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Sold PRLS. A Net Net that Worked Out in One Year.

September 04, 2014 | About:
I don’t write lengthy posts about the stocks that I own as much as I used to, simply because it allows bias to creep in.

It’s much easier to stay objective and execute when you don’t publicly put your ideas out every single time and then have to “defend” yourself.

Take a look at HLF.

I strongly believe that things would have been different if Ackman chose to do things quietly. (I own HLF by the way.)

Even with my Whole Foods Market position, I enjoy hearing the opposite stories and negativity making the rounds. But the questions and comments I get are phrased in such a way that it makes it seem like I’m defending myself.

Looking right isn’t important because even the best investors are correct only 55% of the time.



But the market is full of testosterone.

It’s more important to have bragging rights than a right plan.

And PRLS is not a stock that goes well with the fist bumping group.

A company with no future.

Nothing but cash.

A net net.

“Loser”.

But because I highlighted PRLS a year ago, I want to close out PRLS with an update.

Here’s a vain screenshot of what it did today.

Vanity Performance Chart

Vanity Performance Chart

But the truth is that PRLS did nothing for my entire holding duration until today.

PRLS vs SPY

PRLS vs SPY During Holding Period

That’s the way net nets work.

They do nothing for a year, two years or three years, and then suddenly spike on a single piece of positive news.



(A) Surprises, as a group, improve the performance of out-of-favor stocks, while impairing the performance of favorites.

(B) Positive surprises result in major appreciation for out-of-favor stocks, while having minimal impact on favorites.

(C) Negative surprises result in major drops in the price of favorites, while having virtually no impact on out-of-favor stocks.

(D) The effect of an earnings surprise continues for an extended pe­riod of time.
David Dreman (Trades, Portfolio)



Net nets go from being extremely illiquid to extremely liquid.

Take a look at this example of IFON this year.

How Net Nets React

How Net Nets Quickly Become Liquid

The essence of investing in net nets is for downside protection, and IF good news comes out, it tears the roof off.

Sounds contradictory right?

How can I claim that buying a business that makes no money with no future is protecting the downside?

Well, that’s why there are so few net net investors around.

It’s goes against conventional wisdom and it’s so simple that it’s hard to believe.

It’s not popular to be holding onto such ridiculous stocks.

The testosterone in the market wants to be all in TSLA or the next breakthrough drug.

Something cool.

Sexy.

Not in ugly stocks like net nets.

Buying is Less Than One Half of the Equation

There many rules and advice on selling stocks and it’s been covered a lot already at old school value.

Mostly because I view selling as more difficult than selling.

Some say that buying is only half of the equation.

The mathematician in me says that it’s really one third of the equation.

The other one third is keeping up with the company.

The remaining one third is selling because there is a lot of temptation and bias to continue holding for that “extra” profit.

After all, what goes up, must continue to go up further right?

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Initial Thesis Revisited

Let’s go back to the original reason for Peerless Systems and analyze it again with the benefit of hindsight.

Positive Aspects

  • Generates positive free cash flow
  • Has 90% margins
  • No debt
  • Buying backs shares like there is no tomorrow
  • Trades at less than its NCAV
  • CEO was previously a value fund manager and owns 20%
Negative Aspects

  • Its licensing business will wind down sooner than later resulting in no revenues
  • Looking to change the business into a closed end investment management (this information in the filings is incorrect)
  • Investment in a public micro cap not working out well
  • High CEO compensation
It was trading at 12% below NNWC, and 18% below NCAV. Not a huge upside. Net net’s are supposed to offer 100-300% upside.

But here’s what really happened during the year I held PRLS.

  • revenues increased as their current customers paid a higher price for the cost of a license
  • cash balance grew
  • and shares were continually gobbled up
Share count went from 13.2m in 2011 to its current 2.7m.

I’ve never seen a company be so aggressive with buy backs.

My intrinsic value ranges were

  • Low value: $4.58
  • Mid value: $4.84
  • High value: $5
Peerless Systems Today

Without doing anything, PRLS was worth in the mid $4 to $5.

But with news of their majority stake in Deer Valley Corp, the numbers become less clear.

But good news is good news and the stock jumped. Refer to David Dreman (Trades, Portfolio)’s rule (A) and (B) above.



Deer Valley Corp designs and manufactures factory built homes, provides dealer inventory-secured financing for its factory built homes and provides warranty and repair services for its factory built homes.



I don’t know what the future will bring for PRLS. I was just waiting for PRLS to do something with its cash to unlock some sort of value.

And they finally did.

I’m no real estate expert but I do know that home manufacturers are very cyclical and require macro tail winds to do well.

Something that I don’t want to bet on.

Before the next filing is released, here’s the current status from the NetNet section of the OSV Analyzer.

Net Net Calculation Today

Net Net Calculation Today (source) | Enlarge

And with the stock price hitting my NCAV price target, it was an easy decision to sell.

PRLS Net Net Status Today

PRLS Net Net Status Today

It’s on the lower end of my initial valuation, but I’d rather take profits now than to hold on for another 10-15% of gains in a small position.

Ultimately, I bought a net net with a lower ceiling compared to other net nets, but the downside was very well protected.



Protect the downside and the upside will take care of itself.
Seth Klarman (Trades, Portfolio)



Disclosure

No holdings

About the author:

Jae Jun
Founder of Old School Value (http://www.oldschoolvalue.com) dedicated to offering the most complete and detailed stock valuation and analysis spreadsheet. Investing made easy by importing 10 years of financials and 5 quarterly statements directly to excel for your analysis needs. Save time, make smarter decisions and make more money.

Visit Jae Jun's Website


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