Tuesday, September 28, 2010

Sometimes, It's Best To Take A Pass #2: Northeast Auto Holdings

One of my favorite things to do is to run a low p/b, low market cap, stock screen on companies that are still earning money. Today, I found an interesting nano-nano-cap: Northeastern Auto Holdings. At the time I am writing this, the market cap is just a hair over $55K. When I saw that the P/E was so low that one could feasibly pull out the earnings of the company after ~2.5 months and get their investment back, I must say, my interest was perked!

Northeast Automotive Holdings, Inc. engages in the wholesale purchase and sale of used vehicles in the United States. It involves in purchasing late model used vehicles from dealers and institutional sellers in Northeastern states, as well as in transporting the vehicles for resale in the Pacific Northwest. The company buys used automobiles at auctions, and repairs, cleans, transports, and resells them in wholesale. It sells vehicles through third-party auctions, which act as a marketplace for used vehicles. The company is based in Merrick, New York.

When looking at the financial statements, the company is generating decent returns, and, despite having a tough time in 2008, business prospects seem to be on the up and up. The company seems to have a decent manager, who not only founded the business at the ripe young age of 25, but only takes a salary of $46K... on the face of things, it seems that he is looking to get rich with shareholders, rather than off of them. WOW!

Now, we delve into the 10K... and find this summary of a big monstrosity:

In April of 2008, to aid the company in paying off a small amount of debt and retire some shares of common, the board decided to issue 10 million shares of preferred stock. Now, when reading a little bit, these shares are able to be converted, 1 for 1, into shares of common stock. Additionally, they automatically convert after 3 years of issuance! So basically, what will happen sometime in the next 7 months, is that the share count of the company will increase to over 10.5 MILLION from just over 550K... thats right, roughly a 20 fold increase in share count.

This dilution takes a company that earned $413K on 555K shares, or, 74 cents a share over the past 4 quarters, to one that is earning 4 cents a share and is still superbly illiquid. Literally, over the past 3 months, the company has averaged 8 shares a day trading hands.

But how could something like this happen? The preferred share's conversion rights are not effected by share splits... Isn't it odd that the company, less than a month after the preferred shares were issued, approved a 1 for 30 reverse stock split? Regardless of the intent of the decision, this was certainly a stride that aided in delivering the bulk of the company's shares to the Solko family.

The great thing about this for Solko, is that after this transaction, will go from owning just under 57% of the company's shares(scroll to item 12), to owning ~96% of shares; basically, for just retiring 100K in debt that the company owed to him and retiring a few of his own shares! At 4 cents a share, the conversion is worth $400K in stock. Even after the retirement of the shares he had to give in order to get the preferred shares, that ain't a bad payday.Basically, he is taking complete control of the company, in a way that only bankruptcy could allow. However, even if the company was insolvent, there isn't anyway that a self respecting bankruptcy judge would ever sign off on this.

Still not enough for you? The company had to restate it's financial statements for the year ending in on December 31, 2008, due to a dividend on the preferred shares! Now, normally, one might be able to overlook this... however, we must remember that the accountants at Kempisty & Company audited these statements, and somehow, missed it. It shouldn't be a surprise that the audit firm came under investigation either. Furthermore, the person that discovered the error, was William Solko himself- the very person that the dividend was paid to! This mistake was for just over $400K; is it plausible that someone can forget to account for such a charge, when it went directly from the company into his pocket?

Additionally, in the previously mentioned 10K, we find that the Board has no committees, has 3 members, and one of them is the wife of the founder of the company. In the past, she took home a very nice salary; well over 2x what her husband made. Given the both of their job descriptions, eyebrows could be raised. Without any independence of the board, a history of habitually making late filings with the SEC, and a bunch of weird share issuance, how can one properly value the company?

Does that P/E of .18 or even 2.5 (post conversion) look so good now? For me, the answer is no.

Disclosure: NONE. This is not investment advice. Always research everything that I so much as think about.

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