My Favorite Stock in 2013 and Beyond– 200%+ Upside

At first glance, one may overlook the tremendous value in Noble Roman’s (NROM). It has been around since the 1970’s, has a ~15 mm market cap, and trades for less than $1. However, for the few investors who are willing to take a closer look, an extremely compelling story is emerging. After falling from over $7 during its 2007 peak, NROM trades at ~$.70 despite an extremely favorable business transformation that is so far unnoticed by the market. In five years, I believe the company will be have 60%+ operating margins (~40% ttm) and generate over $9 mm in EBITDA (~$3 mm in 2012). Today, you can buy into this growth story at just above book value and 6X ttm EBITDA. I conservatively value shares at $2, greater than 200% upside, but if their new “Take N Bake” franchise concept is successful (as early signs indicate it will be), this could be a true homerun and conceivably be worth ~$6.

Since very few investors follow the stock, I will give a brief background on the company and describe their various business segments.

Company Background

  • Began in 1972 as a small Indiana pizza operator
  • In the 1980’s and 90’s phased out of the operating store business
  • In the 1990’s and early 2000’s, the company morphed into a franchising and supply chain pizza business
  • In 2008, the company was sued by many of their franchisees who accused Noble Roman’s of fraud as a result of the dramatic failure of most the of the franchises
    • The company spent a couple million in legal payments company and is currently trying to recoup up to $5 mm in counterclaim payments.
    • The judge has already ruled in NROM’s favor, completed dismissed the lawsuits as frivolous, and there is a hearing in mid-February with possible payments to NROM for legal fees.
  • In 2009, the company began focusing its efforts on selling “take n bake” pizzas to grocery stores
  • In 2012, the company started another new segment, focused on opening individual “take n bake” franchises, modeled after Papa Murphy’s success in this market

The Business Segments: The four major segments listed here are described in detail below. Revenue percentages below are based on estimated full year 2012 results.

  • Non-Traditional Locations (58% of revenue)
  • Take-N-Bake Grocery Stores (18% revenue)
  • Traditional Locations (12% revenue%)
  • Take-N-Bake Franchise (1% revenue)
  • Other (11% of revenue). I won’t cover other as it is insignificant (consisting of a couple company owned stores for testing purposes) that have had very consistent operating results, but are not a major source of value (and will shrink as % of revenue going forward).

Non-Traditional Locations

  • This is basically convenience stores/ gas stations. Noble Roman’s sells stores the equipment to make Noble Roman’s pizza (upfront fees) and NROM takes a % of sales as a royalty fee. This is a high margin segment for the locations and a great proposition for Noble Roman’s as well.
  • This is a very sticky business with essentially no costs. Once a location has the equipment, they have little incentive to switch. This makes the segment very easy to value/model
  • Below are the results from this segment (2012 full results estimated)

The company has done a good job growing relationships with large operators of non-traditional locations. For example, it now has a relationship with The Pantry, which has 1,650 locations (see investor presentation). This is a sticky business segment that should at least maintain revenue, and more likely, slightly grow over time as they continue to roll out new units with existing operators of these locations

            2010            2011     E2012
non traditional roy fees           4,425,822         4,023,177   4,340,000

Take and Bake Business (Grocery Stores): ~18% of Revenue, Growing

  • This is the company’s current main growth segment. They started selling “take-n-bake” pizza to grocery store chains in September 2009. These are made that day (non frozen) pizzas that are refrigerated and are taken to a customer’s home to cook and eat that day.
  • The Company has signed agreements for 1,350 grocery store locations to operate the take-n-bake pizza program and has consistently added ~400 stores per year.
  • Each store generates ~$2000/year (ramping up slowly). ~$1.16 accrues to NROM/pizza
  • Again, the company has essentially no costs associated with this segment as they are licensing their brand. The company develops distribution agreements with grocery store distributors, signs licensing agreements with Grocery distributor customers, and services them through foodservice distributors

Individual Take N Bake Franchises

  • Papa Murphy’s is the leader in this fast growing take n bake market. With over 1,300 locations, they are the 5th largest pizza chain in the U.S. and are expanding quickly
  • These locations serve pizza that can be customized when ordered and are then be taken home to be baked. It is fast and cheap.
  • One key competitive advantage is that their food is not considered a finished good, and is therefore eligible for food stamps. Papa Murphy’s has 22% of their sales from food stamps. This gives them a competitive advantage over other dining concepts.
  • Papa Murphy’s is the only major player in the market. The biggest players (Pizza Hutt, Dominoes, etc.) are unlikely to enter the market given it would threaten and cannibalize their existing brand image.
  • NROM believes it is well positioned to enter this market (again via franchising.. another growth vertical that does not risk company’s own capital). There are already two in existence and six more already in agreement. The company’s first store generated an operating profit of 26.5% in its first month of existence
  • The company takes 11% of all sales, and units are estimated (based on Papa Murphy’s financials) to bring in ~$550K/year, leading to $50K+ in revenue to NROM per year

So How Much Is It Worth?

  • The CEO has stated they can double the size of the business with almost no increase in costs. This is the real beauty of their business model—almost all incremental revenue will flow to the bottom line
  • In 2012, the company should generate ~$3 mm in EBITDA based on $7.5 mm in revenue and $4.5 mm in OPEX.
  • I think the company can generate $9 mm in EBITDA in 2017
    • Assumes non-traditional revenue growth is flat (conservative)
    • Assumes the company can continue to sign 400 grocery stores per year for five years. By the end of 2017, this would be 2,000 additional grocery stores. At ~$2,000/grocery store, this results in $4 million in incremental EBITDA
    • Assumes the company will be operating 40 individual take n bake stores by 2017, generating on average $50,000 to NROM/year. This results in an incremental $2 million in EBITDA.
    • Adding this growth to the existing $3 mm in EBITDA gets you to $9 mm in 2017 EBITDA, but how much is that worth?
    • On low end, I believe an asset-light, growing company with 60% EBIT margins would be worth an S&P 500 average multiple (currently 9.32X EBITDA).
    • On high end, I have used PZZI (closest comp) 20.68X EBITDA. Note that PZZI has less than 2% EBIT margins and less EBITDA than NROM despite 2X market cap.
2017 EBITDA Multiple                              9.32 PZZI EBITDA Multiple                      20.68
2017 EV                 87,773,904 2017 EV         194,760,122
Debt                 (4,900,000) Debt            (4,900,000)
Equity Value                 82,873,904 Equity Value         189,860,122
2017 Equity Value/Share                              $4.25 2017 Equity Value/Share                         $9.73
DR 12% DR 12%
NPV/share $2.41 NPV/share  $              5.52
Premium 209% Premium



Am I Crazy? Are These Assumptions Too Optimistic?

  • If you are anything like me, and you are unfamiliar with the story, your inner value investor may be cringing at the above tables. After all, aren’t those growth estimates just pulled out of thin air? Isn’t the take n bake individual franchise concept barely starting for NROM, making a 20X increase in stores (to 40) by the end of 2017 ridiculous? Let me explain…
  • First, under the above 2017 scenario, here is how revenue breaks down per operating segment:

2017 % Revenue

Non traditional roy fees


Grocery store take n bake


Traditional locations


Restaurant Revenue


Upfront Fees


Take-n-bake franchise


Total Revenue


  • The most valuable business segment is the grocery store segment. This also happens to be the growth segment with the most visibility. The company has for three years now built an impressive business segment from scratch, and they have a long runway for growth.
    • Sanity Check: Can they average 400 stores/year for five years?
      • They have signed 1,350 stores in three years. They already have relationships with 14 grocery store distributors that represent over 5,000 stores.
      • The number of grocery store distributors is rapidly increasing as well—already to 14 after Q3 2012 after only 10 YE 2011. At their last industry trade show, the company said they had “leads for 6 new grocery distributors and 30 chains representing 3,134 units”
      • Growth has been accelerating, not decelerating. Through only three quarters of the year, NROM had signed 411 grocery stores this year.  That puts them on pace for 548 this year, well above my run-rate estimate going forward
      • Independent channel check: spoke with a grocery distributor who confirmed that NROM is doing very well with grocery store traction and he expects continued success.
        • Conclusion: 400 grocery stores per year should be manageable for the next five years
  • Individual Take N Bake Franchises
    • Can they get to 40 stores by 2017?
      • Company already has two in existence and six more in agreements for 2012.
      • The take n bake concept has already been proven viable by Papa Murphy’s and NROM is in an ideal position to enter the market
        • NROM franchises are much cheaper to start (~80K) vs. Papa Murphy’s (250-275K) and early indications hint at similar economics
        • CEO has stated he thinks they can get 50 by 2013. This is probably too aggressive (but wow if he is right this would rerate fast), but they are in talks with larger franchise operators to open many units (20+)
        • Conclusion: The Take N Bake market is growing (Papa Murphy’s plans to open 100+ stores in 2013). NROM is the only other real player in the market now (and the large players don’t want to participate), and if their new stores show continued success, they should be able to quickly grow given Papa Murphy’s is 3X as expensive to open. This is admittedly the hardest segment to value, but at the current market price, it is more of a free call option than anything else. You can value this at zero and the stock is still a big winner.

Concluding Thoughts

You can certainly argue on the margins with some of my assumptions: perhaps NROM falls short of adding 400 grocery stores per year, the non-traditional location segment has a small decline, the take n bake franchise concept does not take off, and operating expenses slightly increase. However, at a price of $0.77, representing just above book value, these segments can underperform my expectations and I can still have a very profitable investment given the huge margin of safety. I think the market has ignored this stock and that early investors that jump on this story and have the patience to let it develop will end up with very satisfactory returns. I peg fair value from $2-$6, an admittedly wide range given the potential in the take n bake market. Even the low end of the range represents over 200% upside from the current price.

Why This Opportunity Might Exist

  • $15 mm market cap—under the radar of almost all institutional investors
    • Also zero write-ups on SZ or VIC
    • Trades for less than $1
    • Many shareholders have “puked” this stock out after its precipitous decline from over $7 in 2007
    • Multiple business changes over time have confused and caused doubt to investors


  • Management is paid handsomely for such a small company (but they also own lots of stock)
  • CEO is on the older side and plays an important role in the company
  • Capital allocation—this is always a risk in a business that does not need a lot of investment. I feel the risk is small here though (but still exists) because management has indicated they will use cash flow to pay down debt, and then initiate a dividend

Other Reading


Schuff International (SHFK): Cheap, Ugly, and a Potential Multi-Bagger

Fellow blogger Nate Tobik recently had a great write-up on Schuff Steel calling it a potential 10-bagger. I really respect Nate and enjoyed the write-up, so I decided to take a deep dive into the company:

Investment Overview

Schuff International is cheap at less than half of book value, ugly as a cyclical and highly levered construction company, and a potential multi-bagger with the continued recovery in construction spending. While casual onlookers of the stock may view it as extremely risky— high debt load, big debt maturity in 2013, and a nano-cap with limited disclosure, this risk is misunderstood, creating an extraordinary cheap stock for current investors. The company’s management seems to agree—having retired over half of the shares in the past year at a huge discount to book value.  I believe the stock is a great risk/reward at current levels and is conservatively worth ~$20, nearly a double from current prices.

Key Metrics

  • Market Cap: $42.5, EV: $90.69M
  • Price/Book: 0.48
  • Price/Sales: 0.11
  • EV/EBITDA: 6.85
  • Quarterly Revenue Growth: 77.20%
  • Debt/EBITDA: 4.22
  • Altman Z-Score: 2.82 (within the safe zone)

Business Overview

Schuff International is the largest steel fabricator/erector in the United States. For those unfamiliar with industry, this essentially means that they take steel and alter it to fit the needs of a particular construction project. This is a very fragmented industry because it is very costly to ship large amounts of extremely heavy steel, which is why a $45 mm mkt cap company can be the largest player in the U.S. Schuff operates in Arizona (company headquarters are in Phoenix), Florida, Georgia, Texas, Kansas, California and the New York City area. They typically are paid with a “cost-plus” model and do not have significant customer concentration risk with their largest customer representing 11% of sales in 2011 and no other customers over 10%.

This business is very cyclical, but should be profitable throughout an entire cycle. For example, as recently as 2008, the company made over $97 mm in EBITDA, greater than twice their market cap, and $57 mm in net income. However, the 2008 crash really hurt construction and their latest annual EBITDA and net income is $13.2 mm and ($5 mm) respectively. With such a cyclical industry, investors have seemingly been scared by the company’s high debt load and sold the stock from its $35 high to just over $10, which represents half of book value.

I believe this massive sell-off is undeserved for three reasons:

1) While the company is certainly cyclical, it is also very profitable

From “trough to trough” in the construction market (2003-2011, see chart below), the company’s average unlevered FCF was $20.48 mm, which makes the normalized FCF yield over 22%. Furthermore, the company’s costs are highly variable, which allows them to cut employees and close plants during tougher times in the construction market and thereby avoid disaster years. The company has not had a single year of negative EBIT since 1995 (as far as my data goes back).

2) The cyclicality is somewhat predictable and is currently near a trough

Using national data from the Census Bureau on construction spending, I developed a regression model to forecast Schuff’s quarterly EBITDA. Inputs: Nonresidential Construction Spending and Total Construction Spending. This model is actually very effective in explaining SHFK’s quarterly EBITDA with an R squared of .84

Key Takeaway: Schuff’s quarterly success is so cyclically-based that it is possible to predict their EBITDA using only “national” data suggesting their cyclicality is simply a product of the industry, which should snap back, rather than company specific downturns.

While SHFK has zero analysts covering the stock, is extremely illiquid, and does not offer annual guidance, one can use the model above to predict their EBITDA based on readily available estimates for national construction data. As seen below, analysts are predicting a strong rebound in Nonresidential construction growth in 2012 and 2013.

Below, I include the same model, but it includes a two year projection for EBITDA based on the consensus estimates for national construction data.

3) The EBITDA prediction model, the company’s incredibly aggressive buyback, and the company’s recent moves suggest its debt is manageable and shares are deeply undervalued

The company has nearly $56 mm in debt, which represents over 4X EBITDA. This is a large amount for a cyclical company, leading some people to believe bankruptcy is possible.

Aggregate debt maturities are as follows:

2012: $26,413,000

2013: $4,000,000

2014: $5,000,000

2015: $19,000,000

2016: $1,410,000

First, realize that the debt repayment schedule is somewhat unusual given its lumpy nature. SHFK has over $7 mm in cash on the balance sheet and the EBITDA model predicts $22 mm and $32 mm in 2012 and 2013 respectively, which would be more than adequate to cover debt requirements.

Perhaps even more importantly, the company’s revenue is also tied to a small number of contracts, giving the company much more visibility into future revenue than any investor, especially since the company only files results once per year.

This is why it is so incredibly significant that the company took on MORE debt last year in order to retire 57% of their shares outstanding at less than book value!

Why would management, which owns the majority of the stock, do this if they were worried about their interest payment one year from now? They would be sued, perhaps file bankruptcy, and have their family name and business tarnished.

President and CEO Scott A. Schuff had this to say about the buyback:

“By completing this transaction, we are taking advantage of a unique opportunity to enhance stockholder value while demonstrating confidence in the long-term outlook for our business…Every Schuff International stockholder now owns a greater percentage of the company by a factor of nearly 2.5. The reduction of the total outstanding shares as a result of this repurchase implies a greater share value for the holdings of our stockholders. We believe that the commercial construction market is at or near the bottom, and we are confident that our strategic vision and the disciplined cost controls we instituted nearly two years ago are allowing us to capitalize more quickly on new projects we see in the pipeline”

Also providing further credence to this idea of a bottom, the company recently re-opened their Orlando plant citing demand in 2013:

“We are seeing signs of increased market activity and plan on re-opening our Orlando plant in the first half of 2013,” said Ryan Schuff, President and CEO of Schuff Steel. “We have also centralized our Southeast operations and revamped our executive management team by adding and transferring some key employees to our newly renovated Orlando office.”

Furthermore, the company has an Altman Z-Score of 2.82, suggesting bankruptcy is very unlikely:

Altman Z-Score: 2.82 (within the safe zone)

  • Formula for predicting bankruptcy
    • Z > 2.6 (“Safe” zone)
    • 1.1<Z<2.6 (“Grey” zone)
    • Z<1.1 (“Distress” zone)

Finally, the company’s balance sheet should protect them from any downturn, making their debt load much less of a concern. Trading below tangible book value, with over $60 mm of that book value in land and buildings is pretty reasonable.

Therefore, while the debt load is a risk and something to watch, everything I have examined suggests it is manageable.

If this sell-off is unwarranted, how much are shares worth?

Valuation Method #1—Value based on mid-cycle FCF

-Note that 2003-2011 was chosen because it represents the last “cycle” from trough to trough (in chart above).

2003-2011 Average Unlevered FCF  $20.48
Discount Rate 15%
Earnings Power Value  $136.51
Value of Debt $55.82
Equity Value  $80.69
Total Shares Outstanding 4.15
Value/share  $19.44
Current Value/share  $10.25
Premium 90%

Valuation Method #2—Value based on mid-cycle earnings

  • From 2003-2011, average net income = $19.2 mm
  • I believe 5-10X earnings is reasonable for a mid-cycle cyclical company
  • Implied valuation: $23- $46/share, 128%-356% upside


  • Management interests may not be aligned with minority shareholders.
    • The family may be trying to take the company private, and in doing so, may be deliberately trying to lower the share price by performing their own LBO
    • Should the company default on all of its debt within a year or two, lawsuits would definitely be filed and shareholders would have strong claims
  • The Schuff Family offered a lowball takeout price in 2006 that was rejected.
  • Very illiquid (Average daily volume 1,600)
  • As a OTC stock, files financial reports only once/year


  • Company is deeply undervalued at .4x book value, 2.2X mid-cycle earnings, and 4.5X EV/ Normalized FCF.
  • Industry is very cyclical (currently near trough) with construction spending projected to grow dramatically. This cyclical company should not trade at trough multiples at trough earnings
  • Management, who is most knowledgeable about the financials, was incredibly aggressive using debt to buy-back stock at a large premium to the current price, indicating how undervalued they consider current shares.
  • The company represents a compelling risk/reward and is conservatively worth ~$20

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.

Harvard vs. Einhorn: Chipotle Mexican Grill (CMG)

On September 24th-25th, I traveled to Ithaca, New York with two Harvard classmates, Linxi Wu and Jared Sleeper, to compete in the Cornell Undergraduate Stock Competition.

The Rules: There were six teams total, each comprised of three members. Teams from Harvard (us), Wharton, Cornell, MIT, Columbia, and Dartmouth were represented.

One week before the competition, we were given the stocks to analyze. For the first round, everyone had to analyze Chipotle (CMG). You could recommend a buy, hold, or short. Presentation time was 10 minutes with 5 minutes of Q&A from the judges from Fidelity and Putnam Investments. Three of the six teams would be selected to compete in the final round where each team was given a choice among four education stocks: DV, COCO, APOL, and BPI.

Our CMG pitch earned us a spot in the final round along with the teams from Wharton and Cornell. Our pitch on DV earned us first place overall in the competition with Wharton in 2nd and Cornell in 3rd.

I went in thinking we would probably go short CMG. After all, it’s a restaurant stock at 20X EBITDA and 40X earnings.. cmon right?! The inner value investor in me cringed at that type of valuation. However, as we really dug in every night and tried to understand the business and build out our valuation model, I really came away much more bullish on CMG with a price target of $406.50 (~45% undervalued).

Recently (and after our pitch), David Einhorn came out recommending a short of Chipotle based primarily on increasing competition from Taco Bell combined with its high valuation. Einhorn is one of my favorite investors (if not my favorite), but I was very surprised by his pitch. It honestly seemed so much less sophisticated than his excellent short call on Green Mountain Coffee (GMCR).

The GMCR short pitch was a 100+ page PowerPoint presentation focused on accounting issues that other investors were not properly accounting for. The CMG pitch is just: high valuation + increased competition from Taco Bell? Really?

High Valuation: I also thought 20X EBITDA was way too expensive… until I really dug into the numbers. CMG is less than halfway to reaching U.S. market saturation and I think they are likely to grow into their valuation over time. As you can see in the presentation and the model assumptions, 20X EBITDA is not always expensive. As we point out in our presentation, CMG was trading at an even higher P/E ration in 2006 (44.5X) and has returned 37.6% annually, crushing the market. Just looking at a single metric just doesn’t cut it for such a high growth company.

Taco Bell and their new Cantina Menu: Taco Bell has been around for decades and they are just now putting their emphasis on the Cantina Menu. Why? Because it’s not that great of an idea! If it was such an easy sell and market opportunity for them, this would have come out years ago. While it may have some success, I don’t think anyone is going to start confusing Taco Bell for Chipotle. When we analyzed this issue, we likened this to McDonald’s rolling out their McCafe coffee. Sure some people buy their coffee now from McDonald’s, but this has not cannibalized SBUX or their long-term prospects.

Here is the PowerPoint presentation for CMG:

I am a special situations oriented value investor, so high growth stocks like Chipotle normally don’t find a place in my portfolio. That being said, if I had to go long or short, I’d go long from these levels and I think going short is way too risky. Shorting a strong business is a loser’s game in my opinion. Even if you are right (which I don’t think Einhorn is here), momentum can kill you. Should be interesting to see how this plays out.

Here is the PowerPoint presentation for DV (there will be a separate post later).

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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.

Screening 100 Microcaps: Two that Missed the Cut

I mentioned in my last post that I recently went through ~100 microcaps. Before I get into the results, I want to briefly summarize some thoughts I have recently had about stock screens.

While many investors do stock screens, I think it is very important to always screen for a purpose. It is not enough to just enter the “perfect” screening criteria for stocks– high revenue growth, high ROE, low PE, etc.. Once you start entering too many criteria, you start generating results that look very cheap quantitatively, but often are cheap for a reason.

I prefer to screen for a purpose. Screen for a particular type of result, then search for something among those results. This allows you to really focus on what you are looking for (again, this comes down to having a clear investment philosophy and sticking to it – see my post on risk and eliminating investing mistakes).

Sometimes I screen for insider buying– often these stocks will look horrible, but if I can find a reason why an insider is buying a significant amount of stock before the market catches on, maybe I can get an edge. For example, in my recent screen for insider buying, I found that after a steep stock decline, nine insiders bought Kemet (KEM) stock in May 2012 for a total of $430 K:

I don’t know much about capacitors (their main product), but a screen like this might make me want to find out more (and if you happen to know anything about them or the stock, please comment on the post!).

Sometimes I screen for beaten down companies with lots of pessimism priced into the stock (crazy cheap valuations). Then I search for something positive. I start asking, “Is the market being overly pessimistic with this company/industry/sector?” Are there emotional sellers? This recently led me into the for profit education space, where I believe some stocks, such as Career Education (CECO), have been punished too hard by the market (this may be the subject of a future post). Lisa Rapuano of Lane Five Capital agrees.

Sometimes, like last weekend, I am screening for high quality companies that may be under the radar or underappreciated by the market. In this particular case, I was looking for microcap companies with greater than 15% ROE and greater than 20% ROC in the last twelve months with reasonable capital structures (I hate debt) that were within my circle of competence. While a plethora of these 100 stocks were really interesting, many of them were outside of my circle of competence, and I ultimately determined that only six of them were worth a deep dive. Of these six, I found that three were particularly interesting to me as an investor.

1) The stock that actually had me most intrigued was called Groupe Athena (OTCPK: GATA). The company claims to be a consulting company that helps Indian medical companies obtain FDA approval for their devices/ pharmaceuticals for sale in the U.S. This seemed like a pretty interesting niche—certainly a simple business model I could understand. Here were my initial notes:

Groupe Athena (OTCPK: GATA)

  • $6.6 mm mkt cap, $3.1 mm EV
  • 0.5X EBITDA, 1.6X P/E, 0.7X TBV
  • Revenues grown 100% yoy the past two years, ttm EBIT is $4.9 mm
  • Higher than I would expect capex has led to negative FCF
  • They provide testing and regulatory consulting services to help Indian and Southeast Asian medical companies obtain regulatory approval and facilitate exports of pharmaceuticals to the U.S.
  • Based in Mumbai, India


  • Number of customers?
  • Capex?/machinery?
  • Auditors?
  • Stock Split, dividend, buybacks?, increased IR?

You don’t find too many consulting businesses growing revenue 100% yoy two years in a row at .5X EBITDA and half the market cap in cash. With a $6.6 mm mkt cap, it was definitely worth doing more digging because at this point, I just wanted to find out if it was a fraud. With those metrics, if it wasn’t a fraud, it was likely to be a multi-bagger.

I contacted management of the company and they got back to me rather quickly. I started to ask many questions—about their auditor, their customers, their management, their buyback strategy, increased IR etc. As my questions became more detailed, however, they stopped answering some of my questions. For example, they claimed one of their managers worked at Johnson and Johnson for 12 years. This was a pretty important fact to me—this is something that could be verified and if someone left a reputable job at J&J after a decade, starting a small-time fraud in India seems unlikely.

However, when I followed up and asked who worked at J&J for 12 years, he said, “the name you are looking for is Ms. Pooja Rajpurohit.” However, this person graduated from Rutgers in 2007 and therefore could not have worked at J&J for 12 years.

Other red flags:

  • I could find no information surrounding Allianz Atlantis Partners, their largest and founding investor, who has been selling stock aggressively lately
  • Their website includes generic pictures from around the web
  • The listed website and email address of the accounting firm listed on their financials did not work. They now have a new website with new contact information, but when I contacted them, they refused to answer whether they were the auditor for any other publicly traded companies

I could go on and on as I studied this for a better part of a week, but I was very disappointed with the conclusions from my digging: they are most likely a fraud, and certainly something I am not comfortable investing in. While these are my initial takeaways, I am certainly open to continuing a dialogue with management if they continue to do so and are willing to answer all of my questions with clear responses.

This is just part of microcap investing. You have to do your due diligence and occasionally you will find a gem that is truly under the radar.

2) The second stock I found interesting was  Vapor Corporation– (VPCO). Here were my initial notes:

  • $12 mm mkt cap, EV
  • 0.6X Revenue
  • Vapor Corporation designs, markets, and distributes electronic cigarettes in the United States. The company’s electronic cigarettes are battery-powered products that enable users to inhale nicotine vapor without smoke, tar, ash, or carbon monoxide
    • Very interesting, potentially lucrative market
  • Company has grown revenues tremendously over last few years. In 2008, they had less than $1 mm in revenue, but in ttm, nearly $20 mm
  • Company has never been profitable, but could on the verge of profitability with increased scale. There is also very little volume—would be difficult to establish a meaningful position
  • Insiders own 51% of stock

I liked a lot about this company: extremely high revenue growth, interesting (and addictive) market, and very much under the radar. However, the company has never generated FCF and I see very little long-term competitive advantages. It is unclear to me how the electronic cigarette market will unfold and even if it does take off I am not confident they will capture the economics. Ultimately, this is a company I will keep on my watch list. If they are able to continue to grow top line, but somehow build their brand and improve margins, then maybe it will be worth another look. With no evidence to suggest a competitive advantage, no meaningful FCF, and an uncertain business environment for their products, I’m not sure the stock deserves to trade much higher than its “cheap” revenue multiple. This could change, but it does not quite look like a “no-brainer” to me.

It’s getting late and this post is already getting long. There are two stocks that did make the cut that I will write about hopefully tomorrow, but I feel they deserve their own post. Don’t forget to subscribe to my blog and follow me on Twitter to make sure you don’t miss the next update.


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.

The Variant View: Reading International (RDI)


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.