Investment Idea

The market craziness today has created some amazing buying opportunities. Here is one that Mr. Market is providing that is absurd.

Over this weekend Berkshire came out and made an offer to buy Transatlantic Holdings for $52 a share, an all-cash deal. Transatlantic Holdings is in the reinsurance business. Although this investment opportunity doesn’t require any knowledge about the insurance business or Transatlantic Holdings’ financials. Berkshire’s offer to buy the company for $52 a share is one of the most certain things in the investment world, second only to promises by US Government to pay its debt. Berkshire has never, best of my knowledge, made an offer to buy a company and then run into problems getting cash to finish the transaction. So, for all purspose I look at this offer as something that doesn’t hold any financing risk.

I think the big uncertaintly (not risk) here is Transatlantic Holdings’ board rejects this offer. Typically a board would reject an acquisition offer only if they believe the company is worth more than the offer price. There are other reasons as well, like the board believing the transaction can’t be completed due to financing or regulatory hurdles to complete the transaction. In this case, I think the biggest uncertaintly is board believing the offer price is a low-ball offer. In that case, the board would have to convince the shareholders the company, as a standalone, is worth lots more than $52 a share. If the company is worth less than the offer price, the board would be best served to accept the offer.

We know the type of companies Berkshire likes to acquire. We know the management qualities that Berkshire looks for in potential matches. So we can rule out any risk that the management and board of Transatlantic is using the company as a vehicle for personal enrichment at the expense of shareholders.

At close of day on Monday, the company’s shares were trading for $48.31 a share. The is a difference of $3.69 a share, to the offer price. So you are getting a 7.64% return on an investment if the offer closes. If the offer doesn’t close, the board has to show how the company is worth more than $52/share. There is potential upside if someone else comes and out-bids Berkshire.

The biggest downside on this investment is that the deal doesn’t close. Since we know the quality of management, based on Berkshire’s screening, you have got to believe management is top quality. So management rejecting this offer means you have a good quality management that believes the company is worth lots more than the offer price.

Portfolio updates

Some recent updates to the portfolio. Due to lack of time, the write-up are brief.

I sold out of WellCare and Radisys. Although I believe both these companies are cheap and should do well, I sold out to acquire other companies where I feel more comfortable with the management team and the business. I also want to keep plenty of cash on hand.

Also, early in the quarter I was increasing my holding in Harvest Natural Resources, KVH Industries, and Heckmann. Their shares pulled back early in the quarter for no apparent reason, creating a good opportunity to buy more. All of these purchases worked out well as all 3 have moved up substantially since the start of the quarter.

New Buys

The Dolan Company: A high ROIC company with a strong moat, run by a very strong management team that acquires companies (mostly providing services to the legal profession) and then scales the business. The management team has a history of successfully applying the strategy in early 2000 when the company acquired a group of public records companies. The company sold these businesses and then used the cash to acquire businesses that provide services to the same industry. Most recently the company has acquired 2 companies, NDeX (providing outsourcing for the foreclosure business) and DiscoverReady (providing service for the discovery process in legal cases, the process where lawyers collect information/support for their case).

The company is the leader in providing back-office and IT services to law firms doing foreclosure filing for the banks. The company has a large presence in the big states w/ foreclosures and they are the leader in each of these big states. When a bank wants to foreclose a property, it assigns a law firm to work on its behalf. The law firm can do the paperwork, management of information, contacting/mailing letters to the homeowner, …. or it can outsource it to Dolan Company, their NDeX platform. Dolan gets paid a set fee for each file it takes over. The company has signed long term exclusive contracts w/ large foreclosure law firms for these services.

The foreclosure process has been a stop-n-go. With all the talk in the last 2 years about what to do w/ the large foreclosure pipeline, the only solution is to actually foreclose on these properties. I don’t think there is any other alternative that is going to work. The recent robo-paper problem has delayed the foreclosure process but the number of properties that need to be foreclose only increases. Interesting, the company reported its Q4 numbers today and the revenue/profits were not that strong. The reason was the slow-down in foreclosures. Although its FY 2011 projected numbers stayed the same. So the company believes any delay in foreclosures doesn’t mean revenue is lost, just delayed.

DiscoverReady is a new business acquired a year ago. This is a high growth business, growing double-to-triple digits. One of the major cost areas for lawsuits is the discovery process, where the law firms collect data to support their case or how to fight the case. Basically the DiscoverReady process has shown to substantially reduce costs and time. There have been a few law firms using this service until recently. The company is looking to increase the law firms using the product and so far the results have been very good.

The company also has many other smaller businesses, some of them are the leader in their area. Although the above 2 are the main drivers of growth.

The company has grown by taking on debt to do acquisitions. In the last couple of years, after the 2 recent acquisitions, the company has been working on paying down debt. They have reduced debt dramatically and I believe we will start seeing the company now using the cash flow to buyback shares. In the most recent CC, management said they think the current share prices are cheap and would see anything less than $30/share a cheap (compared to current price of $12. I the $30 target was a bit sarcastic but not too much of a stretch).

The company has about $138M of debt, market cap of $365M. They are doing EBIDTA of $92M w/ expectation of $100M in FY 2011. This is a high margin business w/ little CapEx requirement. Management has been buying shares in the $10 range. The management is accessable, has strong history in this industry, and smart allocators of capital based on their acquisition history.

Hallmark Financials: It is rare to find a very well run insurance company, with huge ownership by management, conservative investment portfolio, history of smart acquisitions, and company buying back shares. To find it at a discount to tangible book value makes is very tempting. The company is selling for 75% of book value, not a huge discount but the company has been growing book value at 16% annually for the past 5 yrs. The company is selling for less than half of the company’s investment portfolio, made up mostly of muni and corporate bonds. The company is controlled by hedge fund Newcastle Partners, run by Mark Schwarz. The company recently announced plan to acquire upto 3M shares, currently there are 20M shares outstanding. So we could get over 15% of the company bought back. In January, Hallmark filed a registration statement in which it mentioned that Newcastle is to sell 3.1M shares to Hallmark. Newcastle currently owns over 31% of the company. I see this as an opportunity to buy the company a discount to book value with plenty more upside from growth in the business and share buybacks. Schwarz has mentioned that he is prepared to hold the Hallmark investment for many more years and has plans to make Hallmark much bigger (The recent selling by Schwarz is due to liquidation request at Newcastle).

 

New buys and adding to existing position

I haven’t been able to update the blog regularly. In the last couple of weeks, I’ve bought some new positions.

Reed Resources

This is a small mining company in Australia with a very compelling risk/reward opportunity. The company has 3 main assets: gold, lithium, and vanadium. Any one of these three assets could make this investment a multi-bagger. The lithium assets are the most interesting and should make the biggest short-term impact on the company’s valuation. The gold assets were minuscule until a few week ago. Although a recent acquisition of a gold mine makes the gold assets worth multiples to the company’s current valuation. Finally the vanadium assets could have huge upside, although it will require a much longer time to realize the value.

I think any of these 3 core assets will make the company worth multiples to today’s valuation. Management has skin in the game and have shown to make smart decisions (the recent gold mine acquisition is a great example).

Some research reports:

- Hallgarten & Company (focused on the lithium assets)
- Shaw research (on the vanadium assets)
- Recent company presentation (detailed discussion on the recent gold mine acquisition)
- A SumZero write-up on the company (requires login)
- Other research reports on the company

 

Radisys (RSYS)

I recently acquired a small position in Radisys. About six weeks ago, the company announced that they won’t hit the Q4 revenue guidance. The stock took a hit and allowed me to buy an initial position.

The company has a market cap of $203M, cash of $133M and debt of $50M. The company has a legacy product that is declining in revenue and a new product that has strong growth ahead. The company should easily do $20-25M in FCF in 2011, creating a huge discount at current valuation.

A few months ago we posted David Nierenberg’s, of D3 Funds, letter to the board. Since the letter, the board has approved a share repurchase plan.

 

MAM Software (MAMS)

This is a micro-cap software company with a huge moat. The company provides an e-commerce solution and business management system for auto aftermarket. The company has been a turnaround story for years. The last few quarters, the company has started to show the strong cash flow generation with high ROIC. The company should be able to make around $6M of FCF annually, compared to the current EV of $22M.

- A SumZero write-up on this company (shouldn’t require login)

 

Also, in the last few days I’ve been adding to my HNR position. There has bee a big pullback in the HNR shares in January, down almost 12%. I don’t believe anything has fundamentally changed with the company in the last month. The results from the Indonesia drilling will still take a few weeks. I see the pullback has a great opportunity to buy a company with a low-risk of a loss and huge upside within the next 6 months.

Portfolio Updates and new buys

I haven’t been able to update the blog in the last couple of weeks. In the last couple of weeks I’ve made come changes to the portfolio.

- TX: I sold out of Ternium. I had said previously that I liked the management, the strong business fundamentals, the location in Latin America, and potential upside from the Brazil plant. The biggest drawback was the price I paid to build my position. I bought it at its highs about 2 years ago. Although I like the company, at the price I paid there was no margin of safety. I sold at a small loss.

New Buys:

Avino Silver: A junior silver producer that has some wonderful assets and backing from Sprott Asset Management. They own land in Mexico that has been proven to produce substantial amount of silver. Their mine was producing silver back in the Conquistadors times, so there is no risk of whether there is silver to be found. It was considered one of the top silver mines in the world, so the assets are very good. The mine was closed off by Mexico for decades. The management team bought the land and is now close to major expansion.

I started buying this one a few weeks ago. Although the shares have moved up, it is still a good buy based on your views on silver.

- The management team is good, runs a tight ship, and has kept a clean capital structure (very little warrants or dilution).
- Mgmt recently reported that the replacement cost is around $40M, compared to the market cap of the company at $60M.
- Mgmt put out an estimate cash generation of $10M based on $900/gold and $15/silver. Silver has doubled since then and gold is higher by $400. So I think the cash generation is more around $20-25M.
- Company has a partnership w/ Goldcorp’s Mexico subsidiary for massive expansion. The results of tests has been exceptionally good, in terms of grade and further expansion of un-mined land.
- All permits and environmental tests are done and company is looking for huge jump in production starting Q2 ’11
- Recently did capital raising from Sprott Asset Mgmt. Sprott got warrants at $1.25, so today’s market price fo $2.20 has a bit of run up but I think there is still quite a huge run-up left.
- Infrastructure in place to do 1,250 tpd.
- Sprott recently did another capital infusion. These transactions are dilutive but management has done a good job on keeping the dilution to a minimum.
- The Eagle Property asset could be a huge upside. Results so far have shown strong silver and Iridium (rare earth material).
- The breakeven cost on production is extremely low, around $7/oz for silver.

At current silver prices of $30, the company could be making around $25M of free cash. Based on what happens to silver prices and the Eagle property, you could see huge upside.

http://www.avino.com/i/pdf/Avino-ppt.pdf
http://www.midasletter.com/news/10031201_Avino-Silver-Asks-You-Like-Mining.php
http://www.gold-eagle.com/editorials_08/blog120910.html

ATS Corp

This is a pure play on the IT services for government agencies. The company has been around for 30+ yrs but it is only recently that the company has cleaned up its act and started growing. New management team had turned the company around, substantially increased backlog, and provides services for mission critical products (making it a strong recurring revenue model for the company).

The company is extremely thinly traded, 2K shares trade on a good day. There are over 22M shares outstanding but very few trade hands. Why? Osmium Special Situations and the folks at Locke & Conway own a large amount of the shares. Both are buying even more.

The company provides IT services for some of the key operating products for governmental agencies. Fannie Mae, one of the company’s big customers, uses ATS services for Fannie Mae’s MBS transaction software. ATS has been providing service to Fannie Mae for years and with what is happening the real estate market, it is unlikely ATS services will be stopped. The US military uses ATS’ services for their order management software. The software is critical for purchasing of food and goods for the military.

The market opportunity has been growing at a healthy pace and its is likely to grow for years to come. ATS is positioned extremely well to grow. The backlog for the company has been growing, operating results are strong, and the company has been smartly leveraging for accretive acquisitions, and using cash flow to reduce debt.

The company is making around $14M of EBIDTA, compared to a market cap of $60M. The debt has been reduced to low teens. Company should be growing EBIDTA organically and levered up the company for acquisition. Typical competitors sell for 8-9x EBIDTA, so you get a huge discount to true value. Based on management’s execution, they have done a great job, there is much higher upside based on M&A and revenue growth.

- Corporate presentation

On my wish list, Hanfeng Evergreen

One of the top companies on my wish list is a Chinese play.

- Hanfeng Evergreen: Of all the Chinese listed companies, this one is one of my favorite. The company sells slow release fertilizers in China and South Asia. The management team is great, company has a long history, big 4 auditors, good governance. The company is the leader in its industry and has a huge first mover advantage. They have a strong brand name, relationship with government, strong margins, clean balance sheet, strong balance sheet growth, and huge growth potential.

Reading the 10K and letter to shareholders, you get a sense the management has done a fabulous job building a bit moat, its brand name and product quality, and taking the right decisions to position the company for a solid long run.

One of the major problems with slow release fertilizers (SRL) is its costs. SRLs have proven that they are great for corp yield and for the environment, especially water. The biggest concern and reason for slow adoption has been the cost of SRL has been prohibitive. Hanfeng has been a leader in the industry.

I would be a buyer if i could get the shares cheaper, although I doubt that chance will come.

More reading:
- Controlled Release Fertilizers: Everything you would need to know about this group of products.

Yukon-Nevada: The valuation disconnect

Yukon-Nevada is one of my favorite risk/reward plays in the current market. It is a classic example of a good company making a bad mistake. Mr. Market with its short-term view hits the company’s valuation hard. The company then quietly goes about its business and makes all the right moves to fix the mistake. Yukon-Nevada is at a point where the company is close to returning to operation levels before the mistake but the shares still trade at a substantial discount to valuation of peers.

In March ’10, management made a presentation comparing the company’s valuation to the peers. I expect Yukon-Nevada to make an announcement regarding its production rate. Management has stated that by July 2010 the company should be producing 150K ounces of gold. The March ’10 presentation shows valuation of peers at the 150K production levels, trading at market cap of 600-1.8B (the market valuation takes into account the reserves at these companies, which the management presentation doesn’t get into). Yukon-Nevada sports a market cap of less than 200M. So we could see a major increase in YNG shares once Mr. Market comes to its senses.

Management also mentioned a goal of raising production levels to 400K ounces of gold in a 2 year timeframe. If management is successful in hitting it goal, we are looking at a home-run compared to current valuations.

New Buy: Yukon-Nevada Gold

I haven’t been active on the blog recently as I’ve been busy with some projects that hopefully will become public soon.

I purchased a stake in Yukon-Nevada Gold (YNG CN) today. I haven’t written up an analysis buy you can read some analyst research papers, from Byron Capital and from Hallgarten & Co

New Buy: Palladon Ventures

This is actually an old purchase that I had sold out of. Today’s press release confirmed my initial thesis on the investment. I bought a very small stake, less than 1%, on PLL today. The company has started shipment of iron ore and figured out all the parts of getting the product shipped to the port, Richmond, CA. The first shipment should be completed by July 2010. If all goes well, we can see major increase in shipment.

New Buy: Cano Petroleum (CFW)

A great little arbitrage opportunity, courtesy of Above Average Odds. Read the write-up, well written and presented. Should be a great return in a very short period.

New Buy: Orion Energy (OESX)

Orion Energy reported quarterly earnings yesterday. The company’s estimates for the coming fiscal year was well below analyst expectations. In the near term the growth might now show up, I still think long run their business model is very strong. The huge drop today was a great chance to buy into it.

I will post more thoughts on this later. For now you can read an older write-up on the company.