Sunday, December 23, 2012

Sturm Ruger: Looks So Good, That It Can't (or couldn't) Be...

This is a post that I wrote on May 3rd after I had a few bourbon and cokes. Apparently, I forgot I wrote it (obviously, I just had a few...) and stumbled upon it when looking at some old drafts... Ruger was trading for $54.7ish at the time and later bottomed out at ~$35 bucks. Since then, it has rebounded quite nicely and has gone back down, and about every other direction- however, at no recent point have I wanted to own a part of the company... This article is out of date in the short term but (I think) is relative to the long... This is especially true in light of recent gun related tragedies. I have made a few minor changes, but, the premise is still there... I don't wish to get into a debate about gun rights or anything like that. This is strictly investment thesis oriented piece and not an emotional or political issue.

Sturm Ruger is one of those companies that I have followed for a long time. I like their products, sold them in a pawn shop I worked at, and can personally attest to their quality/value. However, as of now, I wouldn't trust any of my money to be invested in their stock. In fact, the only time that RGR looked really cheap to me was when it was in the single digits in 2008/2009... But that was when I was investing in IBAL, CTHR, and BH (formerly SNS) and others- RGR just wasn't cheap enough compared to everything else at the time for me to take the plunge.

There are a lot of things to like about RGR... for one, they have no debt and don't seem to like taking it on. Recently, the company's cash levels have swelled (an understatement). In the last 5 years they did some major changes to their production line and became a drastically more efficient company (there use to be a really good presentation on their website and it may still be there- if so, check it out). The company likes dividends and repurchases it's shares regularly. If capital allocation isn't enough, the company recently went from making guns that were relatively antiquated such as "cowboy style" six shooters to making some that I would be willing to consider as an alternative to my favorite handgun, so you have a sort of product revitalization play going on as well. My dad the previously mentioned SR9 that it is a joy to shoot. Hell, I even like the LCP that they introduced a few years back- at the time, it took weeks to get as it was on back order for ever. Despite that, the company didn't use it's pricing power due to a lack of real competition in the product's niche (well, other than Kel-Tec). I was kind of surprised by the move, actually, as every dollar they increased the price would have gone straight to the bottom line, without doing much to curtail demand for the product. That said, a pretty neat piece despite it's need to be fixed in a costly re-call (which the company seems to do an embarrassing amount of).

Getting back to the stock, Ruger's most recent press release couldn't possibly have contained more good news. The company even raised it's quarterly dividend by 67%. Ruger received orders for more units of product in the first quarter of 2012 than it did in the whole of 2011... as such, the company suspended new orders on March 21st and expects to begin taking them again at the end of May- which, one would presume, would create a scarcity for their product. All I can say in regard to that is "WOW."

The company said the following:


"We believe that Ruger is the first firearms manufacturer to build and ship more than one million firearms in one year."


No pun intended, operationally, the company has hit a total bulls eye.

Does this make for a good stock to own? Personally, I would say "not totally." It isn't that I would want to short the company, but rather that I don't want to be long (which is a stance that I will admit to having since it was trading for less than 1/2 present price levels).

First and foremost, I absolutely hate the industry from an investment perspective. To me it is like a hyper cyclical stock- only it's based on the gun toting public engaging in a political war with people that want to see the company put out of business, rather than economic health to stay a float.

From a societal perspective, firearms are something that will without a doubt, become more regulated in the future. I view this as a truth that will come about partly as a result of our population moving to cities where there are fewer chances of people shooting Ruger's products. It has been my experience that most people are generally scared of guns due to news stories that are made to scare people rather than enlighten them. Even when I bought my first couple, I felt like I was doing something wrong... It is all about exposure to the item (and this is coming from a guy that worked in a pawn shop for a year before he bought his first gun). Once someone actually fires a gun, they generally get an appreciation for how safe they can be when properly used/stored and how it is nearly impossible for one to "just go off." Without people living in the country (as in, the middle of nowhere, USA, where AJII's mini mill is located) where it is really easy to shoot, there will likely be less demand for the product (which, to some extend, may also apply to ammunition manufactures).

As such, with a population that is quite polarized, it could be likely that this industry that will eventually die a pre-mature death due to legislation and a changing culture. Under the previously instated assault weapons ban, various types of weapons and clips were outlawed from being manufactured, but not to sell or own. Legislation of this nature could really hurt the demand for Ruger's products. Even one of the company's leaders supported such action.

While I am generally a big fan of old PP&E on a company's books, I wouldn't be surprised if the impressive amount of property that the company owns would be subject to some sort of environmental or health liability due to the nature of it's age and the type of product that Ruger makes (granted, I don't have any hard proof on this, but it's a gut feeling). This alone wouldn't scare me; I would imagine that it's a similar case at other industrial firms. However, when combined with a host of other risks, should be noted.

Another item that I absolutely hate about the firearm industry is that is is constantly ripe for product liability lawsuits. People absolutely hate industries that make things that contribute to the killing people. If it isn't tobacco or asbestos, then it's the fast food industry. At some point, the civilians weapon industry is going to be on the chopping block again. Ruger has historically had a lot of legal action taken against them and recognizes all that's noted in their risk factors. Public opinion is a messy thing to have to contend with and frankly, I view this as a black swan that is pretty easy to see flying in at some point- I just don't know when it will be.

When considering the potential for repeat business, guns generally don't degrade over time. It isn't as if they continually improve in the same way as say, an Ipod or Intel processor. An Ipod (like Moore's law) doubles its awesomeness every few years and historically, on a parabolic basis as has been the case with computer processors. Firearms don't. While Glock really stepped things up ~3 decades ago, many of the best weapons out there are decades old. The AK-47 is unrivaled for what it does and the design is over 60 years old- they shoot well, are super reliable, ammo is cheap, and they are a joy to shoot. The Colt 1911A is over a century old and is basically unchanged. It was the side arm of the US Armed forces until Beretta beat them out (which was really contested) a few decades ago.

Ruger's products can be used forever if properly taken care of (and generally, they are). Coke sells a one time use product that you can stock a pantry with and not feel guilty about. Stocking a pantry with Ruger's products gets expensive really fast, is impractical (anyone that thinks they can take down the government with a few guns and their buddies is totally missing a grounded reality), and will generally ensure that you don't get many dates or that your wife will get angry with you... Given that Coca Cola has higher margins and a likelihood of repeat business in the future, it stands to reason that Coke should sell at a significantly higher p/e multiple. As of now, KO demands ~10% more of a P/E than RGR (keep in mind, this was accurate as of May 3rd- the spread is now much more apparent). Apple sells for a discount to RGR and every product they sell practically comes with a guarantee that they will sell an upgraded version of said product or a complementary item in the not so distant future. If you sell a durable product, you need a steady or increasing amount of demand to do much for capital appreciation. 

From where I sit, Ruger is a bet on a company that you are betting will cash flow an adequate amount before it dies off or changes direction. The liability issues could be a company wrecking black swan that occurs before a large payout to shareholders occurs. I have no doubt that recent events in the news will help the company's sales, but from where I sit, there is simply too much low hanging fruit out there for me to make this bet at what seems to be an excessive price, where even with the recent destruction of nearly 1/3 it's market cap, trades at a price that seems to want there to be future earnings growth.

Disclosure/Disclaimer: I have no position in regard for or against any of the entities mentioned, except for 1 share of IBAL that is owned by an investment partnership I am a member of. I also own some shares of ALJJ. I reserve the right to change my positions at any time. This post is my opinion. Always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.

Sunday, December 9, 2012

Nazis, Human Behavior, and Julian Assange.

I got this article in an email from my cousin, in which, the rules of war were followed due to a sense of Geneva Convention style honor by a German pilot in WW2- a rare thing, based on various references for the battlefields and camps...

Being the contrarian that I am, I immediatly thought of one of the most fucked up modern videos (I challenge you to find better words to describe it with) that I have ever seen:



Thanks go out to Julian Assange for that one. As in interesting tidbit, almost 80% of Americans thought that we were justified to invade Iraq- what do you think that number is at present? My guess is that people have a bad memory of what they thought at the time, or are overly willing to change their opinion and not admit it. I for one, will say that I was for the war, which was an unfortunate trait from my neo-con days. Regardless, I would love to see some data of war support before and after watching the video above.

Moving on...

Certainly, bad things happen in war- often, otherwise decent people don't examine things enough and find themselves (what I hope is) unknowingly committing some pretty egregious acts, as illustrated in the Milgram experiment... Speaking of which, even now, after the experiment was talked about in virtually every high school across the nation, people are willing to kill others as long as they are not held fault (kind of like a lot of war crimes committed by the victors of a war). See the video below.


All I am getting at, is that when examining current world events, where our nation continues to play a political game in the middle east that is only worthy of gossiping high schoolers, maybe we don't quite know what we are getting into. Looking back, it's a basic theme throughout history...

I think that this works as an illustration of how no matter how "advanced" society gets, we still deal with the same basic human fallacies, be they blindly respecting authority, thinking in a herd mentality, or, simply loving to be ignorant. Hell, we still love the same plot themes that the Greeks did millennia ago- I would have thought that we would have moved on by now!? Despite Steven Pinker arguing that we are more civil than ever (which, despite the tone of this post, I agree with) these are things that still exist, where a true contrarian and value investor can profit from the acknowledgement of.

Hence, some of the many reasons why I am long a couple of defense stocks that are already astonishingly cheap even if we don't decide to kill a few (or a lot) people in some far away place. To me, being long cash rich defense parts manufactures which also seem to have nimble operations, are a great hedge (if not unfortunate one), regardless of what happens with the budget. If the world falls apart, then they make a ton of money. If the world continues as is, then they are still cheap. If the world gets better, then I would guess that the market would appreciate their cash, or, it could be distributed. If the companies own some real estate that's (probably) understated on the books, then all the better...


Disclosure: None, though anybody that reads this probably knows that I and accounts that I manage are long MPAD and SODI. This is in no way advice. Always do your own research in regards to anything that I say, do, write, or so much as even think about.

Friday, November 23, 2012

It's Blind Bank Valuation Time!

Are you sick of all these blind valuation posts that offer you nothing more than a set of numbers and goodwill if you post/email anything on them? Well, I have the best of the best blind valuation items for you... Not only is there no wrong answer (partly because we have no idea what the bank is trading for) but also because the best/most entertaining answer (potentially more, if I am feeling particularly generous) will get a prize! That's RIGHT!

Following are some numbers and graphs from a local bank that I use in my hometown- the info came from the pamphlet they left on their coffee table. The bank is not traded in the traditional markets, so this really is about the blindest of the blind valuations that you can find. Just for fun, lets try to put a value on it, with the little bit of info we have here...

Would you feel comfortable having money on deposit here? Would you want to borrow money from them? What is a profitable rate of interest for them to charge? Feel free to throw in any thoughts you may have on other items as well.

Thoughts? Email/comment them and I'll post the most compelling/entertaining cases (can be anonymous or not, your choice) in the next few days/week. If you email, send it to the name of this blog at gmail.com...

As if getting your brief thesis on my blog isnt enough (please detect a huge amount of sarcasm) I will give you further incentive and may send you a really good prize. I may send you a really bad one... but I will certainly send you something if you make the best case in any direction. I'll email you if you win the prize(s). It could range from a flask, to an old box pack of baseball cards, to some tool that I have found useful in the past, or maybe even book or a mini etch-a-sketch... Regardless, it will be a surprise and will be sure to brighten your day- kind of like a white elephant gift!


For the valuation, you get the following:





















Discolsure/diclaimer: I have deposits and mortgage loans at this bank...



Tuesday, November 6, 2012

Voting For Gatewood Galbraith, Instagram, Dividends, and Going To Jail.

Gatewood Galbraith was awesome. I voted for him today, even though he is no longer with us. While in his perpetual candidacy for a slew of offices in Kentucky, he was (unfortunately) never given the chance to serve. Galbraith was the kind of guy that smoked pot everyday and made sure that everyone knew it. 

With the kind of honesty the he exuded, I don't see how you couldn't trust the guy. If that isn't enough for you, he was all about smart governance and getting rid of the 2 party (mockery of a system) that we have in our country. Even more so the case in the Commonwealth. The following series of videos give you a good idea about the guy.



His autobiography is wonderful. Basically, it's a tell all of him doing drugs, shooting guns, getting through law school, practicing law, and running for office- he was kind of like a respectable version of Charles Bukowski. I even have a personalized copy of the book that he signed in my brother's driveway. He couldn't turn off his car because of a failing battery... The guy was classic.

We lost a true treasure when he passed away earlier in the year. He was honest.

I dislike the political slant of Ben Chandler because he seems to cast votes to just stay in office. He's the type of guy who says pandering things like "I want to welcome the new counties into the district" so he can sound homely.

I have met Andy Barr on several occasions and frankly, don't trust him- he is too embedded in the pseudo-republican power machine that rests in Fayette County. He is the kind of guy that says things to the effect of "I am running to save my newborn daughter's future" to try to relate/scare people.

Randall Vance is a guy that is sincere (and supports Gary Johnson, nonetheless), but would probably be in over his head. I once talked with him at a farmer's market where he talked about having mechanized robots to fight our wars and do jobs for us... That's either crazy or being talked about 50 years too soon.

The candidate's debate on KET shows the lack of choice that voters had in Central Kentucky.

As such, I decided to express my distaste for the candidates by writing in a dead person who I still have a great deal of respect for. If that doesn't show a distaste for your selections, I don't know what does... Honestly, I thought the whole thing was kind of humorous, so I snapped a picture with my phone and uploaded it to Instagram, sharing it on Twitter and Facebook.




Then, I was informed by multiple people, that I was risking jail time...

And that, on the face of things, seems to be backed up by several authoritative sounding articles... with names like "Voting+Instagram=Jail" and "If You Want To Stay Out Of Jail, Don't Instagram Your Ballot". It even made it's way to Mashable and The Atlantic. As such, how could you not be scared into altering your normal taking pictures and preserving into the pristine digital clarity that the internet can provide? After all, in both articles, the authors clearly state that Kentucky's laws “expressly prohibit the use of photographic and recording equipment inside polling places.” 


Well, the only problem with that, is that the quote from KRS statutes the articles makes reference to doesn't prohibit cell phones of voters... it actually pertains to making lists of voters with cell phones. There is also a prohibition on certain types of media involvement around the polling place.


In fact, the Citizens Media Law website references legislation that doesn't even pertain to electronic media in a polling place... It does however reference the following:



"No election officer, voter, or other person permitted by law within the voting room,
except for challengers appointed under KRS 117.315, shall use paper, telephone, a
personal telecommunications device, or a computer or other information technology
system for the purpose of creating a checkoff list or otherwise recording the identity
of voters
within the voting room
, except for the official use of the precinct signature
roster that is furnished or approved by the State Board of Elections and is otherwise
permitted by law." (italics and bold are mine)

To further bolster this, the County Board Of Elections Guide Book, which is put out by the Secretary of State, specifically says that you can't bar someone from being in the polling place because they have a cell phone and makes no reference to photographing your own ballot. I wasn't even recording my own identity... It is obvious from the get go that I wasn't doing anything immoral as there is inherently nothing wrong with me taking a picture of my own ballot. Since I am in Kentucky, as I read the pertinent laws, I certainly wasn't doing anything illegal. After all, I wasn't making any sort of list, and I wasn't recording the identity of anyone.


I am guessing that the authors of the articles didn't expressly look at the legislation- and why would they? I would say that they just did some sort of quick scan to make their article sound good. Really, I think that is a pretty common thing. To me, I find it an example where what is commonly "known" isn't  necessarily correct. If this were a financial market, say, in regard to a dividend payment or something, there may have been money to be made. As Saj Karsan has pointed out, I think that TSR could potentially be a great example of that sort of action (check out my comment in the article regarding FRS). Hell, even the recent talk of dividends and share repurchases at Solitron is an example of why you should look into things for yourself.


The only problem with this, is that we have set up a system where people don't try to think for themselves. Maybe it's human nature to be like that, but I certainly have hope that we can eventually be a world in which there is no worry or fear mongering about going to jail for taking pictures with our cell phones, we know when we should get dividends, and otherwise know when we are acting within the law... 


Disclosure/Disclaimer: I and accounts that I manage are long shares of SODI but have no position in any of the other entities mentioned. I reserve the right to change my/our position(s) at any time. This is nothing more than my opinion. You should always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.






Monday, November 5, 2012

Walking Away From A Few Million Dollars Part 4: Contractors, Fixes, and Nosy Neighbors.


If you are just now coming to Ragnar, check out Part 1Part 2, & Part 3 of this story first. :)

From day one, we knew that the problems that most people would see and keep them away from this deal, were the exact ones that made it a good deal since they weren't very bad problems to have (the most blatant which was an easy fix, was the copper vandalism in the plumbing systems). As far as the really obvious stuff (to us) went, we were looking at probably $400K in expenses. Not too bad, considering that we were conservatively expecting monthly rents of roughly $60K and a purchase price for the property of under $300K.

Electrical: Given the amount of wiring that had been taken out, we were in dire need of electrical work. Bill had a contact from his industry days who he thought would be able to get the job done quickly and effectively  They once led a crew and converted a modestly sized plant from 220v to 440v in a weekend, without loosing productivity. That's the kind of work ethic that we needed. A phone call later, we found out that the firm had done the bid for another entity who was thinking about buying the building several years before us. The owner of the electrical company came over, looked at the building and said that while the old bid would need to be changed a bit, it shouldn't be more than $100K and a few weeks to get up and going.

As often seemed to be the case, there were items of contention that came up when we walked through the complex with the inspector, such as how to run wires with a drop ceiling in place. Another was how to safely make electrical connections for cut wires. The inspector generally wasn't really citing anything in the code book for the repairs that we needed to do, because it wasn't in there- instead of arguing on the spot because we knew the codes pretty well, we decided to talk to our contractor who assured us that there was "a way to talk to them" that could get things done. This was one of the first forms of cronyism that was becoming rather evident. After my previously mentioned discussion with the plumbing inspectors I found the whole thing to be nothing short of disgusting.


The Gas Company: To the left, you see an exposed gas line that formerly supplied the largest of the buildings with natural gas. Not only was the pipe undersized to service in excess of 85 unit's worth of gas furnaces and water heaters, but it was exposed above ground (for obvious reasons, they are generally a few feet under ground). In fact, when I first saw it, I walked up to and kind of kicked it just to see if it moved. Not only did it move, but, it had a few inches of give... Not exactly what you want when an explosive gas is flowing through something that is rusting out by the minute... As such, we were going to bury it and needed to talk to the gas company about doing so, since we had no real way of knowing who owned the line.

About a week after first seeing this, I awoke to a call from Bill saying something to the effect of "Jeff, I've done it now... The gas company if flipping out because I tried to get them to meet us out there to talk to them about that gas line." I tried to call the company to sort things out, but, pandora had been let out of her box.

As it turns out, the rep at the call center wouldn't send anyone out there to tell us if the line was the property of the gas company or not- but she did ask if it was a dangerous situation. Bill said something to the effect of "Well, it isn't really dangerous as there is no gas in it, but, someone might trip on it?" This apparently set the representative into some tirade about how that was unacceptable and how they were going to send a team out to investigate...

From what I could gather, this crew had everyone in it but a Navy SEAL. Fortunately, Bill was able to intercept them, and explain the situation. The issue was solved in a matter of minutes. There was no danger, but the line would be ours at closing of the deal. As we originally planned to do, they wanted us to bury the line. The crew was actually surprised that they were sent out for the "problem".

General Contractors: Generally speaking, I do not like general contractors- they are people that in my experience, generally can't do much of anything- be it return calls, show up for bids, do good work... A common thread of them is that they want way too much money to get out of bed and are really good at feeding people truck fulls of bull shit... Despite this, I realized that I was going to have to dance with the devil a little bit and held my nose as I walked through the complex with a few of them to look at minor carpentry work, as well as a decent bit of drywall work, with a whole lot of painting. Even with the problem of getting people to get back to us with bids, we found a painter that would do the whole complex for ~$33K. He was originally from the country and employed a lot of his family. In talking with him, we felt very comfortable and genuinely wanted to employ his firm- after this deal fell through, we found out through first hand experience that they do great work and are a joy to do business with.

Sprinklers: We were able to get in contact with the company that serviced the sprinkler system for the old owners. Since we figured this to be the greatest expense, we contacted them our first week working on the project. When talking to the servicer, he said "Oh yeah! I remember that system. I can't imagine that it will take more than a day, MAYBE 2 to get it up and going again. We charge about $2,400 bucks a day." We decided to budget $10K for our numbers. Because we knew that a bit of copper had been taken out of the valve system pictured on the left.

Bill and I were sure that there were some other issues, but, that is what our budgeting was for. Plus, we added in a healthy contingency for general problems that we would run into. After all, you can generally fix anything, it's just a matter of how much money that you are willing to throw at it!

Elevator: Again, we were able to get in contact with the firm that serviced the elevator for the former owner, who assured us over the phone that it would likely only be $5K to get the system operational. We decided to budget $20K for the job, as my uncle had previously had an elevator installed in his own home and knew that servicing can get expensive quite quickly. In the picture to the right, you can see the old style relay system that it had. These things are pretty amazing in that they are so old, and can still work- however, they aren't necessarily as "good" as newer digital systems.

HVAC: Dealing with HVAC problems created 2 of the more stressful days that we have had. The first was when we met with a contractor about furnace replacement. Bill has been licensed for HVAC for many years and even had experience with it in a former life in industry. We could tell that a fair amount of the furnaces needed to be replaced, but wouldn't be sure how many until we actually kicked the gas on- we were taking an educated guess by sampling them via individual inspection of the flutes and such.

We noticed early on, that certain furnaces had been replaced with the duct work for the returns having re-worked through the closet. While we thought it was odd, didn't pay too much mind to it- attributing it to a lot of the odd work that had been done in the place. When meeting with a contractor; an older gentleman possessing a country drawl, who while likely lacking formal education, really knew his stuff- we got some terrible news. He noticed what he referred to as "white rust" on the vent pipes. I had seen it, but figured that it was due to condensation or water coming down the vent pipe. Bill had just overlooked it. Once we started looking around at the layout of the utility rooms in each unit, Bill and the contractor quickly saw how bad of a problem it was. Basically, the air supplies for both the hot water heater and furnaces were not far enough away from where they were venting to. This causes a kind of mini-vortex of circulatory air and has the potential to cause a whole lot of problems... the "white rust" was a symptom of this.

While we may have been able to push the issue through, it as had been functional and up to code for 40+ years, it wouldn't of been right for the potential inhabitants to the building. We quickly saw that every unit was going to need to have new duct work run so that air could circulate through the apartments properly. This was, in our estimation, going to cost over a quarter of a million dollars, due to the time and labor for framing, installing duct, drywalling for a smooth finish, and replacing the furnaces... Furthermore, we weren't even sure if it would pass code... In our experience, there isn't supposed to be any obstructions in front of a furnace for something like 3 feet. Generally, this is meant as a wall or an appliance.  For our purposes, we were needing to have a box to sit the whole thing on. While this didn't really obstruct the furnace, was infront of it. Another option was to go through the closet and have the return come out in the bedroom, but again, that wasn't exactly an ideal fix as we would need to put grills in the bedroom doors, reducing privacy- not to mention the lost closet space and more than doubling our materials expense... We weren't even sure if the state inspectors would be OK with the fix that we and the contractor had come up with.

My uncle is a pilot and generally takes a flight out to an airport in Indiana with one of his landlord/pilot/contractor buddies once every few weeks. Apparently, the cafe there apparently has a great breakfast (which, is pretty much the only reason they go there). My aunt refers to as "the most expensive breakfast you can eat" due to the cost associated with getting there. Anyway, at one of those breakfasts, Bill's friend kept saying "Bill, there has to be a way to do this. You can't just tear down a building because of this. There are too many of them around for that to be the case."

Bill kept re-explaining the problem. Yet, his friend kept persisting: "Bill, there has to be a way."

A few days later, that expensive breakfast sparked a solution. With some googling, we discovered that Amana makes PTAC units that are designed to work like a heat pump- so they can cool AND heat an area (like the units in hotel rooms). Not only that, but they make them in a size that fit the air conditioner cans that already existed. This was splendid, as we were already going to have to spend upwards of $40K installing window air conditioning units. Not only that, but the PTAC units were only a few hundred dollars more than the AC units and used roughly the same amount of power. All of a sudden, our original $250K fix turned into one that was going to only cost an additional $30K. Further reducing our expenses, we had been planning on spending a bundle of money on new furnaces and repairs for a good number of the old ones... What we had originally seen as a terrible problem that was potentially deal killing, we were likely lucky to have had happen!

Once we knew this could work, we figured that we would price the job out to an HVAC firm in Lexington, as we were going to need HVAC installed in the common areas and some of the 2 BR units as well. When meeting with the only firm that we thought had the resources to tackle the job, the founder of the company came out to meet us. Coming to the job site late, he rolled into the parking lot in his huge (and brand new) black GMC Yukon.

When describing the problem that we had, it took him a while to even understand what we were saying. Which was fine, as it took us a while to wrap our heads around the problem. What did become a problem is when he got into an ego measuring contest with himself where he kept saying that the PTAC we wanted to use didn't exist.... Despite our having a print out of it in Bill's truck. It didn't matter what we told him about what it was, how it worked, and the like- he kept on saying that there would have to be some sort of control mechanism made with a program to aide the unit and that the job would be super expensive.

After a while, he finally got into his SUV wearing his oversized and overpriced watch, and drove off after saying that he would look into the idea and get back with us. He never did.

Don't get me wrong, it worked out well that way. I could tell Bill was fuming and I kept saying "wait til he gets out of the parking lot.... Wait til............" At which time, he spouted off something to the effect of "You can douse your boxer shorts in gasoline and take a stroll through Hell before we will use that so and so on this project!" After a second, he calmed down and said "Not that I am trying to push you around in the decision making here. We are 50-50 partners in this... Feel free to disagree."

"Nah," I laughed, "I don't think that's a good idea. We can find someone else." After that exchange, I understood why the firm in question had a lot of consumer complaints (that we later found out about).

The truly ironic part of this, is that as I was walking through the building room by room to get an inventory of the units that existed (which there were few of), I found one of the PTAC units that we were going to buy over 100 of. Bill found out from an acquaintance that formerly managed the property, that as the old furnaces went out, the owners started switching to the PTACs that we wanted.

Apparently, the "experts" weren't such experts...

Plumbing... Part 2: Another solution that we came up with was in regard to the problem about pressure relief lines for the hot water heaters. The owner of the supply house we were using for most of the materials wanted to get an idea of the project, so he brought an army of his plumber friends to check out the complex. As it turns out, this group of 7 plumbers had decided to team up and put together the bid we would have gone with.

After about an hour of walking and surveying, one of them noticed that due to how the units were arranged, the hot water heaters in every unit were generally back to back- separated by just a wall. We could reduce our gas bills, water usage, chances of heaters going bad, and a host of other problems by simply eliminating 1/2 of the heaters and plumbing 2 apartments hot water lines together. This also solved the problem with the pop off lines that the inspectors were concerned over. The beauty here, is that we would get extra space in 1/2 the units for tenants to have as storage. PLUS they wouldn't notice a difference in their supply of hot water, as there we were going from 1 bathroom to 2 per hot water heater and giving them an even larger tank! A true win-win!

There were a few minor plumbing expenses that we found that day, but overall, was viewed as a victory, since we were again able to cut down expenses pretty significantly.

Nosy Neighbors: About 2 weeks into the process, the lady that lived across the street (and who we referred to as the "cop of the street") was talking to Bill when I pulled into the parking lot one morning. I remember thinking "Huh, that's odd, who is she?" I got out of the car right as Bill had to take a call. She immediately marched over to me and started ranting. I don't remember how it began, but it very quickly went to her saying things to the effect of "You're not going to turn this thing into a Section 8 nightmare with drugs running in and out all of the time because of you renting to (insert a host of different minorities here)."

I stood there, looked at her (bewildered), politely ignored her blatant racism, and responded with something to the effect of "Ma'am, I don't have any desire to spend a bunch of money on this place and invest a lot of my time in it, just to see it go to Hell and eventually lose it to the bank because we take on bad tenants. If you look at the places that both Bill and I have, we care for our properties and try to get good tenants. Sometimes, we mess up, but we try to correct any problems as soon as we can. Besides, I don't think that drugs will ever be an issue her because we are going to turn this into elderly housing. Sure, we will take Section 8, but there are a lot of good people on the program. Plus, we will screen really well because we want to help your property values go up. I really don't want to rent this place to the same type of people who have already destroyed it once."

This didn't phase her and she immediately went into a diatribe as to how I must have known the previous owner and how we were in cahoots with the bank to juice money out of the property. At this point, I started to get a little bit corse and said "Look, I have no idea who owned this place, all I know is what I have heard from other people... and that is this: of the money he got from this place, he either poured it down his throat or snorted it up his nose.... that's why no repairs ever happened here and......."

"Well, you just said you knew him!" she interrupted.

Getting irritated as there were a few other exchanges here, I said "No, I didn't... Quit interrupting me... I am trying to help you out here..."

Thankfully, Bill got off the phone. I am pretty sure he sensed how badly this interaction was going. At this point, I was fuming. He calmly came over, gave her his card and said "check out the business I run and call me if you have any questions." She started going again about some random conspiracy that would have seemed reasonable for a regular listener of Alex Jones, but Bill persisted. Again calmly saying "Hey, I promise you, I have a good reputation. Check out the business I run and call me with any concerns that you have."

After that, she was practically eating out of his hand.

I however, was eating out of no ones. She walked back to her house. Bill and I walked into the building to prepare for meetings later in the day. As Bill retells it, as soon as we were in the lobby of the main building, I, in a rare outburst of anger yelled something to the effect of "******* **! You're **** going to have to deal with that **** _____ ****! Because I am not going to deal with that kind of **** ***** **** ********!" Which, to those of you that know me, can attest that I can come up with some interesting out ways to express my distaste, with an assortment of words that are generally not used by a whole lot of people. Hey, we all have our flaws... :)


Bill, taken back for a second, chuckled, and said "OK". I then took a drink of my sweet tea, took a deep breath, walked down the hall, and made a call to a contractor. I was then un-phased as I was pacing around like normal, going about my work for the rest of the day.


These 2 instances of us flying off the handle are about the only time that either of us were in too bad of shape during the stressful 4 week ordeal. Though, there were other stressful times. Really, I think that these sort of illustrate how well we were working together. While it certainly isn't preferable to get angry about something, I think that it is generally a good thing when people can occasionally fly off the handle and then be OK with each other or the situation in a matter of minutes. If in an argument over something, it is a good thing to be able to disagree, come to an agreement, moving on and then going to get lunch.

That kind of understanding is important to have in relationships.

_____________________

After all of this, I was pretty sure that I was getting ready to solidly be a millionaire by the coming fall from the equity that was getting ready to be added to this lifeless building. When considering the kind of cash flow that this thing was going to throw off, each of us were going to end up with a pretty nice residual income that wouldn't take a whole lot to maintain. While I knew something could fall through, it seemed unlikely (as such I wasn't yet counting my chickens)... We only had to get definite plans for the elevator and sprinkler systems, but weren't too worried because we had already talked to the firms that were familiar with the systems. Other than that, we just needed to hatch a final plan with the state regulators, who we had already felt out and talked to about things, basically having (what we felt) was a pretty good understanding of things.

We were set.

Wednesday, October 17, 2012

Solitron Is Moving In The Right Direction.

On Monday, shareholders of Solitron Devices (SODI) were generally happy to read through the just released 10Q. Despite the company not being quite as profitable as in other times, the backlog had grown quite nicely- indicating future earnings. Even with the prospect of the dreaded "fiscal cliff," I personally remain confident in my margin of safety due to the company's excellent operations and pristine balance sheet. The real meat and bones of the report however, were the following 2 items.


(1)     On August 28, 2012, the Company  repurchased  99,943 shares of  its common stock from a stockholder in a privately negotiated transaction at a price of   $2.75 per share.  The Company has not adopted a stock repurchase  program or plan._______________________________________________________________
ITEM 5.            OTHER INFORMATION: On October 15, 2012, the Board of Directors of the Company approved a resolution to hold annual meetings of the Company’s shareholders approximately six weeks following the filing of the Company’s Annual Report on Form 10-K each year.
As was first in his letter to the board of Solitron by Nate at Oddball Stocks, the need for improved governance through an annual meeting has been of the utmost importance. Additionally, Nate had addressed how a reasonable repurchase of the company's stock would be a great investment of capital. This really got the ball rolling as far as communications with the company went. Later, Valueprax and I became interested in the matter- Valueprax communicated first by letter and later by phone and email. I called for a share repurchase on this blog and in emails to the company. I also suggested in an email to Saraf that they announce a meeting in their next 10Q- after all, it just made sense for them to do.

As Nate noted in his most recent post on the matter, it wasn't just bloggers that had an effect on this. There were many others contacting the company in separate efforts as none of us had a huge desire to trigger the company's poison pill, make SEC filings, or endanger the company's valuable net operating losses. I know of a lot of shareholders (some owning a a full spectrum of shares) who emailed and called the company to express their desire for a repurchase of stock, dividend(s), and an annual meeting. A big player who carries a big stick (and deserves a big thank you for communicating with the company) is Tony Chiarenza who recently wrote a letter to TSRI. His communication was undoubtably quite valuable. 

To Tony and everyone else who communicated with the company, thank you!

To me, this goes to show just how much the internet has been a game changer. I for one was able to find that there appear to be no restrictions on the repurchase of common stock by getting a correspondence between the Florida EPA and Solitron from the EPA; it just took a few minutes to email the department, and a matter of hours for them to respond! After this, forwarded a copy of the agreement to Mr. Saraf and basically said "Hey, I know that it is a widely held belief that the company can't repurchase stock due to this agreement... But as I read it, I don't see any restrictions. What am I missing?" Holding true to his previous shareholder relations, he said that it would be discussed at the next board meeting.

Interestingly, on the note of the agreement I am not totally convinced that there is even a restriction on dividends; though, I will admit, I have a pending Freedom Of Information Act request in for the Federal Agreement at this time- the devil is in the details, and it may be in that agreement or simply an unwritten understanding between the 2 settling parties. Regardless, here is what I got from the Florida EPA and I will be posting the agreement from the Federal EPA when the FOIA request is finally fulfilled.

Solitron Proposal



I have been and remain 100% convinced that small shareholders now have a much more level playing field with the bigger players, given all the tools at their disposal to find virtually whatever they want. Using these, there are now a whole lot more ways to make compelling cases for value creation to the managements of the companies that the small shareholders are the owners of. In the recent experience with Solitron, simple research made it clear to me that we were right in our requests, since the courts in Delaware regard the holding of annual meetings to be a basic functions of corporate governance and is addressed in Title 8, Chapter 1, Subchapter 7, Section 211 of the Delaware statutes. For example, in various cases, it has been made clear that a shareholder’s right to compel a meeting is “virtually absolute" and the courts have held that “The statute does not distinguish between large and small stockholders, nor between those in accord with and those in opposition to existing management.” Furthermore, it was easy to find that the “... court jealously protects the right of a stockholder to seek an order compelling an annual stockholder meeting...


As Nate pointed out in his most recent post, without the internet, there is little chance that any of these positive developments would of happened. Without the internet, I would have never had the good fortune of knowing and talking Nate, Valueprax, Tony, and a ton of the other concerned shareholders of Solitron. Hell, without the internet I wouldn't know the vast majority of the people that I email with and bounce ideas off of. There are too many to name and they range in location from Eastern Europe to Texans, to Taiwan!  As Saj Karsan has pointed out, Twitter is a great way to meet other investors as well- John Wald is a perfect example of a blogger that I found because he followed me on, and is active in the Twitterverse. The guy has a good blog too! Mind you- anyone who does a post on (let alone knows about) KEWL and flys planes is cool in my book! You can even find out about cases where proxy access is used by a small shareholder named Daniel Rudewicz.

Nate called this "Social-Activism," I call it "Blogtivism" (which is a term that I stole from a commenter or emailer a while back), and Wexboy sarcastically calls it "Socialized Capitalism." Regardless of what it is, I hope to see the effort to enrich all the shareholders of the companies that we all hold and love really take off. If there would be one thing that I would love to see Ben Graham be wrong about, it would be in regard to his statement "that the typical American stockholder is the most docile and apathetic animal in captivity."


If you don't have a blog, consider starting one. If you don't have Twitter, consider getting it. If you are a concerned shareholder in a company you own, consider communicating ideas to them about ways to enhance the value of the company or to do the right and legal thing... Like have an annual meeting. Alone, you may not have much of a voice. But when a lot of people engage in a respectful and reasonable discussion with management, productive changes can happen.

Certainly, the story is far from over with Solitron and there is more work to be done. However, the company is in a better spot than it was (and the volume and share price seem to have noticed a little bit). 

As for me? I call this a good start and look forward to seeing what happens in the future.

Disclosure/Disclaimer: I and accounts that I manage are long shares of SODI and have no position in regard to any of the other companies mentioned. I reserve the right to change my/our position(s) at any time. This is nothing more than my opinion. You should always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.

Thursday, September 27, 2012

Solitron and Blogtivism.

As a long time observer of Solitron Devices, I have constantly been interested in the company and it's common stock as it has been a perpetual net-net of sorts. As a shareholder/beneficial owner with a position that is slowly growing I have grown ever more concerned about the company's governance in recent months.

I personally have little concern that SODI is a fraud, as Nate at Oddball Stocks outlined. That said, the company's constant lack of an annual meeting really bothers me. Not only is it not in the spirit of Delaware law to not have such a meeting, but the company has not held an election of the (staggered) board in quite sometime. Again, this is definitely not in the spirit of the company's By-Laws or Articles of Incorporation.

Here, Valueprax illustrates his interactions with the company. I strongly suggest checking out his post, as it is somewhat similar to my interactions with the company's management. While I never contacted any members of the board (other than Saraf), I have had a roughly 20 minute phone conversation and several email conversations with Mr. Saraf. In my phone conversation, it was apparent that people had been calling (in what seemed to be a response to posts such as this one and this one at Oddball Stocks) asking him to liquidate the company. Obviously, this set a bad tone from the start, as I think I was immediately lumped into this group of people who want something that I don't.

As I pointed out on this blog, the idea of liquidating a great little company such as Solitron is utterly absurd and I would much prefer a combination of share repurchases at opportunistic prices and then dividends when shares are not available. Frankly, I think that the company is sitting on too much cash at the moment- as is evident from the fact that it not only survived, but prospered in one of the worst economic downturns in modern history!  Furthermore, when the company is selling below what seems to be a reasonable liquidation value, there is no reason to not buy back shares like crazy!

Anyway, once I made sure that Mr. Saraf knew that I wasn't a proponent for liquidation, the conversation went a bit better, though, was still tense. It is obvious that he views this company as his baby- which, when a person builds something of this nature, is understandable. However, there are certain changes that need to be made as a matter of accountability to the shareholders, who are partners in the business- an annual meeting is an obvious one. This is for various reasons- legality being one and transparency to shareholders being another.

If anyone is interested in contacting me in regard to getting the company to get on the right track of having an annual meeting, I would love to chat: ragnarisapirate(at)gmail.com. HOWEVER... This is in no way a request to vote shares together or anything of that nature...

Disclosure/Disclaimer: I and accounts that I manage are long shares of SODI. I reserve the right to change my/our position(s) at any time. This is nothing more than my opinion. You should always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.


Tuesday, September 11, 2012

KSW Is Getting Acquired.

KSW has always been an interesting nano cap. At one point, I briefly held a small position in it. Anyway, they just announced that the company is getting acquired for just a hair over $32.1 million (a nice premium to the prior market price). The company certainly wasn't in a high growth industry- they installed really big HVAC units in NYC, but they were a company that was wrongly beaten down and left for dead in the depths of the Great Recession; they traded for well less than net cash! This, despite being a well run company with the founder owning a glut of the stock.

I will spare you further details on the company as they are far to easy to find from value investing blogs in a Google search.

http://finance.yahoo.com/news/ksw-acquired-32-1-million-174117262.html

Congrats to all of you longs.

Disclosure/Disclaimer: I have no position in any regard to KSW. I reserve the right to change my position at any time. This is nothing more than my opinion. You should always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.

Tuesday, September 4, 2012

Henry Blodget Misinterprets Facebook's 8K...

As my disclaimer suggests, I think that it is important for readers to always check sources and research the articles that they read. Simply because someone has a good reputation or a blog that gets a ton of hits, doesn't mean that they don't put something out there that isn't true. I would argue that the vast majority of the time, these mistakes are unintentional. While I would imagine that is the case here with Henry Blodget, the point remains that you should always get in the weeds, so to speak, and do your own work.

Henry Blodget, who I generally enjoy hearing thoughts from on various videos on Yahoo! Finance and such, wrote an interesting article on the recent 8K from Facebook. In it, he made some claims that are not entirely true and one that is totally false. For example, he said that 2 directors will soon be selling stock to cover their tax bite from the IPO, when the 8K actually said that they "intended" to sell the shares to cover their taxes.

Though, there are a few things that he, in my mind, missed the point on, which while nuanced, are a bit deal. The first is that he wrote that "Mark Zuckerburg will not sell anymore stock for at least a year." However, the actual text of the 8K reads:
"Mark Zuckerberg has not adopted a Rule 10b5-1 Plan and has informed us that he has no intention to conduct any sale transactions in our securities for at least 12 months."
Having no intention to sell and and actually committing to sell (or not sell) stock, as was referenced by Blodget to an article by John Yarow, are two totally different things. Though, I admittedly have no reason to not believe these individuals will not follow through with there intentions.

These two points, are nitpicking. However, I have seen instances where intentions became something completely different. Plus, these first two points are indicative of an even greater problem in the article that is totally false.

The meat of the misinterpretation is where he states the following"
"Facebook is about to do a huge stock buyback, at less than half of what it received for its shares at the IPO four months ago!
No, you probably didn't catch that.
And you can be forgiven for not catching it. Because the filing didn't say anything about a buyback.
But, it's true:
By deciding to withhold 101 million shares of the employee stock grants and pay its tax bill with cash on the balance sheet, Facebook is effectively buying back those shares and retiring them. At $19 per share, the tax bill will amount to $1.9 billion, and the 101 million shares are worth about $1.9 billion.  So Facebook will effectively be using $1.9 billion of cash to buy back its own stock."
He later says the following:


"Now, to be clear, Facebook isn't going to go into the open market and buy back $2 billion worth of stock. It's going to retire the stock it withholds from employees and then give the cash value of these shares to the government."


Notice how he makes reference to them "retiring" the shares? Well, that may the effect for the short run in regard to shares outstanding, but when reading the 8K, you find that the company doesn't seem to have any (for lack of a better word) intention of retiring them:

"The 101 million shares that are withheld by us as a result of the net settlement of Pre-2011 RSUs will no longer be considered for accounting purposes to be issued and outstanding, thereby reducing our shares outstanding used to calculate earnings per share. These 101 million shares will become eligible for granting as new awards or shares underlying new awards under our 2012 Equity Incentive Plan." (Italics and underlining mine)

So there you have it, the company probably isn't going to retire them at all. They are probably going to award them to executives and employees in the coming years as compensation. If the company truly is undervalued, then, retiring the shares would be a great move. As was the case a while back, I am still not convinced that they are in anyway cheap... Instead, this just seems to be a great move for company executives, at the expense of a bunch of people who must have thought Facebook could take over the world. As a side note, both of the portfolios that a buddy and I constructed by throwing darts at a Wall Street Journal have kicked the ever loving shit out of Facebook's stock. Time will tell if that trend will continue, but I am betting it will.

In closing, after writing ~95% of this, I just scanned the comment section of the article and realized that someone beat me to the punch with the point that I was in regard to the retirement of shares (how's that for honesty?)... That said, I still thought that this would be an interesting post to put up for you all.

Disclosure/Disclaimer: I have no position in anyregard to Facebook, but am a user of it. I reserve the right to change my position at any time. This is nothing more than my opinion. You should always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.

Saturday, September 1, 2012

Portrait Of A CEO: Frank Erhartic


Frank Erhartic: One of the few CEOs who isn't afraid to get his hands dirty.

When I first went to Virginia to do scuttlebutt on my investment in Sitestar (which grew considerably after said trip) I thought that I had a pretty good feel for the company. On my second trip, I quickly realized that while I had a decent idea of what was going on, I didn't have a full appreciation for the situation at hand. For example, Frank Erhartic, the CEO of Sitestar is willing to do what most investment bankers would consider grunt work and actually work on a house when needed- this continues the tradition set by Roger Griffin at International Baler, where CEOs that I have a high opinion of are willing to do work that is far less glamorous than sitting in an office- Griffin as an example, landscaped the HQ of IBAL his first weekend on the job (on his dollar) and would even occasionally step into the line to weld balers to boost moral.

When talking to Frank in advance, I had told him several times that I would pay for lunch or dinner at whatever place he wanted, which was an open invitation for him to gouge me by going to a nice steakhouse or something. Where did he pick? A Chinese Buffet where the total bill (after a healthy tip for the 2 refills of the water that we drank) came to 19 bucks. I kid you not- while on this trip, I spent more money on a single bar tab/dinner in Charlottesville OR on all my highway tolls and the 2 trips I made to McDonald's, than I did on that lunch.


To describe the place we went, I will reference you to Yelp!: Larger cities like New York, Washington DC, Chicago celebrate culture with museum openings, art exhibitions, and galas.  Roanoke celebrates culture with Asian buffet openings.

Now, onto more serious matters.

Executive Compensation: It's obvious that this guy's idea of dining out is less than mine, which is saying something. I just hoped that this transferred over to his running of the business, which I already kind of expected given his cost containment in the executive suite: as CEO, Erhartic made $13K last year and the CFO of the company made well under $50K. While eating, I asked him about his low salary. He said rather than take a big salary, he would rather make money on the increase in the worth of the company (he owns about 1/3 of the shares) and that he was able to live off of other investments he had made- verifying what I had previously thought. His thoughts on salary and common stock ownership seem to mirror my own.


This was backed up with how he has gone about buying properties for himself and the company; it seems that the only properties that he has personally bought since Sitestar started their real estate acquisitions were ones that he wanted to personally live in. 


Moving To Roanoke: When asked about commuting between Lynchburg and Roanoke, he responded "I moved here (Roanoke) because this is where the deals are." The sense of trying to get a better deal all the time was showing as a common theme for him. Hell, when I was talking to him about 10% discount cards to Lowes (which you can also use at Home Depot) that you can get in the moving packets at the post office, he was way ahead of me. Erhartic talked of how he used to buy them on Ebay. Basically, if you pay a high price for them on Ebay and spend more than $30 bucks at the retailer, you break even. On a purchase of $1K, which is pretty typical at Lowe's and Home Depot (which will honor Lowes coupons) you save a decent amount of cash. Personally, I give my tenants a discount in rent if they to go to the post office for the moving packets and give me the cards. At a buck per card, it can save them some serious money on their rent and I come out way a head if I spend more than $10 bucks at the store; something that I can probably count the number of times that has happened on 2 hands. In fact, just 2 nights ago, I saved over $300 dollars by using one!



The Internet Business: While it is obvious that the internet business is losing steam, it has managed to remain profitable and cash flowing. Erhartic credited that in large part to efficiencies that had been created from the get go. For example, he made a lot of the costs (like capacity) variable so that while they paid a little bit more by not having a fixed contract initially when things were growing, they wouldn't be saddled with burdensome contracts when revenues eventually fell. At some point in the near future, he was going to be flying to Washington state to work on some more efficiencies for the internet business. 

Erhartic also spoke of how email had traditionally been one of the most troublesome items for them, which is why they always wanted to outsource it to other firms that could handle the job not only better than they could. I would think that if people are not constantly having problems with their email, that they would be less likely to change internet providers. In turn this should keep revenue from declining as fast and ensure nice margins. While I have no idea how long the internet business will last, I am comforted by the fact that it's costs are pretty scalable. Erhartic still gets offers to buy ISPs and such, but weighs their prices against the real estate that he can buy from Sitestar's filings, it's pretty obvious where he has been directing our company's capital.




Software: At lunch, I asked Frank how he found all the properties that he had bought. After grinning, he pulled out a sheet of paper from his pocket and unfolded it. It had pictures of properties, property info/specs of the houses, and some hand written notes on it. He explained to me in detail, how he had created a computer program to scour the internet for various sales to find properties in the area with all the specs and various values that had been assigned to them by different people. He pointed to one on the page and said something to the effect of "I know the guy that lent the money on this... He generally only lends 1/2 the value of the house." Erhartic also pointed out that sometimes, auctions for houses only go up for a few hours one day and get taken down, but still occur. This program apparently accounts for that when he prints out his sheet of results- giving him not only more, but better information than most people are able to get.

He also developed a website with software that is great for the managing of properties and there may even be an app in the works. At various points when I would ask how much he had paid for a property versus what it was worth he would just pull up the data on his phone and say something like "well, I bought this 6 months ago for $55K, when finished I'll probably be able to sell it for $90K. This is for a house that in my estimation only needed about $5-6K in work. It was kind of spooky, because probably 90% of the time, he would say something to me about what needed to be done to the house or the cost of fixing the house it was almost exactly the same as what I was thinking. At times, I felt like the guy was in my head.



The Economics Of Flipping: One might ask why there is such a large discrepancy as to why a house can be bought so cheaply (say, $55K), such a little amount of capital be put in it maybe $10K), then sold for a premium (around $100K). In my own experience, it is rare that a person looks to take on a project house to live in. Bankers and especially the government, don't like to or won't lend to owner occupants for houses like that, which eliminates the majority of home buyers... A lot of real estate investors are in a situation where they are either over levered or are real estate rich and cash poor, which eliminates even more buyers. Then, there are the investors that simply don't want to fool with residential real estate and want to use larger amounts of capital on bigger deals. As an example of a deal killing amount of work, the bathroom on the right turned out to be a great development for Sitestar. All that it really needs is a new light, mirror, faucet, and vanity. After that, a coat of paint and thorough cleaning which would have been done to the whole house any way, and it will look like $100,000 bucks. Total cost for the bathroom upgrade? Well under $500 dollars (even if you use nice stuff) and a day's worth of work.

Once the house is fixed up, first time home buyers are still able to get into a house that is in good shape with next to no money out of pocket through federally subsidized loans. The last house I sold was for just a touch more than $65K and was REALLY nice. It was actually nice enough that there were no comps in the neighborhood for the sale price. Anyway, the buyer got me to pay closing costs and such, rolled that amount into his loan, and as I recall, walked away from the closing table only having about $550 dollars of his own money in the deal... That's less than the security deposit I would have charged if I had rented the house out. Literally, is was far cheaper for him to buy the house from me, than for him to rent one in far worse shape! This types of artificial demand that the government discourages and then encourages likely won't be going away and can really play into Sitestar's hand. 


The company is also selling options to buy to renters of some of the houses as well; yet again, a great way to get money for shareholders and to help people on the path to home ownership. The house pictured to the left is one of them.




Networking At The Courthouse Steps: 
While at lunch, Frank said something about needing not having much time since he needed to get to an auction that was taking place. Being interested, I suggested that we both go- a request that he quickly obliged. We left the buffet in his standard Audi TT (which was a few years old) that had tools and supplies in the trunk. There were a few kids toys in the car as well, so I figured that this is a guy who likes his kids and works a lot. What started as a simple auction turned into a days worth of driving, looking at houses, co-ordinating workers, and conversation.

We arrived at the courthouse steps a bit early and talked about how we each got started in real estate. His start was relatively similar to mine- while in college, he bought a 6 plex that was fully occupied. If I remember correctly, he said that within a few weeks of closing, he lost 4 of the tenants and the heat went out. At that point, he was kind of like "Well, what am I going to do now?" The answer came pretty quickly and was exactly what I did, years after he: he was going to work his way out of the mess. Erhartic grew from there, learning along the way.


There were 2 scheduled auctions, one of which was canceled. In the picture above and to the left, you see everybody that was there (less me). Frank and the gentleman in the red shirt were the only 2 that were interested in bidding on the house (which from our previous conversation, seemed like a decent deal to me)... This gave me a pretty good idea as to why Sitestar is able to get the buys that they do on houses- there is very little competition in the area!


While standing around waiting for the auction to happen, Frank started talking to the older gentleman on the far left. It came out that he had some property in the area and that he was looking to buy more, just not on that day. Frank immediately seized the moment to network with him by inviting him to a local real estate investor gathering (where he is the Chief Technology Officer of the group). He also talked to him about potentially selling some of the properties that Sitestar owns.


The auctioneer needed to verify funds from the interested parties, but when she came to Frank, she skipped over him, saying something to the effect of "I know you're good" as they joked and had a quick conversation about the bidding. Ultimately, there was a bidder that was on the phone who purchased the property (I think via the attorney that was doing the auction, but, I am unfamiliar with the process in Virginia). Frank and I left, both thinking that there was money to be made on the house as either a rental or flip, but not so much that it was a stupendous deal for Sitestar.


Rentals Vs Flips & Leverage: As I believe prudent to do in my own business, Sitestar is not a one trick pony that only does flips or only does rentals. Frank told me that looks at ways to generate the highest return on investment. Naturally, I wanted to know when he was going to implement the use of leverage as it is a superb way to boost returns on real estate, especially when interest rates are low, Sitestar in in fantastic financial condition, and they have properties that will generate margins that are significantly in the double digits. While not boxing the company in to one way of doing things (flexibility is always nice), it seems as if the company will be getting some more rentals and then come to a point to where they can take on a million or so in leverage, using those cash flowing houses as collateral.

This led to a conversation where I asked what the ideal amount of money for the company to have when it comes to real estate. Frank said that he would really like to have $10 or so million to throw around on deals. He spoke of a nearby Gold's Gym that had recently sold for around $3 million, when it was probably worth north of $4 million, with an assessment just below of $3.75 million. When briefly going over the return on a cash investment in the place relative to the rents on the appraised price, you would be looking at percent that was solidly in the teens, in the first year without allowing for any growth in the price of the property... Pretty impressive.


Quality Of The Houses: An item that I noticed and was continually impressed by was the overall quality that most of the houses in Virginia were constructed with. I can't express enough just how shocked I actually was. Very few of them had any problems with setteling- in Central KY, this is a fact of life that we deal with. Personally, I have (much to the chagrin of my realtor) probably walked away from or given lowball offers on 50 houses simply because they had basement walls that were letting in water and have significant bows. Almost all of the houses in Virginia had copper piping that was in tact. Again, a rarity here. Frank generally checks the houses out before buying them, but as far as good bones go there seems to be little need. From what saw, he either does a great job with screening, or builders are a lot better in Virginia and people are more honest when it comes to stealing copper for drug money than they are here in Kentucky. I tend to lean to the former of those scenarios. Regardless, I was quite impressed with the 15 or so houses we sa.


Getting Tenants To Pay More:
Another great way to make money that Frank had copied from another landlord, was to get tenants to essentially pay for upgrades to houses. As an example, he can go to his tenants every year or 2 and say something to the effect of "Hey, due to the costs associated with doing business and rising prices in the rental market, I have to raise your rent by $25 a month. However, I can do an upgrade to your house. New counter tops, carpet in a few bedrooms, or something like that." This works out really well, as it gives the tenant something tangible in exchange for the upgrade, so it makes them feel like they aren't getting screwed. It can also keep workers busy if they don't have much going on. It's a win win for everyone involved.

While driving around, I even got to take a look at the lease and the rental application that the company uses. Both were very similar to my own. In both instances, Erhartic did just as I had; compiling useful info from a host of others that he had read, taking the good, forgetting the bad, and coming up with a very good and concise document that should hold up well in court in the unfortunate event of an eviction.

A Potential New Line Of Business? Erhartic has been thinking of even more ways to ensure profitability for the company and made mention of the potential for Sitestar to get into property management or even to start something along the lines of a partnership where they can raise outside capital to buy properties with where Sitestar would be a general partner. The software that he is developing would aid greatly in this and as most of you readers know, money management (which is essentially what Sitestar could get into) is something that generates incredible returns on invested capital. Will this eventually happen? It's hard to tell, but there seems like there are a lot of deals out there (say, the previously mentioned Gold's Gym) that this would be perfect for. With everyone and their brother wanting to make some sort of investment in real estate, this would be a great way for the company to offer a service to people that don't like getting dirty but want to own some real estate. Again, a win win for everybody.


Juicing Value Out Of Houses:
One thing that Erhartic does in every house he buys with a basement, is finish it. It is an easy, quick, and relatively cheap way to really raise the value of a place. When he does so, his crews don't do a poor job either. Notice in the picture to the right and how the lumber on the floor has a different color than that of the studs going vertically? That's because when framing in the wall, he makes sure to use treated lumber for the bottom plate. It costs a few dollars more per 2x4 maybe adding $35 or $50 dollars to the cost of every house, but makes for a really nice job since the lumber on the floor is resistant to water, condensation, and a host of other things that aren't good.


To see further evidence of the quality of work that the company does, check out this video I took the first time I was in one of the houses (I was let in by one of the workers on site), and compare it to the following pictures of the same house about 6 months later. Keep in mind, this isn't the only house that the company did a lot of work to!

























Problems That Come With Growth: Whenever a person or company grows a new line of business quickly, there will inevitably be growing pains. This is something that is a constant worry with real estate, as contractors and laborers are often very skittish and retention of quality workers who work all the time and are honest is difficult. Frank combats this a little bit by refusing to hire smokers, as they often bring down an entire work crew by taking smoke breaks. He has had issues with various workers not showing up on certain days, but is working to improve the situation through a few different means. We threw back and forth some ideas on the matter, and hopefully they will be beneficial.


Additionally, when there are so many houses that need a little bit of work and are available at distressed prices, focus needs to be on buying the properties and striking while the iron is hot. When a company grows an operation of this nature from nothing in June of 2010 to  well over $2.6 million in real estate at the end of last quarter, with the properties carried at cost, there will be houses that don't get fixed up for a while. While I would prefer things to go quicker, fixing up houses is something that you have to keep a close eye on. Since the company doesn't have any debt against the ones that are not rented, they can afford to wait. In the meantime, they have the ability to sell them off to a "do-it yourselfer" or another investor. It doesn't strike me as a bad spot to be in.

As a side note, you can get abetter idea for the houses the company has for sale here and the ones that are for rent here.



Me Swinging The Hammer: The last day that I was in Virginia, I met Erhartic at one of the houses that a crew was in the process of finishing out. As some of the workers weren't there (it was a Saturday) I figured that I could take a little bit of time to lend a helping hand. As such, I hung a basement's worth of electrical boxes and bore holes through studs and joists for wires to be run through. It was re-assuring to me that Frank was at the house working, just as he said he would be when he dropped me off at my car the previous night (somewhere around 10 PM).


A while ago, I learned a trick from my brother, who picked it up from our great uncle that comes in handy when hanging electrical boxes, that I wanted to share with Frank. You can get a uniform height on them by essentially using your hammer as a measuring tape. Simply put your hammer, head down on the floor, and hold the electrical box on top of your hammer to place it before you nail it into the stud. It's a trick that a lot of people never really think of, so I told him about it. He just grinned and said "Yeah, I do that too."

At that point, I chuckled, thought to myself "of course you do..." and went about my merry way. Also, you might notice that I was hitting the nails in the box with the side of my (well actually, Sitestar's) hammer. For a free piece of home improvement advice: when hitting nails at a weird angle, I like to use the side to set the nail as it is bigger than the head. You are able to get the nail set straighter, use less force, and won't ever hit your hand. After a few blows, flip it and hit away as you normally would.

After a few hours, Erhartic, his daughter (who was hanging out with her dad while he worked), and I all went to Burger King to grap a quick bit to eat before I ventured back to Kentucky. We talked about the business some more, he educated me on "subject to" sales of real estate, and we even talked about the need to re-establish the company having annual meetings in the near future. In parting, I asked him what I always ask a CEO, roughly: "Is there anything else that you like to say about what's going on for any write up I might do?"

His response? "Just be honest."

On my drive home, despite thinking that there was some room for various improvements, I was pretty impressed with what I saw. It takes a unique type of person that can literally smell a crawl space and have a decent idea of what will be wrong with a house. If one can do that, run an organization, and understand capital allocation, there is the potential for a real winner.

EDIT (9/3/12): A reader asked me if I talked to Erhartic about the USA Telephone related debt that hasn't been paid for sometime. When talking to him, he said basically what I heard from the CFO a long time ago. "Look, we pay people what we owe..." was his response. When asking about the time frame for it coming off the books, Erhartic basically said that he was in the game for the long run and wanted to focus on buying properties rather than negotiate out of something that they don't owe now, or ever for that matter. Understandably, he seemed to be in no rush, 


Disclosure/Disclaimer: I, various members of my family through accounts that I manage, and our family investment club are long shares of Sitestar. As is public, we make up a group that has a 13D filed with the SEC in relation to our investment in the company. I have not bought or sold any shares of the company since the last amendment to the 13D was made, but reserve the right to change our position at any time. I assume that all I say is accurate, however, I am human and do screw up- as such, you should always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.