part of an effort to get the entire board to analyze the real estate operations together and then to decide how to best monetize them- be it keeping them (in part, or all) as rentals, flips, wholesales, and the like. I was given the run around and at one point was even told that the company didn't have the info, despite the company having cost basis accounting for the whole of their real estate portfolio, which is disclosed in their SEC filings. After pointing that out, I was shrugged off.

As was noted earlier, a new 13D group has been formed. In this demand letter, we requested the books and records of the company to investigate possible mismanagement, as well as to receive a shareholder list- both of which we are entitled to review, by law. The company never responded and wouldn't sign for the certified letter that Steven Kiel mailed the request to them in. On June 12th, the day after we hoped our request to be honored, Steve and I drove to Lynchburg, Virginia (cumulatively, around 20 hours) to attempt to meet with Dan Judd, the company's CFO at Sitestar's headquarters. We wanted to have a constructive conversation with management in regard to our request.

Steve and I met at Sitestar's headquarters around 10:30 AM. We made a request to one of the employees to meet with Mr. Judd, who despite our numerous attempts, refused to meet with us. Ultimately, we gave the employee a copy of our demand letter, which she took to him. After an hour or so of us waiting, she came out and told us that she had take a 30 minute lunch and lock up the shop. We continued waiting outside, hoping Dan would come out- he didn't. Steve and I finally walked across the street to grab lunch and when we came back, Dan's car was gone. We waited awhile longer and no one returned… Interestingly enough, while we were waiting, some Sitestar customers came by the shop to drop off their internet payment, but no one was there to take it, so they left.

These and other items indicate that things are clearly not as they should be at Sitestar. As if the recently reported operating results are not enough, undelivered promises of holding a legally required annual meeting, a rental property portfolio barely progressing, the lackadaisical attitude of management correcting errors in the company's annual report, and refusal to meet with a group consisting of ~15% of the shareholders (one of which, is a board member), indicate that there needs to be a significant change. We, as a group, are committed to taking whatever action is necessary to preserve and enhance the value of Sitestar.

Certainly, we hope that further friction can be avoided- we would love nothing more than to resolve these problems in an amenable manner to both shareholders and management, and continue to be willing to have a dialogue with Frank and Dan. However, when management's defense has historically been that of an ostrich burying its head in the sand, stronger measures seem needed. If our requests are not honored by the end of this week, we will be moving ahead with our demand for the books, records, and shareholder list by compelling the company to give them to us via court order. Because this lack of production is so egregious, we plan to ask the judge to force the other board members to reimburse us for our expenses related to this demand out of pocket, rather than from the coffers of the company, which belong to all shareholders.

We have a request for the other  minority shareholders: PLEASE, contact us. We would love to hear your thoughts. Thus far we have been contacted by a significant portion of the shareholder base and believe that there is a lot more support out there.  It doesn't matter how small your position, we need your thoughts and support, and would like to communicate with you.

Jeff Moore
(859) 230-3115

Steven Kiel
(571) 766-8089

Jeremy Gold
(323) 642-8043

Christopher Olin
(323) 642-8043

Disclosure/Disclaimer: I am long shares of Sitestar (SYTE) and represent shares of Sitestar in accounts that I manage. The same is true for the other members of the 13D group that has been put together. This post is my opinion. I reserve the right to change my positions at anytime. Always do a ton of your own research before so much as thinking about doing something that I think, talk, write, or so much as even think about.

Tuesday, March 4, 2014

Differences In The Types Of "BAD" Governance.

Often times, people paint corporate governance with very broad strokes. In the animal like nature of The Increadible Hulk, investors can scream "Poison pills bad! Staggard boards bad! Share repurchases good! Voting structure bad!!!!" When often, these, and so many other points should be investigated on an individual, and case by case basis.

Obviously, share repurchases are not always a good thing- as Warren Buffett points out in his most recent annual letter to Berkshire shareholders, buying back stock below intrinsic value (note, not neccessarily market price, book value, or some stated multiple) is wealth creating for shareholders, whereas purchasing stock above intrinsic value is value destructive. Dividends can be similar- if the company can reasonably expect to grow investment at a greater rate than its shareholders, generally, a dividend would be a bad thing to pay.

In the instance of Winland Electronics, a poison pill was adopted, which the company claims was to protect the Net Operating Losses (NOLS) of the company. While many think that these are only negated when a change in control occurs, by someone buying 50% of the stock, that isn't the case. It's a much more complicated rule that has to do with 5% shareholders and the amount of stock that they purchase (here is an easily Googleable article, which doesn't go nearly in depth enough). This is the exact same sort of poison pill that ModusLink, formerly known as CMGI adopted. You can also look at insider transactions to see how they go about creeping up their stakes so as to not lose the NOLs. Clearly, this poison pill is a good thing for the small company, especially when the board is plumb full of value investors. Even just a few million dollars of NOLs means the world, when your whole market cap is just a few million!

Other instances, such as that of ITEX, the poison pill seems to be more about the CEO controlling the company, based on a historic disregard for shareholders and lengthy legal battles by management. They even had an interesting share buyback that while value creating (since it was implemented below the intrinsic value of the company) seems to also have been done to get rid of shareholders that wouldn't have voted with management in the coming proxy battle. And this is after certain items (such as a dividend) had been pushed for by shareholders, which has clearly helped the share price rise in a responsible way, over time.

In other types of governance related issues, last year, Solitron Devices was forced by various shareholders to have an annual meeting. At the meeting 2 of the former directors of the company were ousted, simply because they didn't get enough votes to stay on the board. Now, one of them is back. The company also initiated a staggered board, which would seem to only serve to entrench management... in light of previous struggles with shareholders, this doesn't seem to be very shareholder friendly, which is unfortunate- at the Solitron Annual meeting, there were numerous shareholders that attended, both large and small, united by their desire to see the company do well. Thus far, few suggestions have been taken by the company other than holding an annual meeting and a small buyback of shares in a private transaction.

Paranoia seemed rife when the company responded to questions at the meeting (here is the transcript.) As a side note, a lot of the quotes were misattributed to specific shareholders, and a lot of stuff was missed in the back and forth. (On a personal level, I am not a quack when it comes to drones, there was a load of sarcasm in my voice!) Interestingly, one of the old directors came up to a few of us who were talking after the meeting (Nate at Oddball Stocks and Valueprax can back me up on this one) and told us that the company would have lost x number of dollars (I think a few million, which was absurd) if they would have held an annual meeting every single year that they hadn't. This stuck with me, as the resentment of holding the meeting in the first place was clearly still there, despite righting the wrong of the company not operating in a legal manner for nearly 2 decades...

Often times, the will of shareholders is totally ignored. Even when the right thing is done, there is often still work to do- just look at the whole of the situation with Solitron. Despite the progress that the company has made, a ton of shareholders are still not happy with how things have been going, and likely think that progress is longer than originally expected. Several shareholders were outright angry at the annual meeting! However, activism is often a slow process in the small cap world, due to capital, legal, and time restrictions. With Solitron, any change seemed to be met with great resistance, after all, the company is the CEO's baby, and "outsiders" can't go about changing things in weeks or months...

In light of this, it is important to remember that if a company doesn't act in the interest of all shareholders, it falls on the shareholders themselves to do what is right and make the needed changes. This is true whether it is a big company such as Motorola, small company such as Syms, or even smaller, which is what this and a lot of other value blogs are known for. The companies are yours- make your voice known!

Disclosure/Disclaimer:  I own and represent shares of TPHS (formerly Syms) and Solitron Devices, but none of the other companies mentioned, though, reserve the right to change the positions at any time. This post is my nothing more than my thoughts/opinion. Always do a ton of your own research before so much as contemplating anything that I say, do, write, or even so much as think about.

Sunday, January 12, 2014

Rurban Follow Up (Now, SB Financial)

As you may recall, friend and fellow value investor DTEJD1997 did a guest write-up a while ago on a company called Rurban Financial, here is his follow up. Please note the disclaimer at the bottom- he owns shares and I don't. Regardless, it is a neat bank that has been fun to follow. He has also done analysis on Nevada Gold, a company which I have owned shares of for a few years and written up several times (though, I was a bit early with my thesis beginning to play out, but that is a story for another time). Additionally, we have worked on a few other investments together, the most public of which was Calloway's Nursery.

Without further ado:

Hey all:

This is DTEJD1997, and I wanted to revisit Rurban Financial and give an update as to what has happened and what Rurban's future prospects are.

NOTE: Rurban is going to be announcing earnings on Tuesday, January 21st 2014. It will very interesting to see what they report.

In the past couple of years, Rurban has accomplished quite a bit. The most notable thing is that they have changed their name and ticker symbol. Rurban is now known as State Bank Financial Group, ticker symbol: (SBFG).

Since my first article, SBFG has turned around their operations and are now solidly profitable. They took charges for bad loans. They also took a lot of write downs in the data processing division. A lot of people were let go in this division. It is a fraction of it's former size and it appears that most of the problems there have been solved. After these write downs, REO was sold and the loan book and capital base has improved. As a result, reported earnings are now well over $1/share. Actual earnings are somewhat higher than reported earnings!

Regulatory capital levels have improved and SBFG is now well capitalized. They are no longer under increased FDIC scrutiny.

And perhaps most importantly of all, SBFG started a dividend and raised it once already.

Well DTEJD1997, that sounds all well and good, what has happened to the share price? I am pleased to report that it has gone up, tremendously so. Recent trades have been around $8/share. However, when you look at the underlying financial metrics and likely future earnings, SBFG is STILL undervalued and has room to run!

Let me explain my thinking:

I'll start with the easiest and move to more difficult things:

Insiders are purchasing shares.
Insiders have been steadily purchasing them ever since I wrote the first article. Some of the shares purchased have been at prices HIGHER than what SBFG is trading at today. These aren't huge purchases, but they are several hundred shares at a time. These are frequently DIRECT purchases using their own money, not just option exercising. The trend is strong, continual purchases.

This is an EXTREMELY bullish sign.

Actual earnings are higher than reported $1.13/share

Earnings of $1.13/share is giving SBFG a P/E ratio of just over 7.  Flip the equation, owner's earnings are reported as about 14%. HOWEVER, this is NOT ENTIRELY ACCURATE! Why? SBFG bought out a couple of very small local banks a few years ago. There was some goodwill and intangibles associated with the takeovers. SBFG has steadily been writing this amount down. This is a non-cash expense. Thus, true cash earnings (owner's earnings) are actually in the realm of $1.28/share. This brings the P/E down to about 6, and the true earnings yield jumps to close to 17%.

As earnings have increased, so has the Return on Equity (ROE)

This critical measure of management's skill has increased to just over 10%. While this is not a tremendous return, it is certainly very respectable. It is even more respectable when you can buy SBFG at a healthy discount to book value! I think it is highly likely that ROE will increase in the near future. The rate of gain will start to slow from past rates, but if ROE can get to 10.5%, 11.5% or even 12%, shareholders will be in a good position. I will further suggest that shareholders are going to be in an even better position when the market realizes that SBFG should be trading for about book value.

There is simply no reason that a stock earning over 10% ROE on a normalized basis should be trading for significantly LESS than book value. I am confident that SBFG will be re-rated higher. The only question is how long it takes...

*NOTE ON BOOK VALUE* SBFG has a good amount of "intangibles" on the balance sheet from past acquisitions. Thus there are TWO measurements of book value. Shareholders have "regular" book value, which includes intangibles, and then there is "tangible book value", which excludes intangibles. Obviously "tangible book value" is a more conservative measure. A sharp purchaser can still get SBFG at a slight discount to tangible book if they time their purchase correctly!

Regulatory capital levels have improved to “well capitalized”

Of course, the FDIC required capital levels are rather low for my tastes, but they are a good starting point. As per management of SBFG:

"Capital ratios continue to improve, however it still remains a primary focus of management. The Tangible equity ratio improved by 65 basis points over the past twelve months, and now stands at 6.20 percent. All bank regulatory ratios remain in excess of "well-capitalized" levels. At September 30th, 2013, State Bank's Total Risk-based Capital was estimated to be $60.0 million, $21.6 million above the well-capitalized level. The Total Risk-based Capital Ratio is estimated at 12.6 percent."

In the intervening quarter, the equity ratios have further improved with Tangible Equity/Tangible Assets further improving to 6.18 and Tier 1 capital improving to 10.53.

Asset quality is rapidly improving

Asset quality is improving with SBFG reporting nonperforming assets of $8.8 million for the current quarter, lower by $0.6 million, or 6.7 percent, than the prior-year third quarter. From the latest quarterly report:

Net charge-offs of $0.3 million were just 25 basis points for the quarter and up slightly from the prior-year third quarter. Delinquency levels have declined, with the 30-89 day category totaling $0.4 million at the end of the 2013 third quarter, compared to $0.7 million for the prior-year third quarter. Mr. Klein continued, "All of our asset quality measures, especially delinquency, have shown improvement. We have continued to add to our loan loss reserve, resisting thus far in 2013 to release loan loss reserves to impact our earnings."

So SBFG's loan book is well reserved against future losses. SBFG will continue to grow it's loan book in the future. Small additional incremental earning improvements will continue to come from improving asset quality.

If the economy continues to improve, the loan reserve ratio may prove to be over reserved. Thus, there is a possibility that future earnings will be "juiced" by releasing funds from the loan loss reserves. The other possible way to increase earnings is to LOWER the future contribution to the loan loss reserve, as it is already more than adequately reserved
Problems at the data processing division have largely been solved.

Losses were incurred, massive write downs taken, and people were let go. The data processing division is now a relatively small part of SBFG. Gross revenue was only $700k for the quarter. Win, lose or draw, the data division is now a relatively small part of the company. I believe it is a small operation and won't make much of a difference either way going forward.

So it is clear that SBFG has made tremendous progress and has turned the business around. What about the future?


I strongly suspect SBFG is going to expand their loan book in the upcoming year. I think the expansion will be relatively large, as management has done two interesting things:

The first interesting item is that they filed a S-3 "Shelf Registration" statement with the SEC. They are taking the first step towards raising $30MM in future equity. As CEO, Mark Klein stated:

"Our performance has benefited from the strategic initiatives we implemented across our organization over the past three years. We reduced our problem assets early on, and have since maintained a consistently strong and stable portfolio of quality loans. Revenue growth has been derived from both loan growth and fee income; in particular, our geographic expansion of residential mortgage banking activities has been well-timed to enhance corporate profitability and attract new households for continued enterprise growth. Additional capital can enable us to pursue future banking opportunities that will contribute to the continued growth of the Company, while preserving the capital levels of SB Financial Group and State Bank, which are both currently in excess of well-capitalized requirements."

Raising capital will allow SBFG to greatly increase the size of their loan book. This is going to be a major expansion.

The second interesting item is that SBFG has retained Lambert, Edwards & Associates of Grand Rapids Michigan to head investor relations and to conduct outreach to potential shareholders.

"We are excited to partner with LE&A. Their team of investor relations and financial communications experts will help SB Financial leverage its recent re-branding initiatives, enhance our strategic communications, target and engage the investment community, and build-out our shareholder base,"
Mark Klein, president and CEO of SB Financial Group.

In addition to everything Mr. Klein stated, I think the OTHER reason the public relations company was hired is to get the share price up. The share price needs to be raised BEFORE issuing more equity to prevent dilution to existing shareholders.

As a shareholder, I do NOT want more equity issued at $8/share. That is below book value! Book value is $11.41, with tangible book being about $8. If equity could be issued at a price higher than tangible book, yet lower than stated book, I think most current shareholders would be OK with that.

If shares are issued around $10/share, that probably would be OK if management has a good place to put that capital to work. it appears that the S.E. Michigan and N.W. Ohio real estate markets are strong and are continuing to be improve.

Issuing $20 or $30 million in new equity would allow SBFG to enter new geographic areas and increase the loan book tremendously.

I am going to guess that management is planning a major expansion into the Columbus Ohio area. Another possible area is expanding operations in Indiana.

The success of the future expansion comes down to whether management can earn MORE on the additional raised capital than it is on the existing capital. If so, the expansion will be accretive to existing shareholders and thus a success. There is a very good chance that it will be. Management knows which areas are ripe for growth. They already have a lot of infrastructure in place to handle new growth, as evidenced by the steadily improving efficiency ratio . Insiders have also been steadily purchasing shares indicating they think the bank is undervalued.

If you have read this far, you may be thinking "Well DTEJD1997, that is all fine and good, but what of the risks"?


The main risk is that management is too anxious to grow the business and issues equity that dilutes existing shareholders too much.  As a shareholder, I want my position strengthened, not weakened or diluted. It is not entirely clear at exactly what price management intends to issue shares, so this may be a misplaced concern.

Assuming that new equity is not sold too cheaply, there is execution risk in growing the loan book. Management will have to be judicious in putting the new money to work. I think they can do it, but there is some risk.

There is also risk from rising interest rates. I do not think that will be too much of a risk in the near future, but it could be a larger problem a few years from now.

Of course there is a risk that the economy as a whole, or in Ohio and Indiana, will weaken substantially. There is not much management can do about that.

And finally, this bank was driven into the ditch once before, and it very well might be at some future point. It is generally NOT prudent to buy banks and then hold them indefinitely. Banks trade in long term cycles. In my investing career I saw the tail end of the S&L crisis, the internet boom & bust, the housing bubble, and the Great Recession. Buying banks when there is trouble and panic, holding them for a while, and then selling them when things are exceptionally good is a much better strategy than buy and hold. There are a few banks that are exceptions, but these are a rarity. Witness how many times Citibank and Bank America have boomed and bust. These cycles last YEARS, sometimes almost a decade. So we may have many years left before it is time to sell.


The end result is this, SBFG is still one of the best values in small banks out there. The P/E ratio is unreasonably low at a level below 7. They are trading at a significant discount to book value. SBFG has insider buying, with NO selling. There have a dividend that is growing. Take any financial metric that you want, and SBFG is demonstrably cheap, low P/E, low P/B, growing dividend, etc.

At some point, the market is going to re-rate SBFG at higher valuation levels. SBFG will probably never be a huge growth stock, nor will they be a top tier bank. THEY DON'T HAVE TO BE. As investors, we are capable of getting a superior return as the market is selling SBFG at too great a discount. Superior returns will be realized as SBFG gets rated higher. Will SBFG ever sell at market rates? Maybe not, but it does not have to. Go from a 7 P/E to a 10 P/E and you have over a 50% gain when you factor in dividends and organic growth!

*Please do your own research and due diligence. Don't take my word for it, verify it for yourself. I own shares of SBFG and may trade it at any point without advance notice.

***Jeff has no position in SBFG, but certainly thinks it is a neat little company.***

Sunday, December 22, 2013


Not to turn into the doomsdayers at Zero Hedge, but seriously: the next crash is coming... Without a doubt. Here are some screen shots that I took a few minutes ago, which undoubtedly prove it.

Note, this is for the Dow Jones Industrial Average, as of December 20th. It seems that with the market generating just shy of a 30% return in the past year, everyone has forgotten what it is like to lose money. Sure, you would of had some pain by investing at the end of 2008, but since then... WOW!

Compare the most recent period with the 5 year period ending in 2007. The markets peaked out right before crashing... As is the case now, everyone was used to making money... Then a huge crash occurred that made for a great buying opportunity about a year later.

Go back another 4 or so years, to the previous time the market peaked... Again, in the previous 5 years, people just couldn't remember losing money in equities. After all, there was a new normal where companies were valued based on future sales- who gave a damn about current earnings!

Wait a minute... That sounds eeeeeeeerrriiiiilllllllyyyy familiar, doesn't it (TSLA, FB, TWTR, AMZN, etc). Certainly, revenue, margin, and earning expansion have always been theses which have been with us.

Now, check out what the market did in 1987... again, we see that in the previous 5 years, people didn't know how to lose money.

It certainly seems that one could easily come to the conclusion that we are certainly doomed based on these 5 year examples. The expansion has gone on for too long! The world will again collapse!!!

That is, until we get a little bit more in depth; in the next chart, we can see that for the 5 years before 1999, we had a ton of growth in equity prices, with a bull market lasting a full 10 years!

Before that, there was a good bull market that lasted for a significant amount of time before the 1987 crash too...

For long time readers, it should go without saying that this blog has a healthy dose of sarcasm... Once asking why Federal Reserve didn't buy 1/3 of the nation's housing, just to bulldoze it in effort to stimulate growth and even throwing darts at a Wall Street Journal to see what would happen with some random selections versus Facebook's stock (once noting the company's margins, relative to the world's population). That carries to now- these charts illustrate how a taking something that could on some level, seem reasonable- to an illogical extreme (and frankly, doing so in a pretty dumb way) can have some serious points in regard to allocating capital.

For me, the market being at an all time high is only kind of frightening- not alarming, since it is reasonable to think the world will continue to grow wealth- yes, even here in the US. We could very well be in some great economic expansion that the market isn't pricing in yet. Look at the last 2 screenshots for a example of decade long stock market growth (forgetting about tailwinds and conditions for a minute). We are now at a point where people have probably forgotten what it is like to actually lose money on stocks- everyone seems to be long and all about investing in equities. People can also have a short memory. Key to remember here, is that in the past 5 years, it didn't matter if you are a stereotypical growth, momentum, or value investor- it would have been hard to not make money in the past 5 years... And you could have done so by doing some pretty stupid things at the time, which could look incredibly smart- even clairvoyant, now... If repeated under a slightly different situation in the future, could permanently impair capital.

Which brings us to the present day...

Maybe the miracles of monetary policy are going to save us and we can unwind these low interest rates, or, keep them where they are without sparking inflation. Maybe you believe the profit margin arguments, and think that they can stay historically high for a host of reasons. Maybe the 5 and 6 foot tall children in Washington DC are going to finally get along, which will make the country calm enough to buy things again. Maybe the massive de-levering is going to stop, borrowing will pick up again, which along with the low levels of inventories companies are sporting, and the velocity of money will finally reverting to the mean that the Fed wants. Maybe it will happen in a way the Fed doesn't want and inflation blows up, proving that equities have been cheap...

Or maybe none of this will happen and other bad items such as high government debt, Obamacare, and persistent unemployment will send us into a death spiral. There will always be arguments as to what is going to happen, how something will affect something else, and even once said events happened, people will still argue about it. Frankly, I know that I am not smart enough to weigh so many variables and come up with much of a macro view about things. If anything, I like the words of Seth Klarman here: "I think bottom up, but worry top down."

What I do know is this: good deals are getting ever harder to find. A few years ago, it was easy to buy companies where you could be reasonably sure it could liquidate and the initial investment be safe, or at the very least, could bleed cash (practically) forever, as long as they kept the rate of loss to their worst quarter of the last recession... Now, it seems that most investors are looking at companies based on their current/future earnings, with a healthy growth assumption. None of which generally price in a recession of any sort- my gut says that won't end as well as they hope. In recent conversations I have had, people have even proposed getting in bed with some pretty unscrupulous management teams, basically because the stock is the cheapest thing that they can find.

This strikes me as a bit worrisome and something that was very easy to avoid in the near past.

Furthermore, there this bull market, combined with the ever increasing access to and acceptance of the internet, more writers have become widely read, more fund managers reputations made (or broken), and even bloggers have earned jobs as analysts or money managers in a way that no one would of ever thought. This is an interesting time to live in. A lot of people are probably lucky (including me) because of the tailwinds that they have had behind them. It will be interesting to see how people do once the markets start to turn- because eventually, the DOW will have more than a few down days! That should separate the men from the boys so to speak, especially as a lot of the value investors that are active on the interwebs are long only. Keep in mind that due to the internet, victories are a lot more visible, and, we are at a point where they have been more visible, with a huge bull market- basically, a feedback loop of egos (both for investors and their investors), based on a ton of independent variables that could literally not have happened in conjunction at any other point in history.

The lessons of Bill Miller shouldn't be forgotten- star of the investment community to a pariah. Pariah to talented manager again- this could happen to everyone out there, only you wouldn't need billions. A bear market could be more humbling than investing in a fraud!

When everyone out there feels smart for investing, one should probably feel the dumbest. Literally, I have practically been hitting my head against the wall, trying to find new investments that I feel truly comfortable with. As such, I am doing my best to control my emotions and sit on more cash like investments than ever before- be it the recent Chromcraft Revington buyout by Sport Haley, Ethanex, and even a pawn shop chain that was recently bought out and is in the start of an orderly liquidation- there are a few others too. There are potentially few insurance companies that aren't reporting that are pretty interesting as well, but that is a totally different story, for a different post. Rental housing can be good too, so long as you get a good deal- which I think I have been able to do in a few instances recently. However, be warned that the hedge fund types paying in excess of 115 months rent for rentals- before fix up costs?!- are likely not going to do well in the long term. Additionally, the securitization of rental payments is probably as bad of an idea as a mortgage backed security... especially when it is done by people who have probably never swung a hammer. Even publicly traded net-net looking REITs such as Trade Street Residential seem to be overpaying for their properties- the newness of them, alone should be scarry, which is something that was talked about in my beat up Jason Zweig edition of The Intelligent Investor. Certainly, they could do well, but there is a great deal of risk in them. Alas though, this is again the subject of another post...

Regardless, it is key to remember that deals are almost always out there if you look hard enough, turn a lot of rocks over, and inevitably, go down a bunch of dead ends. In the midst of a raging bull market, deals may not be in the form that you think. Let us all be more diligent than ever. After all it's about time that we really earned the money we make.

That, and probably re-read everything Ben Graham ever wrote. Notice the overall downward trend in Benjamin Graham related searches on Google Trends over the course of the bull market? Me too... That might be a touch telling as to where we are at in the grand scheme of things.

Happy hunting.

Disclosure/Disclaimer:  I own and represent whatever is left of the Chromcraft Revington shares that I purchased a little bit ago. I also own and represent share of Ethanex, Premier Exhibitions, that pawn shop I mentioned, and a small insurance company that has not reported to the SEC in over half a decade. Other than that I have nothing in or against any other security mentioned. I reserve the right to change the positions at any time. This post is my nothing more than my thoughts/opinion. Always do a ton of your own research before so much as contemplating anything that I say, do, write, or even think about.