Four Stocks to Fit in a Basket of Negative Enterprise Value with Certain Profitability: GENC, ABAT, TRGT, TSRI

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Dec 23, 2011
There is a wide variety of strategies in value investing, based on the three pillars which Benjamin Graham has described: Mr. Market, Circle of Competence and Margin of Safety. It can be net-net positions, where the stock is trading less than the liquidation value. It can be based on the relative multiples valuation compared to peers, which Buffett called “Generals: Relatively Undervalued" when he was running his partnership. It also can be investing in the great moat businesses at fair value, etc. Generally, it can be divided into buying into the businesses which selling for less than either (1) asset value or (2) earning power.


As earning power is very hard to define, and it depends on the predictability of the business as well as the moat around that, not many investors can pick a great business without spending a lot of time doing the “scuttlebutt approach” which can help them really understand the good side, the bad side and the unbeatable side of any businesses. That is why it seems to me that many Buffett wannabes will start out picking cheap quantitative stocks and get some diversification.


The key concept “Buying a stock is like buying a piece of the business,” means you, as the purchaser of the business, have to bear all the liabilities the business has, and can use all the cash and assets it has on hand. So we have the definition of “negative enterprise value,” meaning that the buyer theoretically gets paid to purchase the business. I wrote a piece on the basics of enterprise value or market capitalization, and which one investors should choose.


Normally negative enterprise value businesses are not very profitable businesses. So a basket of negative enterprise value businesses along with profitability can make a good portfolio. Currently, I have found four stocks that match the screen of negative enterprise value with a certain level of profitability.


Genco Industries (GENC, Financial): This stock has been mentioned several times on GuruFocus, and I personally had written on it in the article, “Genco Industries: $15 Million in Cash and the Company for Free.” GENC is the leading manufacturer of heavy machinery used in the production of highway construction materials, synthetic fuels and environmental control equipment. The company has two manufacturing sites, one in the U.S. and one in the UK. It is quite profitable, experiencing a loss in only one out of ten years. Currently the enterprise value is -$28.2 million, with the net margin of 13.2%.


Advanced Battery Technologies (ABAT, Financial) is a company which develops, manufactures and distributes rechargeable PLI battery cells using lithium cobalt oxide anodes. The products are used in electric vehicles, mine lamps, walkie-talkies and consumer electronics. The manufacturing site of the company in Harbin, China and administrative office is based in New York. Although with the market capitalization is $42 million, but with the cash level of $74 million and debt-free, the enterprise value is -$32 million. ABAT, since 2006 got positive growing net income, from just $6 million in 2006 to $37 million in 2010. The return on equity for the past 05 years has been mainly in the north of 20%, no single year is under 20% level.


Another candidate is involved in pharmaceuticals, which relies on the medicine research and development of neuronal nicotinic receptor for the treatment of nervous system. The company is called Targacept (TRGT, Financial), and it has been also mentioned quite a number of times in our site as well. It got $213 million in cash and cash equivalent, $4 million in debt and now around $180 million market capitalization. So the enterprise value of Targacept reached -$37 million. The profitability is on and off, it just got $11 million profit in 2010, generating operating cash flow for that year of $138 million. The stock just got bought up to 16% of the company by one of our gurus, Seth Klarman. Readers can read further at my previous post on Targacept position.


Last but not least, TSR Inc. (TSRI, Financial) is in the business of providing contract computer programming services to its clients. The company supply technical computer personnel to companies to supplement the in-house staff IT of the clients. Net cash and short-term investment reached more than $8 million, approximates the market capitalization, and the company’s debt free. So the enterprise value is close to zero. However, it can be in the portfolio of negative enterprise value because of the consistent 10 year even low but positive net profit.


This is the subjective viewpoint of the author, and it is not the recommendation to buy, hold or sell the stocks mentioned in this analysis. Anyone who wishes to buy, hold or sell the stocks has to do his/her own analysis at his/her own risk.