Clark Inc: the Canadian Icahn at a discount?

Clarke Inc is a Canadian holding company that is run by activist investor George Armoyan. Just like Carl Icahn George Armoyan has a bit of a reputation as a bully. He actually got banned from a couple of municipal buildings in Halifax last month because of ‘threatening’ behavior:

“They made me wait for an hour and 15 minutes without giving me the courtesy to come out,” said Armoyan, whose family company, Armco Capital Inc., is one of the largest development firms in Atlantic Canada. “Then all of a sudden I see police guys come over because I was tapping my feet and I was looking agitated and angry.”

The attraction of Clarke is that the company is trading at a discount to net asset value, the company is steadily buying back shares and it is paying a decent dividend. How big the current discount to NAV is is easy to calculate since the majority of assets are publicly traded:

Clarke Inc NAV

As is visible the company is trading a decent discount to NAV, but a discount less than 20% is ordinarily not enough to get me interested. Unless the investments of the holding company are capable of outperforming the market a holding company deserves to trade at a discount because it has overhead costs and there are usually tax inefficiencies.

Tax inefficiencies seems to be minimal at Clarke because it doesn’t pay taxes on capital gains or dividend income. It might have to pay income taxes when the pension benefit asset is realized. I wasn’t able to figure this out with certainty, but I do think it is probably that they have to pay 31% in income taxes when it is realized (if I have a reader that knows this for sure, that would be nice). Assuming that they need to pay taxes this would reduce NAV by CA$9.3 million.

The negative value of the overhead is a bit though to figure out since the company used to own operating subsidiaries that have their results consolidated. George Armoyan got paid close to a million dollars in pension benefits last year, but since he is now only the chairman of the board and not the CEO that might not continue. But the new CEO is obviously getting paid, they have a CFO and probably some other staff at the holding company level as well. And there is of course an auditor to pay, and I assume they have an office somewhere as well. At least CA$2 million in yearly operating costs is probably an optimistic estimate. Capitalize these costs at a 10% discount rate and we have another CA$20 million liability that is missing from the NAV. If we would include this and the taxes in the calculation the discount would be a meager 7.4%.

The last major component missing from the calculation is whether or not the investment manager is able to generate (positive) alpha. This is something that I usually don’t want to bet on, but in this case it might be reasonable. The latest quarterly contains the following graph:

Historical results Clarke IncThis looks like a pretty decent result, and it is. Book value increased at a 14.3% CAGR while both the S&P/TSX and the S&P 500 managed something closer to 5% during this period. While this sounds pretty impressive I’m actually a bit skeptical whether or not this result is attributable to skill instead of luck. If we ignore the past two years where Clarke posted phenomenal results the company would have performed roughly the same as the S&P/TSX for an eight year period but with more volatility. Not being able to beat the index for an eight year period sounds pretty crappy to me, but I might be overly harsh? It doesn’t inspire confidence.

Conclusion

If you think George Armoyan is able to beat the market Clarke is probably a pretty good investment, especially if he is able to beat the market at a significant clip. If he is unable to beat the market – and unfortunately that is for most investment managers the case – the company is probably just marginally undervalued.

To be fair: I haven’t included the impact of the share repurchases in my calculations. Buying back approximately 5% of the outstanding shares/year at a ~15% discount (taking taxes on the pension asset into account) should result in a little bit of alpha. It’s not very meaningful though.

Disclosure

No position

Conrad reports poor results for Q3 2014

Conrad reported results for the third quarter of 2014 last week, and unfortunately it contained a bit of a nasty surprise since revenue was down 9.6% compared to the previous quarter and net income took a bigger hit and went down 34.1%. The backlog also decreased 22.0%. This is obviously not a good development, and not surprisingly management’s discussion of the results have a cautious tone compared to the previous quarter:

Although we are optimistic about the long-term prospects of our business, we also take note of near-term risks. Current declining oil prices and a decrease in demand for tank barges used to transport petroleum products produced from shale plays lead to some uncertainty about our shorter-term demand and margins.

Although bid activity has been good and we are pursuing many opportunities, we have not signed contracts as anticipated which is leading to gaps in our production schedules.

Luckily the drop in earnings isn’t as bad as it looks from the surface. A bit buried at the bottom of footnote #2 we learn that Conrad recorded a $2.2 million provision for unprofitable contracts. This cost is fully recognized as soon it becomes evident while earnings are recognized based on the percentage of completion method. This heavily penalizes the earnings of the current quarter with a cost that should not reoccur (and is not necessarily incurred in this quarter). Without this item earnings would have dropped more inline with revenue: ‘just’ ~13 percent instead of 34 percent.

The Company recorded total charges of $2.2 million for the quarter ended September 30, 2014 (and no charges for the year ended December 31, 2013) in cost of revenue to reflect revised estimates related to anticipated losses on uncompleted vessels in progress in the repair and conversion segment. The offsetting credit was recorded in costs and estimated earnings, net in excess of billings on uncompleted contracts. As of September 30, 2014 and December 31, 2013, approximately $2.2 million and $0, respectively, of this provision are included in costs and estimated earnings, net in excess of billings on uncompleted contracts.

At the same time management is also seeing new opportunities:

Management continues to engage in a detailed business planning process to identify potential uses of the Company’s cash. Although we have experienced a decline in demand for inland tank barges, we have also experienced increased opportunities to produce different types of vessels for emerging markets. Some of these vessels would be larger, take longer to start production, and take longer to complete than vessels we have constructed in the past, and some may require additional capital expenditures. Management is pursuing and evaluating these opportunities and intends to take them into account in making a recommendation in the near term to the board regarding the use of the Company’s cash.

These new opportunities might also explain why the company didn’t declare a dividend this quarter. The past two years Conrad paid a 2$/share dividend at the end of the year, and while the dividends were not classified as regular dividends I was expecting something similar again since they now have more than $10/share in cash. While a dividend would have been nice I don’t mind not receiving one this year. I do trust Conrad’s management team to do something sensible with the cash, and that is the important thing.

Disclosure

Author is long Conrad

Jumping off the GSAT short train

If there is one thing I’m allergic to when I’m shorting a stock it’s a high borrow fee. When I started shorting Globalstar earlier this month the borrow rate was below 1%. Unfortunately that is changing and at the moment you already have to pay more than 5% to borrow to stock. Because of that I have exited my position today after already reducing it two days ago (when the borrow fee started to rise). My timing is a bit crappy compared to what would have been possible in this time period, but can’t complain with a 27% return in less than two weeks.

GSAT borrow feeDisclosure

No position in GSAT anymore

Awilco Drilling: back to square one?

I bought Awilco Drilling in the beginning of 2013 at 90 NOK/share, and after peaking at 162 NOK/share almost three months ago the shares are back to where they started. I was fortunate enough to sell a part of my position near the top, and the big question is of course: is it time to start buying again? Unfortunately the answer is not an easy yes since intrinsic value has been dropping as well. Oil prices are lower, and as a result day rates are also declining.

A glimpse of what is happening with day rates was offered by Transocean last Wednesday when they announced that the Transocean Leader was awarded a four year contract with a day rate of $335,000. The rig was previously operating for $400,000/day for Statoil in Norway on a contract that started in 2012. Since day rates have increased since early 2012 I’m afraid that Awilco’s day rates will drop more than the 16% implied by the new Transocean contract. Awilco is operating under contracts that were made in 2013.

To analyze the impact of various possible future day rates I have created a small DCF model. The two items that have the biggest impact on the calculated intrinsic value are future day rates and the discount rate. With a day rate of $275,000 and a 12.5% discount rate we get today’s share price ($13.80) as fair value:

Awilco Drilling DCF model

A $275,000 day rate is 30% below the current day rate. I think this is a bit pessimistic for Awilco since day rates in the UK remained at ~$250,000 even when oil dropped to $40/barrel in early 2009. With day rates at $300,000 the model spits out a value of $16/share while at a $325,000 (representing a 16% discount) fair value per share would be $18. I think using a $300,000 day rate is a reasonable base case. Unfortunately this means that Awilco is probably just slightly undervalued at ~$14/share. So even though the shares have dropped significantly the past months I wont be in a hurry to add to my position.

Disclosure

Author is long AWDR.OL

Joining the GSAT short bandwagon

Kerrisdale Capital presented their case for shorting Globalstar today with a lot of hype. The small asset manager took a page out of the Bill Ackman playbook and hosted a live presentation and webcast while also publishing a lengthy report on a brand new website. When a short case is made so public you have to wonder if it is possible to have an edge as a small retail investor who never knew the company existed until today. I obviously do think I have, but it’s quite possible that I’m overestimating my abilities in being able to play this game.

Dealbook describes the short case as complicated and relying on a lot of jargon which makes it difficult to summarize in a sound bite. I don’t think it is, although some technical knowledge is certainly helpful. My attempt to summarize the thesis in a single sentence:

WiFi congestion not a problem: limited value of a 4th 2.4GHz WiFi channel in the US

GSAT is trying to get FCC approval for using their 2.4GHz spectrum for this purpose. The other part of the company is a money losing mobile satellite services business, so monetizing their spectrum asset is crucially important. Their spectrum has some value, but it will be very though to monetize. In almost all cases there is sufficient free spectrum available on the 2.4GHz band, while newer devices communicate using the 5GHz band where an abundant number of free channels are available for high-speed WiFi.

At the same time it will take the company a lot of time to do anything with the spectrum even in a best case scenario. After they receive FCC approval they somehow need to get manufacturers of phones, access points and other equipment to support the new 2.4GHz WiFi channel. This is doable with just a simple firmware update. The reality however is that phone/tablet/notebook manufacturers prefer not to spent too much resources on older products while most consumers wouldn’t take the effort to upgrade their firmware. At the same time support for a 4th 2.4GHz band is irrelevant for new devices since they already have 5GHz support.

I don’t see how GSAT will be able to effectively monetize their spectrum. Their spectrum is a solution for a problem that never really existed and is already solved in the latest WiFi standard.

802.11ac Is Here Today and Will Dominate in the Future

Disclosure

Author is short GSAT