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Why I Would Not Buy Net-Net Company Kent Financial Services

January 17, 2011 | About:
Greenbackd

guruek

80 followers
If value investing is about buying a one dollar bill with 40 cents, then mini-cap (is there such a word?) Kent Financial Services has it all: according to GuruFocus Benjamin Graham Net Current Asset Value Screener, the company is the selling at the deepest discount to its net current asset value, as defined by Father of Value Investing Ben Graham himself.

Currently, the company has 2.76 million shares outstanding; shares are selling at $1.45 per share, making its market cap about $4million. The company has $10.70 million in total asset, $10.60 million of that is in cash and equivalent. Total liability, short and long-term included, came in at $0.85 million. On per share basis, the book value stands at $3.57, most of that are in the form of cash (data source: GuruFocus).

Essentially, investors are paying $1.45 for $3.57 worth of cash, or, in another word, 40 cents for a dollar.

But wait! Before you place the order, check out these factors first:

1. This is the link to the website for Kent Financial Services, Inc. Although the home page shows a picture with five people, as you would see as you read on, that number overstated the total headcount for the company by 150%. As a matter o fact, the two names at the button of the page describe the total number of people working in the company more faithfully. They are Mr. Paul Koether (Chairman and CEO) and Bryan Healey (Chief Financial Officer).

2. My next stop in my “research” is the “About Us” tab of the company’s website. Small as it, Kent Financial Services is actually a holding company. The page is short, so I quote the whole thing, including the links:
Founded in 1955, Kent Financial Services Inc. ("KFS") provides administrative and financial consulting services to other companies and operates primarily through the following subsidiaries:

Kent International Holdings Inc. is a publicly traded company (stock symbol “KNTH.PK”) currently seeking to redeploy its assets into an operating business through an acquisition or merger. We intend to use its available working capital, capital stock, debt or a combination of these to effect a business combination with a target business which we believe has significant growth potential. The business combination may be with a financially stable, mature company or a company that is in its early stages of development or growth, which could include companies seeking to obtain capital and to improve their financial stability. We are not restricting our search to any particular industry

Additionally, Kent International has developed a niche social networking website, www.chinauspals.com, designed to promote cultural exchange between the citizens of the United States and those of the People’s Republic of China


3. Next stop, click on one of the two links to its subsidiaries www.chinauspals.com. I don’t about what your browser returns, but mine says:
Forbidden

You don't have permission to access / on this server.

Additionally, a 403 Forbidden error was encountered while trying to use an ErrorDocument to handle the request.


That is not good, how can “a niche social networking website” stay in business without being online?

4. Next check out the other subsidiary, Kent International Holdings Inc.. The link works and home page of this company says:
Kent International Holdings is a firm interested in acquisitions and/or reverse mergers of small to medium sized companies.
the page actually has a bit more information, but I had to be selective to keep you interested. You get the picture: the only operational subsidiary of Kent Financial Services is sitting there to buy a company or to be bought. Look further into the subsidiary if you want to buy the pink sheet company.

5. Let’s get back to Kent Financial Services website, and allow me to skip the two tabs labeled: “Management” (for we already know there are two people) and “Our Services” (for we know there are not many, even though the website says otherwise).

6. Let’s bring up the latest 10-Q in the "News Room", the one for the quarter ended on September 30, 2010. At the beginning of this article, I talked about it balance sheet items. A quick glance shows those numbers are correct. Indeed, KENT is selling at a discount of its net-net current asset.

7. Next I look at the Income Statement: For the three month ended on September 30, 2010, company achieved a total revenue of $8,886 (no zeros omitted, same below), incurred $159,729 in expenses. Factoring in other numbers that I do not have time to get into, for the quarter, the company lost $89,251 or $0.04 per share.

The nine months numbers are more representative to the state of the company: for the nine month ended on September 30, 2010, revenue was $27,023, expenses were $527,758, net loss was $360, 133, or $.14 per share.

8. The 2010 numbers do not look too promising, so let’s check out those for the previous years in the 2009 10-K. 2009 had a revenue of $45,633, expenses of $836,572, and a net loss of $530,593. 2008 had a revenue of $382,244, expenses of $837,018, and a net loss of $339,430. Whatever they did in 2008, they are not doing it anymore.

That is not very promising: we have a company that basically is doing nothing other than paying out salary and expenses.

9. I want to find out a bit more about the salary figures. Since they are only two people and they are executives of the company, so that is easy. It is disclosed in the the 2009 10-K (Page 25):
NOTE 7 – COMPENSATION CONTRACTS AND POST-EMPLOYMENT BENEFITS

Paul O. Koether’s employment agreement ("Agreement") pursuant to which Mr. Koether serves as the Company's Chairman is for a three year term at an annual salary of $240,000 ("Base Salary"); this term is automatically extended one day for each day elapsed after May 12, 2008. Mr. Koether may terminate his employment after a change of control for good reason in accordance with certain provisions of the Agreement, at which time he would be paid the greater of the (i) Base Salary payable under the Agreement through the expiration date of the Agreement or (ii) an amount equal to three times the average annual Base Salary paid to him during the preceding five years. In the event of Mr. Koether's death during the term of the Agreement, his beneficiary shall be paid a death benefit equal to three years Base Salary, payable in 36 equal monthly installments. Should Mr. Koether become "disabled" (as such term is defined in the Agreement) during the term of the Agreement and either long-term disability insurance is not provided by the Company or such policy does not provide an annual benefit to age 80 equal to 80% or more of Mr. Koether's Base Salary, he shall be paid an annual disability payment equal to 80% of his Base Salary in effect at the time of the disability. Such payments shall continue until Mr. Koether attains the age of 80.

Bryan P. Healey’s employment agreement (the “Healey Agreement”) pursuant to which Mr. Healey serves as the Company’s Chief Financial Officer is for a two year term at an annual salary of $140,000 (“HealeyBase Salary”), this term is automatically extended one day for each day elapsed after May 15, 2007. The

Healey Base Salary was increased to $156,000 annually effective January 1, 2008. In the event of Mr. Healey’s death during the term of the Healey Agreement, his beneficiary shall be paid a death benefit equal to his then current annual salary in equal monthly installments for the remainder of the term of the Healey Agreement. Should Mr. Healey become disabled during the term of the Healey Agreement, Mr. Healey shall be paid such benefits to which he is entitled under the terms of such long-term insurance as the Company has provided him or 80% of his salary for the remainder of the two year term of the Healey Agreement, whichever is greater, in accordance with his regular payment schedule.

The Company has accrued approximately $720,000 as of December 31, 2009 and 2008, for post employment benefits related to Mr. Koether’s contract. Accordingly, the Company charged approximately $35,471 to operations for post employment benefit accruals in 2008.
You can do the math, the company is committed to pay to Mr. Koether (Chairman and CEO) and Mr. Healey (CFO and Director) a total of $415,471 per year, live or dead (sorry, I don’t mean to be disrespectful). You also know that the $720,000 long term liability is for “post employment benefits related to Mr. Koether’s contract”.

10. It does not appear shareholders can do much about this heavy overhead. According to the 2009 10-K, as of February 26, 2010, all directors and officers as a group own 2,176,757 shares, or 59.22% of the company.

And Mr. Koether has been buying the stock in the open market, according to GuruFocus data, since the beginning of 2010, he has bought about 61,000 shares. In other word, Mr.Koether and his buddies have a firm grip of the company, making changing in the executive compensation scheme not likely.

In conclusion, while paying 40 cents for a dollar sounds like a good idea, in case for Kent Financial Services, there is very little incentive for the management and majority shareholders to return the one dollar to the shareholders. Prices reflecting on the full value may never come, while the company’s funds get distributed to the management in the form of compensation.

For this reason, I will avoid the company. So much for that idea!

Fortunately, there are 24 companies showing up in the GuruFocus Benjamin Graham Net Current Asset Value Screener, companies selling below net-net current asset value. Check it out.

Disclosure: No Position

About the author:

guruek
Greenbackd is a former corporate advisory and securities lawyer working in value-oriented activist funds management.

Rating: 4.2/5 (13 votes)

Comments

rob.will
Rob.will - 3 years ago
Great article, thanks for the insight. I think that it's also appropriate to mention another teaching of the Master, Ben Graham, which is to know the company that you are investing in. That no matter how cheap the prices, as measured by various quantitative and even qualitative factors, behind every stock certificate is a living breathing business. Some are frauds and very very bad businesses and some are very very good businesses warranting a long term holding(thats more fisher i think). A company like this could not even be a turn around situation due to the fact that management owns the majority of shares and continues to buy them. Some Mungerism here, their incentives are TOTALLY misaligned with ANY other shareholder except themselves. They are in my opinion 21st century robber barons (albeit on a minor scale), because they plunder the businesses coffers while making it seem as if they are conciliatory to other shareholders. Perhaps a reference to the SEC might be appropriate... oh wait, we don't want another David Einhorn or Harry Markopolos situation.

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