Wednesday, May 30, 2012

Why I Am 13D-ing Sitestar.

There are a lot of things that are correct with Sitestar... hence, I decided to allocate a good bit of my personal and my family's investable funds towards it's common stock as an investment. After buying a good amount of the shares that have traded since last June and going out to Virginia to do research on the company, it has come time to file a 13D with the SEC. Is everything right with Sitestar? No. Virtually every company has issues of some sort. It is my hope that through this post, future posts, and all my interactions with the company, that I will be able cast a light not only on the items that should be honed, but to also shed light on all the good things that the company seems to be doing. In this, I am offering an opinion about a company where I represent the second largest shareholding entity.

As my 13D will say when filed with the SEC, I have purchased the shares for investment purposes because I believe the company to be undervalued. As I have spent the majority of my working years in real estate, I do have some suggestions and perspective that I think will be helpful for increasing the intrinsic value of the company- hence, the 13D, rather than a 13G. Please be sure to check out my disclosure/disclaimer at the end of the article.

One of the first items that comes to mind is that Sitestar is (and has been) out of favor. Since I posted on them a while back, I have received  numerous emails and comments, few of which have been overly positive. Generally, it seems that people are thrown for a loop when they see that an internet company with what seems to be a dying business, is allocating cash flows towards real estate. Don't get me wrong, it's a fair point. As highlighted in my first post on the company, from what I could tell almost a year ago through internet searches, the CEO, Frank Erhartic, has a history of investing in real estate. For example, he and his wife Julia, own the building that Sitestar uses for it's headquarters.

It also appeared that they had several houses that they owned as rental units. As a landlord, I know from personal experience- you learn a ton on your first few houses. Effectively, when they moved shareholder's money into real estate, I felt that we were getting said education for free.

A few months after I started really getting into the company, I decided that I wanted to look at the real estate and pull deeds on the various parcels. So, my Uncle Bill (who is also a landlord, with significantly more property than SYTE) and I took a 7 hour drive and paroozed around central Virginia for a few days. At various courthouses, we pulled and printed every legal document that we could get our hands on that had anything to do with the company. As an interesting side note, due to how you search for documents in Virginia databases, I was able to print everything that came in as a search result without really looking at it. I did so so that I could review the items later as we were pressed for time. As such, I now inadvertently have a copy of Frank and Julia Erhartic's marriage certificate... upon this realization, Bill and I both got a pretty good chuckle. What I thought was good a good research practice, quickly turned into me feeling like a stalker. Eeeek.

When going through the deeds we found that there didn't appear to be any recorded liens on any of the properties that the company owned- just like their filings have implied. We also found out what I had suspected in my first post on the company- the Assessor's website data wasn't necessarily correct in regards to the prices that the company paid for the various pieces of real estate that the company owns... my hunch that I spoke of in a previous post where I said "Additionally, in regard to the amounts paid for the properties, I have not looked at the deeds, but, they may have been purchased at lower prices " turned out to be correct... They have been purchasing properties for significantly less than the assessed amounts. Here are some examples from that post, with the deeds scanned below:

Here is the screen shot that I took a while back of said data. Matching the addresses on the site with the Tax ID numbers on the deeds. The way that I read said deeds and info is as follows:

Greggin Dr, had an Assessor's sire sale price of $187.5K. On the deed, it was sold to Sitestar (as is indicated by the "considered amount") for a paltry $45K.

5460 Clearwood had an Assessor's site sale price of $173K. On the deed, it was assessed for $172.6K and a sale price to Sitestar of $97,074.

3719 Janney Ln had an Assessor's site sale price of $155.5K. On the deed, it was assessed for $155.5K eliminated a loan on the property for a whopping $169.5K, ans was sold to Sitestar for $113.6K.

This seemed a bit fishy to me... I knew that the considered amount on the deeds were the equivalent of the sale price, but, I was curious as to why the sale price on the deed mismatched the sale price on the county's web page. So while fact checking, I called the County Assessor's Office to find out. They told me about a problem with the GIS system software and I even got word of this article in the local paper that explained the problem! Here is the relevant snippet and a screen shot of the article (italics, bold, and underlining are mine):

The recordation tax is based on either a property's sale price or its assessed value, whichever is higher. Until recently, the sales price was almost always the higher of the two — so the county was able to just stream that figure straight to its GIS site. But that changed when the housing bubble burst a few years ago, resulting in occasions where a property sold for well below its assessed value.
"It's only become a problem in the last maybe two years, when the sales prices started going under the assessments," Assistant County Administrator Diane Hyatt said. "Before it never showed up because the sales prices were always higher than the assessments."
As a result of the shifting housing market and software glitch, people have found numerous cases where the county's GIS site lists the sale price of a property as much higher than what the buyer actually paid.


Moving along to the actual properties, these were the first 2 that that we came to in our travels:

Both seemed like nice pieces of real estate. The first still had some work to be done, but, it appeared that it was in the process of being painted and such.

While driving from the 2nd house on my list to the 3rd (just a few blocks away), we drove by the picture on the left... I first noticed the yellow sign, as it had been at one of the previous houses (pictured above) that we looked at. I didn't know about this particular address being owned by Sitestar, but I wanted to check it out and get some pictures, nonetheless. Upon jumping out of our rental truck, I saw that there was also an info box. I remember thinking "That's cool, I will get to see the specifics on this property." When I opened the box, I found the following 2 stapled sheets of paper:

Sometimes, it's better to be lucky than good. This was definitely one of those times.

That's right. In January, I found out that Sitestar had it's hand more in the pocket of the Virginia real estate market than I originally thought... In fact, the picture of me smiling by the treasure chest of a flier box is an understatement as to how I felt about that we had just stumbled upon. But there was one problem. When I got back to Kentucky and pulled the info on the properties on the sheet, they were not under Sitestar's name, which was a bit confusing to me... I had previously noticed months before that the company had owned a house with an entity called BCK Properties (the property on Showalter). And yet again, BCK came up as the owner of a few of the parcels that SYTE had for sale. In a brief conversation with the CEO talking with the CEO, I asked about this. Erhartic explained to me that they buy some of the properties with other entities, in a sort of partnership and then split the proceeds accordingly. This confirmed what I already suspected when talking to a worker after I walked through one of the houses that was being repaired... When asking him about his job and such, he made mention of the "group" that Frank is a part of that buys real estate together... In fact, here is a video I took of the house. It had the wiring ripped out, so, they were fixing the problem. It really didn't strike me as that big of a deal, as I am pretty used to seeing copper vandalism.

When I went into their HQ, there were cables strewn EVERYWHERE behind a partition that had various modems and such, which, I took as a good sign for an internet service provider. A whole lot of people seem to be worried about an ISP branching out into a polar opposite type of business. I am not concerned for a few reasons. As stated earlier, when I originally started buying shares of the company, I knew for fact, that the CEO (and his Realtor wife) have a significant amount of experience in real estate, as they have seemed to have successfully invested in housing in the past. Next, we are at a time when buying real estate, even if they mess up (which, I don't believe is happening) and get a less than good deal on it, probably won't hurt the company too bad over the long run... For me, with the company trading at a significant discount to book value, I get even more safety.

My overly simplified way of looking at the situation, is if the company is buying real estate for, say, .70 cents on the dollar, and if I bought shares of the company for say, 1/2 of tangible book, I am essentially buying that real estate for .35 cents on the dollar. If they overpaid by 20% (which, based on the rents I think they can get out of them, I am pretty sure is not the case) I am still getting the real estate for less than it's worth.

They are also diversifying their investments not only in higher end houses, but, there is also some commercial space, the pictured one above had paint, tables, ladders, and maybe some other tools in it and might have been a store house for the renovation projects. The company is also buying lower and middle range housing. Regardless of location, the theme is common: Erhartic seems to be buying most all of the real estate for  significantly less than it's worth. In the most recent quarter, the sales that the real estate unit garnered indicated that as well. When taking into consideration how much they invested to repair the sold properties, the cost of revenue was ~78%. Looking at what the company has left, I think that there will be higher margins to come in the future.

There are some houses that we went to which the company had actually sold. Below are some examples and another that is in the same area, that the company presently owns (I added in a panorama of one to show the neighborhood). The addresses with attached Zillow links and the consideration amounts, are 4965 Showalter Rd with a Zestimate of $106.2K, a sale to SYTE and BCK of $85.7K and a sale to an individual of $110.5K in Sept of 2011. 1924 Greenwood Rd has a Zestimate of $188.3K with a sale to SYTE of $138.2K, then a sale to an individual for $180K in January 2012. Lastly 1652 Brandon Avenue has a Zestimate of $202.2K vs a sale to SYTE of $126K. Furthermore, the rents that Zillow estimates the company could get (which make pretty good sense, based on what we saw) have the ability to be substantial. This may make for an opportunity for the company to create a revenue stream in the future. Sitestar also has historically paid much less than Zillow estimates, which as a rule of thumb (since Zillow can screw up), makes me quite happy. The properties all seemed to be in excellent condition.

Moving along from the real estate side of things, check out the legal proceedings from the 10K... it looks like the company is getting ready to have a touch more than 5% of it's shares canceled due to a spat with former management- I view this as a share repurchase that the company pays almost nothing for! You can check out the specifics of the case at this website.

The company is also cutting costs. Just take a look at executive expenses from some recent filings...
Frank R. Erhartic, Jr., President, CEO and Director, earned a salary of $13,000 and $93,308 for the years ended December 31, 2011 and 2010, respectively.  He received no other compensation.  Daniel Judd, CFO and Director earned a salary of $46,642 and $45,200 for the years ended December 31, 2011 and 2010, respectively.  He received no other compensation.  Julia E. Erhartic, Secretary and Director, earned a salary of $6,000 and $13,000 for the years ended December 31, 2011 and 2010, respectively.  She received no other compensation.
I take it that Frank is trying to make his money from the company from both the equity line that it occasionally uses, as well as through rental payments that the company makes.
The Company leases its corporate headquarters located at 7109 Timberlake Road, Suite 201, Lynchburg, VA 24502 from Frank R. Erhartic, Jr., a stockholder of the Company pursuant to a lease agreement entered into on November 23, 2003. Pursuant to the lease agreement, the Company pays Mr. Erhartic rent in the amount of $48,000 per year. The lease agreement expires on November 1, 2013. Mr. Erhartic also is owed varying amounts on a line of credit he has with the Company and on occasions he draws down his line of credit to take advantage of investment opportunities that arise from time-to-time.
It seems that the company is not using realtors to sell houses, but, rather the CEO of the company (his cell phone number is on the flyer). In the most recent 10K, it was stated that he received no other compensation from the company, other than interest on the loan, rent from HQ, or the $13K in salary, so, there should be some cost saving there that others in the market won't have the advantage of. It seems that Frank has set up a nice real estate business.

With the company being so geographically concentrated in their real estate holdings (basically, within 2-3 counties in Virginia), employment numbers in the area come to mind of some importance. Well, here they are. While they weren't that bad to begin with, the economy in the area is showing signs of improvement- a good point for the residential real estate market.

So, what did buying the shares needed to throw me over 5% of outstanding shares, at the company's present price, which has been hovering around $2 million dollars, buy me? For starters, I got well more than the market cap in owned real estate, which seems to be worth well more than was paid. There seems to be very little in the way of debt since the company has not been paying on a note from the USA Telephone acquisition. As I pointed out before, the company will likely owe less than the stated amount (and potentially, nothing) once the matter is settled. Additionally, I was able to purchase part of an internet business that is presently cash flowing. when it does eventually die off, I would imagine that the company would be able to sell off the remaining customers to a bigger operator, impair the goodwill on the books, and have a some sort tax asset (though, am not sure as to the extent). If they decide to keep it, then they may be able to acquire a dying industry at favorable, discounted prices, from distressed operators- giving Sitestar further economies of scale. Add into this that the company doesn't historically use an overabundance of leverage and I think that investment risk goes down.

Are there problems or things that could be better? As with any investment, sure. It might be interesting to see some of the houses get fixed up and moved quicker. I would like to know if they are maximizing potential tax assets through the usage of 1031 tax exchanges on the properties that they are selling (such as has been done with Consolidated Tomoka-Land Company). I would love to see a reverse share split happen- greater transparency with the company through the form of an annual meeting would be nice as well. I would be absolutely ecstatic to see an expansion of the company's share buyback program. But for now, I really like the company and have open buy orders.

On a more personal level, in my home area, the real estate market is really hard to acquire things at attractive prices unless you are paying cash without having to pay virtually anything in interest on said cash. If I do happen to find a deal that is overly good (and, they do come around if you look), then I can get a large amount of leverage on the property- often, for more than I buy the house for (funds to fix it up with), and not tie up my own capital. Thus, freeing it for other investments or uses. Since Sitestar essentially represents the cash buyers that are keeping me from being up to my eyeballs in the Lexington, KY real estate market and they are trading at a significant discount to book value (making their real estate even cheaper for me to buy) I am more than happy to allocate funds their way. The significant discount that they trade at to what I think their intrinsic value is, is in my mind, a form of levering my indirect investment in their owned real estate.

Disclosure/Disclaimer: I, various members of my family, and our family investment club are long shares of Sitestar. I have no position in or against CTO. This article is nothing more than my opinion and thoughts as to why I invested in the company. I assume that all I say is accurate, however, I am human and do screw up. Due to how the company owns and buys it's real estate, I may have messed up in posting pictures of properties that the company owns, or, owns part pieces of real estate through an investment group. While I have open buy orders, please remember that I have the right to change my position at any time. Always do a ton of your own research before even contemplating anything that I say, do, write, or so much as think about.


Ian Cassel said...

Great Post. More investors should do microcap due diligence like this.

Ian Cassel

ShadowStock said...

nice work Donald... I mean Mr Trump

Andy said...

Great post. The real question is how do you protect yourself from management changing course on compensation once the real estate starts to see gains. Any profits could go out the door as fast as they come in given the already low levels of compensation.

Do you know who controls the stock? Largest shareholder?

I see Dash Acquisition, someone I recognize from the Corner of Berkshire forum re. SNS, Denny's fame or flame.

FYI, perhaps upgrading to Disqus comments would be good?