Many value investors that I respect have been attracted to Reading International (RDI). Whopper Investments, Jae Jun, Andrew Shapiro, and now, a recent Barrons article, have all highlighted hidden value in the company well in excess of the current market value. RDI has previously been one of my largest positions, and I even won a Harvard stock competition with a friend pitching a sum of the parts story. While I agree that RDI is substantially undervalued when compared to its assets, I disagree that it represents a particularly compelling investment today because of management’s disregard for minority shareholders. I recommend small investors take advantage of the recent “no news” Barrons article pop to sell shares and buy into cheap businesses where management is more properly aligned with shareholder’s incentives.
For those unfamiliar with RDI, the story is rather simple. It operates a cinema business and owns real estate. It sells below what is a massively understated book value (their land is worth well in excess of the value held on the balance sheet). In other words, this ~$6 stock is conservatively worth over $10 (see presentation) if management wanted to unlock the value. However, they don’t. There is a dual class share structure with all of the voting power concentrated with James Cotter, the CEO and Chairman of the firm. This ensures that minority shareholders can have no say in what actually occurs at the company or any strategic direction.
I knew all of this before I pitched the company for the Harvard competition, so what has changed since?
First, shortly after my pitch, Capstone Equities made a $100 mm bid for two of RDI’s New York Properties, Union Square and Cinema 1, 2, 3. Note that these properties only have a combined gross book value on the balance sheet of $32 million. Capstone, a minority shareholder, repeatedly tried to negotiate with RDI but claimed their management was unresponsive (their letter is worth a read). This was an excellent opportunity for management to unlock value for shareholders, many of whom have put up with poor share price performance for many years. However, they again showed an unwillingness to sell their core properties and unlock value, saying they wanted an option to co-participate in any development.
The second thing that changed my mind is when I recently visited with the company’s CFO at their Los Angeles office. While he was very nice and I thank him for meeting with me, I must say that I was disappointed as a minority shareholder in many of the things he had to say. I think all minority shareholders deserve to understand the mentality of this management team.
When asked about share buybacks for such a clearly undervalued stock, the CFO basically did not have an answer. He acknowledged that the company is incredibly cheap and that buybacks would make sense, but clearly articulated that a meaningful buyback program is not in the works. This is just poor capital allocation. A real company without a dual class share structure would consider the opportunity cost of any capital allocation decision. When you are clearly selling below the value of your real estate, buying more real estate, rather than share buybacks, is an indefensible capital allocation strategy. The only explanation is that they care more about building a family-owned real estate empire than they do about minority shareholder interests.
When asked about asset sales, he admitted that the company often has an emotional connection with some of their properties that makes them less willing to sell. As an investor, I simply cannot put money with a management team that is emotional with my money—especially one that cannot be held accountable by shareholders because of the dual class share structure.
The recent Barrons article said nothing new—the company is cheap. I agree with that and all of the other investment sites I mentioned earlier agree with that. After all, it is hard to make a case they are not extremely undervalued. However, whether something is undervalued or whether it is a good investment is not always the same question. In this case, the stock is extremely cheap relative to its assets, but it should be (and has for many years)! Why should the company trade at full value when management is emotional with shareholders money and is clearly misallocating capital?
There are really two risks in investing in stocks. The first is what you are buying is worth less than what you are paying. There is almost zero risk of this with RDI. The second, less talked about risk, is that it takes too long for fair value to be realized, which dilutes your IRR on the investment. This risk is tremendous with RDI given management’s mentality. I fully understand why some investors might choose to stay in RDI and try and bet on the gap between the current value and fair value closing, but that is really speculation in my opinion. The company has owned these assets for many years now and I have no idea when management will decide to do the right thing for shareholders, but after my meeting with the CFO, my gut says the answer is not very soon.
Therefore, when I look around at the investment universe and ask myself whether RDI is one of the best opportunities in the market, I have to pass. While it could easily work out given the discount you are paying to fair value, the risk that the price flounders around over the next ten years as management continues to buy assets and never unlock value is too great in my opinion. If you are interested in learning about some of my favorite ideas that are both cheap and have a clear path to realizing value, subscribe to my blog, like the facebook page, and follow my twitter (all are found on the right-hand side).
Disclaimer: The content contained in this blog represents only the opinions of its author(s). I may hold long or short positions in securities mentioned in the blog. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. This blog is not a solicitation of business– the content herein is intended solely for the entertainment of the reader and the author.