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ALCS Interesting with Activists In Play

June 24, 2013
whopper investments

whopper investments

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Upfront note: I wrote this analysis on May 15th. Since that time, the share price has risen a bit, and the company reported quarterly results. Overall, however, nothing has really changed. However, I still do not have an investment in the stock.

ALCO (ALCS) is the renamed version of a stock I’ve followed for a long time, Duckwall. I will say this: the fact the company lost their awesome DUCK ticker is almost enough to make it an immediate pass for me.

All kidding aside, I’ve followed the company for a long time and always avoided investing them. Here’s a quote from the last time I wrote them up that illustrates why I had avoided buying them

I know what you’re thinking- another profitable net-net? Hooray, those things are awesome!!! Plus, this one has a niche!!! Buy buy buy!! Not so fast, hombre. The problem with DUCK is it likely deserves to trade as a net net permanently. They company may have a niche, but it’s a really unprofitable one with no moat (maybe even a negative moat). The company’s return on capital is horrendous, and until they show a willingness to improve returns and reduce invested assets by liquidating inventory, the company is destroying value simply by staying in business. The other problem is that the retailing business is, by its nature, inventory intensive, and if they cut down on inventory they may kill the business (actually, maybe that would be a good thing for shareholders!!!). Unless they can do SOMETHING to improve profitability, you’ll be investing in a company that can grow equity value somewhere between two to four percent per year. While that may sound nice, trading at about half of book value, that would translate into a return of 4 to 8% per year for an investor at today’s prices. Unless you can buy them whole and liquidate everything, I’d stay away from this one!
However, two things have recently happened that have made me think shareholders may be about to see a big value boost.

First, this 13-D was filled on them, and it contained this line

In October 2012, the Reporting Persons contacted the Issuer to discuss strategic opportunities and the Reporting Persons’ possible investment in the Issuer. On January 22, 2013, the Reporting Persons submitted a formal written offer to the Issuer for either the Reporting Person’s acquisition of the Issuer or a strategic partnership between the parties. On May 3, 2013, the Reporting Persons contacted the Issuer to request a meeting with management and the board of directors of the Issuer to express views regarding the Issuer’s performance, prospects and operating strategy. There is no meeting planned as of the date of this Schedule 13D.
The company promptly responded by announcing same store sales for the first quarter were slightly down, driven by bad weather. O, and they also established a shareholders rights plan. I can’t tell you how much I hate those things, and it certainly does put a bit of a damper on the whole situation. Still, make no mistake: that 13-D puts the company in play.

Perhaps more importantly, however, is that the company bought back over 600k shares last year. The company started the year out with 3.8m shares outstanding, so that 600k buyback is impressive in and of itself. However, the company’s book value at the start of the year was over $27 and their average repurchase price was a bit over $7. By my calculations, their share repurchase added roughly $3.75 to book value. That’s a return on equity of over 15% if you consider that gain income!

I mentioned in my quote at the beginning of the article that shareholders may be better served simply liquidating the company than actually operating it. Share repurchases done at this level are actually the best of both worlds: they serve as a semi-liquidating payment while allowing the business to continue operating. What surprised me so much about these payments were how unexpected they were: insiders own basically no stock, so their incentives are normally aligned towards keeping capital at the business unit level so they can grow the company and their salaries. In many ways, it was actually against insiders’ interest to purchase shares, as their bonuses are based on ROE and share repurchase done this far below book drive book value way up, which increases equity and thus reduces ROE and insiders’ potential bonuses.

The way I see it, the merger offer is interesting, but the share repurchase is what really makes the investment interesting. There’s also plenty of asset protection here- NCAV comes in around $15, and book value is over $30.

There are certainly downsides here. The company’s not exactly cheap on an earnings basis: trailing P/E from continuing ops is roughly 20x, and investing in this company is very “catalyst” dependent. I don’t mean that you need a sale or something to do well here. What I mean is that if the company doesn’t return capital in some way, be it through share buybacks, dividends, or an outright sale of the business, the investment is going to do pretty poorly. There’s so much asset protection here that capital impairment is unlikely, but having the stock price go no where is a real possibility.

There’s another downside here: even though management has been returning capital and buying back shares despite the fact it’s probably against their own incentives, it was mainly through one big block repurchase, which suggests they might have done it just to keep a huge block from hitting and distorting the market versus actually thinking about shareholder value. And they can still think of plenty of ways to waste shareholder money: the company decided to drop $2m to move headquarters from the middle of no where to Dallas. Why? I think the start of this question from conference call summed it up perfectly:

And so to spend $2 million to $2.5 million to relocate to a major metro, although I’m sure that makes life easier for alot of people and build out finance department and things like that. Why now? To do something like that, I mean, what changed?
Overall, though, I think the reward outweighs the risk. This is pretty much a simple netnet with tons of assets that simply has a few nice kickers in the form of the possibility of more share buybacks or a potential acquisition. Maybe management does nothing and the stock goes no where for a few years. Maybe a buyer takes them out for a premium in the next six months, or multiple activists get involved and force management to focus on share repurchases. Maybe the board wises up and brings back the DUCK ticker. Who knows? All I know is the asset protection makes me feel comfortable waiting.

Disclosure: no position as I write this May 15th, but have a few limit orders out to buy shares.

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Rating: 2.0/5 (5 votes)

Comments

chihin
Chihin - 1 year ago


Not sure about your logic regarding "share repurchase done this far below book drive book value way up". Doesn't share repurchase results in the reduction of shareholders' equity, thereby increasing ROE instead (assuming net profit remains the same)?

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