Thursday, October 24, 2013

Prizes, Blind Valuation, and Some Bank Stories.

My first blind valuation post yielded some pretty good responses, and yielded a small amount of discussion in the comment section.

First the light hearted part of the post, then on to some more serious thoughts.

To the right is part of the prize pack that I sent out a while back... An un-opened Teenage Mutant Ninja Turtle (soccer kickin' nonetheless!), Marathon Oil 10-K, and Maker's Mark gift box (#KentuckyPride), Dronex stickers, and some labeling tape. An assortment of some overall great items. ;)

I sent the above prize pack to Henry, who's comment can be read here.

First and foremost, the financials were picked up in the lobby of my main bank, which was going to lend my uncle and I the money to buy and fix up a condemned apartment complex (the deal fell through). I'd be willing to guess that someone at the bank is reading this, and if so, please understand- any criticism of your industry in this post isn't directed at you- it is merely observational of the industry as a whole- I think you guys are great! :) Heck, for some of the other bankers that are out there reading this (@schornack and others) you all are cool too. Now that I think about it, a lot of my observation is actually not of bankers, but the regulators that essentially controlling what you are able to do.

Anyway, what struck me as insightful of Henry's comment, was that he was the sole person who pointed out why a person would want to be lent money from a healthy bank (which is something that I hinted at in the post). I have personally witnessed people get squeezed on loan terms, covenants, and interest rates by banks who were in financial distress, and have myself even been squeezed on interest rates and terms by a bank in the bluegrass that was under a lot of pressure from the FDIC... In my case, my business was the healthiest that it had ever been up to that point- the bank (well, I suppose their regulators) didn't seem to like that the subject property was vacant at the time of a refinance, that I had a lot of tenants on month to month leases (besides the fact that the tenants had been in the houses for long after their original year lease ran out), and that I had been dumping money into my houses. I had always thought that a bank would like that, as their collateral was better- I mean, isn't that part of why Sear's has had an odd relationship with it's customers and lenders? That it just uses it's real estate to suck cash out of?

Anyway, getting back to the point- a lot of those items stuff made my income levels look artificially low, and in turn, suppressed various ratios that the bank was needing to show that they had a healthy loan portfolio. All this, despite that I could have paid off the loan off by selling some stocks and was also waiting for the right tenants to put in the house- who, when they eventually came along a few weeks later, stayed in the house for nearly 5 years- until one of them unfortunately passed away (he was a really good husband, father, and decent guy)...

Nate at Oddball Stocks has talked of looking at an investment in a business as if you were their lender, a concept which I have always thought of as being really smart. I would add that it is noteworthy to also take a look at the actual lenders to businesses that you would be willing to invest in, or that you borrow money from. There are tons of examples. One of the more interesting ones is that of Syms essentially being forced to liquidate, because their lenders (Bank of America) were in the process of raising capital through the calling of loans. In the case of BAC, it could have played into a warrant thesis as it was part of their rush to raise capital to get on solid financial footing, which would ultimately make the warrants really valuable.

Champion Industries was not only taken over by their lender, but was also forced to sell off their most valuable asset (and the only one that seemed to cash flow) because they were not meeting various financial covenants. Granted, Champion was in a bad spot, but then again, their lender has not been in the best of shape in the recent past either.

Wells Fargo squeezed Infosonics in 2010, despite the company's horde of cash. To me, this shows that if you are investing in a net net, there should generally be some sort of viable business, or at the very minimum, a way to ensure that there are no random variables. That said, I have invested in some pretty atrocious net nets (Express Jets before the buyout, anyone?). There are a ton of examples that we can bring up in both the net net and lender mentions. Conversely, it is always interesting to look at companies that have no debt, but stubbornly keep paying fees to keep lines of credit open in the event that they are needed. For some interesting reading on those matters, go back and look through the annual reports for Envirostar and International Baler (I wrote on EVI and IBAL)

The bottom line here, is that lenders, like leverage can be a double edged sword. When they work... MAN! You and the bank can make a ton of money- but is something goes awry- it can also be bad for everyone! Sometimes this works out quite well- in the instance of Syms, the business model was totally broken and the real estate needed to be sold off or redeveloped. It was a win win for everyone, except the Syms family, whose stock was sold on the cheap in the bankruptcy. In others, a lot of people get burned- look at my previous examples.

There is an old country saying that my great uncle told me my great grandfather would say: "Bankers will always hand you an umbrella when the sun is shining and then turn around and jerk it away the second they see a cloud." Certainly- some harsh words, but the guy did live through the depression and just about lost everything in it.

I think that I will sum up a lot of this post with another country saying: "It's all about whose ox is getting gored."

To any bankers (or others) reading this, I would love to hear your thoughts on these matters- feel free to drop me an email, call, or leave a comment.

Disclosure/Disclaimer:  I own and represent shares of Trinity Place Holdings (formerly Syms) and a single share of International Baler (IBAL). I reserve the right to change the positions at any time. This post is my nothing more than my thoughts/opinion. Always do a ton of your own research before so much as contemplating anything that I say, do, write, or even think about.

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