Jul 22 2016

Where to Exchange Money

By |July 22nd, 2016|Blog|0 Comments|

Euro_Series_Banknotes

They say specimen so you don’t try to print them off at home. It’s hard to see how anyone would get what your inkjet spits out confused with a bill, but there it is.

The best place to exchange money is inside your credit card.  Sometimes that’s not possible, in which case we’ve got a list of the rest of the places that you should exchange money.  Ultimately what you’re worried about here are fees.  There are plenty of people out there willing to sell you some story about how they know how to time currency transactions in order to save you money.  The financial world is full of superstitions like that, do your best to ignore it.  If anyone out there thinks I’m wrong I’d be happy to take a bet on the subject.

Credit Cards

Alright, now I’ve said it twice.  Just get one without a foreign transaction fee and call it a day.

High Yield Checking

There are a few high yield checking accounts out there.  The basic idea for these is that you jump through a few hoops and the checking account pays you an above market rate of interest (up to a specific balance) and will often reimburse ATM fees. I recommend Consumers credit union. The requirements usually involve using the debit card a dozen times in a month and setting up direct deposit.  The interest rate alone is generally worth it, but using it to change money from foreign ATM’s is the icing on the cake.  Whenever I need cash abroad I just get it from a random ATM, knowing I’ll be reimbursed.

Your Local Credit Union

You should probably be a member of your local credit union.  In principle the profits from the credit union flow to you rather than to shareholders.  Generally this means that all kinds of things are cheaper at the credit union.  Of course because they don’t have to look after their profits sometimes bureaucracy can get a stranglehold on your credit union and the fee schedule might not make any sense from any perspective, so it pays to check that your credit union is actually giving you a good deal.

What’s a good deal? Whatever google tells you the exchange rate is, basically.

Also, as a bonus your credit union may eventually convert to a bank, in which case you’ll have an opportunity to make money in its conversion.  (You see, the owners of the credit union are its customers, when it converts to a bank it will be owned by shareholders.  To convince current owners, that’s you, to do the conversion the credit union needs to offer you something valuable.  Usually, that means you can purchase stock at a discount.  That’s a fantastic deal.  Your credit union probably won’t do this, but it’s essentially random upside. )

Your Local Bank

Usually you can order foreign currency, online or by phone, in advance from your bank and get a good rate with a minimal fee.  If you show up at the teller demanding Euros you’ll probably get a rate that’s not quite as good.

Their Local Bank

It’s not going to be a great deal to do this, and I’d anticipate it to be somewhat worse than your local bank, but your mileage may vary.  (That’s what YMMV means if you ever see it on line.  That’s one I have to look all the time.  That and TFW, or SMH.)

(That feel when, and shaking my head, respectively)

(I can’t imagine saying either of those things so often that you’d need to abbreviate them, but TYHI.)

(There you have it; That one’s not real but what are you going to do?)

Buy Euros From American’s leaving the country

They need to get rid of their foreign currency, you need the foreign currency.  You can probably get the fair rate, since either of you are going to get screwed at your destination.
Cash Exchange

These places exist mostly in tourist spots.  They’re pretty universally awful, only use in an emergency.  Alternatively, send your enemies there.

Don’t have enemies?  You will if you send people here to change their money.

Cash Exchange at the airport

This is good for when all of your foreign currency gets stolen, as well as your atm card, but you still have a roll of $100’s in your sock.  Change just enough to get you to the nearest bank, or some other place that will repair your problem.  Even then you might be better off begging other american’s for bus fare, or hanging out near the forex place looking for people who look like they’re departing the country.

 

Jul 19 2016

Fortune Industries (FDVF)

By |July 19th, 2016|Stocks|0 Comments|

This is what I imagine it felt like to be a fortune shareholder.

This is what I imagine it felt like to be a Fortune shareholder.

Fortune industries is a Human Resources company.  Basically small to medium sized companies outsource their human resources department to Fortune. Why talk about them? Fortune Industries is the cheapest company I know of on an earnings basis (excepting cases where the business is obviously in sharp decline, like Outerwall). I’m sure there are cheaper companies out there, but Fortune has a special history.

What happened at Fortune

The CEO of Fortune Industries had some money trouble back when it traded under the ticker FFI.  He had put up his shares in FFI against a personal loan.  Unfortunately, he couldn’t pay that loan and it looked like the bank was going to foreclose on the shares.  The company didn’t want to be majority owned by some random bank, so they sprang into action.  Management formed another company CEP, and used this company to do a buyout of Fortune Industries.

Long story short, somehow, the number of shares outstanding went from about 12 million to 55 million, existing shareholders were substantially diluted. As far as I can tell all the company got in exchange was cancellation of the preferred stock, which in my view, was not worth 80% of the company.  Management got majority ownership of the company for a song, I can only imagine it was this one:

I sincerely hope they had to sing it before getting the company handed to them. Fortunately (I see what I did there*), the company would borrow a bunch of money and buy out small shareholders for $0.61 per share.

The trick to this was that only shareholders who had bought before a certain date would get bought out.  When this was announced the stock price of Fortune Industries collapsed.  Arbitrageurs considered this an opportunity, they could buy shares for Fortune for about $0.15 figuring that the company would have to buy them out even if they didn’t make the date in order to get the number of shareholders below 300 (the maximum number of shareholders a company can have before it can no longer be considered “private”).

This didn’t actually happen.  Fortune  and a bunch of shareholders who thought they were going to get a free double or triple were instead stuck with shares that simply could not be traded.  This continued for months as the untradable shares sat in the brokerage accounts of people sure they were just going to make a quick buck.  In the meantime fortunes operating results, under the heavy debt load, stayed stable.  The company continued to grow.

Roughly a couple years ago the company was able to get listed under the symbol FDVF.  All at once the arbitrageurs attempted to sell. This pushed the price down far below where it was before it went private, despite the fact that operating results had been improving.

Operating Results

Over the years since going private Fortune Industries has seen mostly growth.  The company is highly leveraged, so increasing revenue has helped earnings substantially (going from operating profit of 2.5 million to 4.3 million over the last three years, adjusted for non-cash compensation from CEP, and a goodwill writedown in the initial year).  Earnings have been used to pay down debt, which currently has an interest rates ranging from 5.75% to 10%.  Paying down this debt essentially gets the company an immediate ROI equal to the interest rate.  This is extremely good when the company also has organic revenue growth on top of that.

The Hair

This investment has some issues with it.  For one part, small shareholders are certainly just along for the ride.  Management owns over 90% of the company.  It’s probably more efficient for them to take profits in the form of greater pay rather than dividends (management compensation is generally tax deductible at the company level, while dividends are not).  This merits keeping a very careful eye on management compensation.  Unfortunately, it isn’t at all clear to me how one could keep an eye on management compensation.  The figures aren’t public.  It does appear that there is some sort of earn-out for management from the controlling company CEP, and management will earn about $2 million in restricted stock over the next 5 years, not from the owners of Fortune Industries, but rather from the owners of CEP (this should probably be read as, the previous CEO Marc Fortune).

The real hair is that, in my view, this management team already stole the company.  Maybe they’ll do it again.  I can’t think of any reason for them not to.  The money maximizing route for management at this point is to sit on their majority ownership of the company and vote themselves salary increases.  There aren’t any members of the board which aren’t also members of CEP.  The only member of CEP which doesn’t have an incentive to simply vote for salary increases is Marc Fortune.

Valuation

Flatly, the company is inexpensive.  It last traded at $0.29 per share, and over the last 12 months it’s earned $1.96 million.  The number of shares outstanding is about 55 million.  This works out to earnings of $0.035 per share.  That leaves us with a price to earnings of about 8.  This would not be so impressive, unless we looked at the fact that the q4 from the previous year I’ve excluded as it includes a non-cash compensation charge that appears to be non-dilutive.  I estimate that the actually P/E is closer to 6.  In my view that makes up for a great deal of problems.  I’m not currently long Fortune Industries, but if the price to earnings drops near 4 or 5, I would definitely pick some up.  I think that over the course of the next few years, barring any recessions, earnings will probably grow at 8-12%.  I estimate that this is roughly the return a holder of Fortune Industries would see over the next few years.  Barring, of course, management just stealing the company again.

You might be inclined to think that I would advise against buying and holding this company.  After all, a company can double any number of times you like, if management leaves with everything at the end, who cares?  That’s a fair point, but I think that while it is possible that something like that does happen, I think it’s relatively more likely that the company just grows and pays down debt.  There is no incentive for the company to pay a dividend, but if you have a long-term time horizon I think that eventually something good will happen.  I don’t know what (maybe a buyout), and I don’t know when (5 years), but buying companies at a price to earnings of 6ish will probably be good if you have a basket, and you’re willing to sit.

Disclaimer: I have no positions in any stocks mentioned, and I have no plans to buy or sell any of the mentioned stocks within then next 72 hours. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article.  Always do your own research before making any trade, buying or selling any stock mentioned.

 

*It was a pun.

Jul 15 2016

My Worst Investment – It Gets Worse

By |July 15th, 2016|Blog|0 Comments|

A few months ago I wrote this article: My worst investment-ever. The short version is that I invested in a company (Premier Exhibitions: PRXI) which owned the titanic artifacts, figuring that the artifacts were worth much more than the entire company.  I could go on, but it’s really better that you just read the article!

I Was Right

So it turns out, the warning signs that I had feared turned out to be really accurate.  On June 14th Premiere Exhibitions declared bankruptcy (so the stock symbol is now PRXIQ).  Glad I got out when I did, right?  In between when I sold them and the present they had done a 10:1 reverse share split.  So while, I had sold between $0.50 and $0.22, those numbers would be equivalent to $5, and $2.20.

When the declared bankruptcy the stock was at $0.20, 90% lower than what I had last sold it at.  At this point, I had felt pretty good about my decision to sell.  After all I had avoided turning a 90% loss into a 99% loss.  How great is that?

What Happened Next

I submit the price chart of Premier Exhibitions without comment:

Yes, it's up 2000%.

Yes, it’s up 2000%.

So…yeah.  At this point it’s hit $3.86 after hitting an intraday peak north of $4.  Why is this happening after Premier declared bankruptcy? Aren’t bankrupt companies supposed to be worthless?

Post-Bankruptcy

In a bankruptcy everyone gets represented in the order of their claim on the company.  The important thing here is that people the company owes money, like suppliers or creditors, get paid before any preferred stock, and the preferred stock gets its liquidation value before the common stock gets anything.  Basically in a bankruptcy the company is liquidated in an orderly fashion and whatever is left goes to the common shareholders.

So What’s Going On?

The important issue here is still that Premier Exhibitions owns the Titanic artifacts and salvage rights.  A few years ago they had an agreement with a museum to sell the Titanic artifacts for $189 million (about $24 per share).  If premier is able to sell the Titanic artifacts for this much they will be able to pay creditors quite easily, and after all debtors are paid the common stock will receive a payment of $156 million or about $20 per share.  This seems like a good deal when PRXIQ is trading for $3.86 per share.

It seems really unlikely to me that Premier exhibitions will be able to sell the titanic artifacts for that much.  What seems reasonable?  Perhaps $50 million? This would leave about $18 million for shareholders or about $2.26 per share.  I don’t have any particular reason to believe the $50 million.  Frankly valuing these artifacts can kind of feel like throwing darts at a board.  Basically your breakeven today is a sale of the titanic assets for $62 million, assuming the rest of the company is worthless (and man do I ever assume that the rest of this company is worthless).

My (Further) Mistakes

So what happened to me here?  Well, it appears that I shouldn’t have sold the stock in Premier that I had.  While I was right that Premier was likely to go bankrupt I hadn’t considered that the stock could still be valuable even if they were bankrupt.  Nothing I bought with the proceeds from my Premier stock managed to double over the period, and I would have been better off had I not sold it.  Increasingly, I’m coming to the conclusion that I want to own assets.  Why am I trying to sell them? It’s easy to get lured into too much activity if you’re willing to sell the stocks you own, and while I may have just gotten unlucky with the Premier sale, sales in general just seem to be a bad idea.

Putting 10% of my portfolio into Premier was a mistake, my worst mistake.  It appears that the opposite of a bad decision at one price can be another bad decision if done at a different price.  If I’d have stayed invested in Premier I’d still probably be down 80% or so, but I’d be better off than I am today.

Will I get back into Premier?  Well, it depends on the price offered, and it depends if I can confirm that the Titanic artifacts will be sold, and it depends on whether or not I can figure out what price they are likely to be sold at.  For now the answer is no.

Disclaimer: I have no positions in any stocks mentioned, and I have no plans to buy or sell any of the mentioned stocks within then next 72 hours. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article.  Always do your own research before making any trade, buying or selling any stock mentioned.

Jul 11 2016

Advant-e Corporation (OTCBB: ADVC)

By |July 11th, 2016|Blog|0 Comments|

bar code

Welcome to the wild world of Electronic Data Interchange!

Advant-e corporation is a tiny company.  There was a time when it was a tiny public company but it is now private and non-reporting.  The main attraction for Advant-e tech is that it makes a lot of money compared to it’s market cap. In 2015 it earned $2.6 million, or 45 cents per share.  The market cap of the company was $23.5 million and individual shares last traded for $4.  The earnings yield of the company is currently 11%.  It generally pays out an annual dividend of 20 or 30 cents per share.  The dividend typically gets paid sometime in spring or summer and this past year it was $0.20, or about 5% on the last trade.

So What Does Advant-e Do?

Advant-e corporation provides an Electronic Data Interchange (EDI) for grocery stores, auto dealerships, and more recently, healthcare providers.  If that doesn’t mean anything to you, I’m unsurprised.  It didn’t mean anything to me either.  The definition from wikipedia is unhelpful as well,

Electronic Data Interchange (EDI) is an electronic communication method that provides standards for exchanging data via any electronic means. By adhering to the same standard, two different companies or organizations, even in two different countries, can electronically exchange documents (such as purchase orders, invoices, shipping notices, and many others)

So what?  Well, this allows grocery stores and grocery store suppliers to do business with each other using a common format.  This doesn’t sound super important but grocery stores are typically only interested in working with suppliers which can support the EDI that they use.  The model here, then, is for Advant-e to give grocery stores access for free.  They then act as a toll booth for suppliers to get access to the grocery stores.

There isn’t really any point for a supplier to use an EDI that doesn’t give them access to the most stores, so the fact that Advant-e has access to a lot of small grocery stores makes it harder for a startup EDI supplier to compete.

This generally only matters for small grocery stores and suppliers as larger chains have their own systems.

Growth

So, how has this model been working out?

Advant-e

Click to enlarge

Pretty well, up and to the right is what you want to see with revenue and income. Here’s something more concrete (all dollar values in thousands):

Year Revenue gross profit net income
2007 7160 4660 1020
2008 8870 5390 1060
2009 8650 5090 1200
2010 9300 5640 1590
2011 9588 5800 1710
2012 10106 6145 2000
2013 10705 6468 2393
2014 11720 7385 1510
2015 11895 7081 2620

While we do see a little dip in gross profit in 2015, and revenue has clearly slowed, I chalk that up to the shuttering of Merkur in late 2014 early 2015.  Merkur was a division of Advant-e that also did EDI but was software-based rather than internet-based, it helped companies by sending faxes of their paper documents. .  The division never performed all that well and was written off in 2014 (you can see a dip in net income there.)  The company was then reorganized integrating Merkur’s assets with the rest of the company. My best guess is that there was some loss of Merkur revenue which hid more growth in the company, as the internet-based branch (called Edict systems) did $10.3 million of revenue, in 2014.  Even a small drop in the revenue from the Merkur end after the reorganization, could have hidden a significant amount of growth.

Risks

Oh man, where do I even start?  There’s so much hair on this, it could replace Trump’s piece.

  • It’s only recently not a penny stock due to a reverse split (more on that later).
  • It’s an internet company, who even knows if it’ll be around in 5-10 years.
  • It’s not a reporting public company so you don’t get the same amount of information, and they simply do not have to disclose as much.  For example, how much does the CEO make?  No idea.  This is compounded by the fact that the CEO owns more than half the shares.  Really, a lot of money could go out the side door if the CEO just started giving himself raises.
  • The stock is extremely illiquid.  It has traded between $4 and $5.50 in the past week, some days it doesn’t trade at all.
  • If you were a small shareholder you probably had some trouble with this recently for reasons I’ll get into in a future post (a recent reverse split may have cashed you out at market price, the horror).  Suffice to say small shareholders in the past haven’t been treated in a way I would consider fair.
  • Even past all that, there’s just a basic business risk of working with small grocery stores.  I don’t have any reason to believe small grocery stores are even going to be around in 10-20 years.
  • The company rents its location from a company wholly owned by the CEO for about $400,000 per year.  I’m not sure if this is a fair rent or not, but this sort of thing just generally smells bad.

Summary

Even given all the hair, I can’t help myself but love this stock.  It’s got basically everything I want.  Priced low, management pays the profits out in dividends, it grows.  Management owns a bunch of the company and, hopefully, their interests are therefore aligned with mine.  It’s illiquid, it’s tiny.  My fervent desire is to simply sit on these shares forever.

Disclaimer: I am long ADVC, I have no plans to buy or sell any of the stock within then next 72 hours. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article.  Always do your own research before making any trade, buying or selling any stock mentioned.

Jul 8 2016

You Can Beat the S&P 500 Index Return

By |July 8th, 2016|Blog|0 Comments|

It should also be noted that you can get crushed by the S&P 500 Index return as well.  It is basically an article of faith in the personal finance community that one ought to invest in index funds, perhaps particularly the S&P 500 index fund.  There are a couple advantages to doing so.  It’s easy.  It’s cheap.  You get the average result.

Most of my money is in index funds.  That’s the case because most of my money is in a 401k type plan.  Index funds are the only reasonable choice that I have from my plan sponsor.  This is a good thing, I suggest you keep most of your money in an index fund.  For example, here is the S&P 500 index return over the last 100 or so years

S&P 500 Returns

This is a logarithmic chart. That there is good news. Chart taken from wikipedia.

You’ll notice that the increase of the S&P 500 looks roughly linear on the logarithmic chart.  You know how when somethings growing like crazy, they’ll say it’s “growing exponentially”.  This chart is literally what it looks like when something grows exponentially.  Historically, the S&P 500 has been a very good place for your money, earning approximately 9.05% with dividends reinvested over the last 100 years.  When you include inflation this value drops to roughly 6.86% from 1871 to the present.  Sometimes, due to volatility, this can mean decades of low to no returns.

What the S&P 500 is

The S&P 500 is a collection of the 500 large companies selected by the S&P 500 committee to be representative of the US stock market.  The major requirement is that the market capitalization (this is the combined value of all the shares of a company at the market price) is greater than $5.3 billion.  The stocks in the index are then weighted by their market capitalization.  This is convenient for index funds because they don’t have to buy or sell a little bit of a stock just because its price changes.

What the S&P 500 misses

In my view the S&P 500 leaves out two major types of company.  Foreign companies (though 27 are currently included in the index), as well as small companies (in this case we’ll consider sub-billion dollar market caps to be small).

Large foreign companies can generally be invested in by choosing an international index fund like the Vanguard Total International Stock Index Fund.

To get exposure to smaller companies you could buy a small-cap index fund.  You might want to do this because small capitalization stocks on average return more than larger capitalization stocks (about 3% more since 1930).  Over long timescales that extra 3% really adds up.  Think of it this way, if you expect to earn $700 after inflation from investing $10,000 in the S&P 500, you expect to earn $1000 from small cap stocks.  Obviously returns are not that smooth, but that extra 3% is a very hefty amount.

The Problem With Small Cap Index Funds

My biggest gripe with small cap index funds is that they are still huge!  The median market cap in the Vanguard small-cap index fund is $3.3 billion.  There’s a lot of room below that.  The problem is, if you get much smaller it’s very hard for an index fund to build a position.  The bid-ask spread on tiny stocks can be very large, some days tiny stocks don’t even trade.  If you manage an index fund and you have mandate to buy all of the stocks, how do you deal with this?

Often, you just don’t.  You either hit the ask on these stocks and pay a huge spread, or simply do not invest in stocks with low liquidity.  These frictional costs aren’t included in the expense ratio of the fund.  These costs can be as much as 1% annually.  Additionally, forced selling from these funds during market panics can push down the prices of illiquid stocks substantially.

How to beat these index funds

My investment philosophy is stems from a few simple ideas.

  • The market is mostly efficient.  Therefore most of the time buy and forgetting index funds is a great way to go.
  • This efficiency comes from highly informed, highly skilled professionals who work against each other in the markets resulting in prices that very closely reflect true value.
  • Areas of the market where highly informed, highly skilled professionals do not exist, or are severely constrained probably have significant mispricings.
  • It is possible for an amateur to spend enough time and do enough research to identify these mispricings and exploit them for profit.

So I seek to invest in areas where professionals cannot or will not go.  The most obvious area is nano-cap and micro-cap stocks.  A mutual fund manager, no matter how intelligent generally just can’t invest in a company with a two million dollar market cap.  If they manage $100,000,000, why are they going to spend years trying to build up a $100,000 position in a tiny illiquid company?  The answer is that they simply will not attempt it.

This also means that they don’t bother trying to calculate the fair value of that company, and many companies like this can languish in obscurity for years with market prices far below fair value.

What if you’re wrong?

Now, to be fair, it could be that the market for nano-cap and micro-cap stocks is efficient.  Maybe I can’t exploit mispricings for profit because maybe there are no mispricings.  That could be true, but I would still argue that my practice of buying tiny stocks and sitting on them would still be a good strategy.  There are a couple reasons for this:

  1. The small cap premium. Smaller capitalization companies are more risky, and therefore return more. As we saw earlier, this is about 3%. I would expect it to be higher for even smaller companies, if I’m wrong and the market is efficient.  If two assets returned the same, but had different levels of risk, why would anyone invest in the riskier asset?
  2. Illiquidity premium.  If your money is illiquid your investment is less useful to you.  If two assets returned the same, but one was very liquid and the other you required you to sit with a limit order for 6 months to get your money out, why would you invest in the illiquid asset?  Therefore, if the market is effecient there is some premium for investing in illiquid assets.

So therefore…

Heads I win, tails I win.  I love situations were I can be totally incorrect and still win.  Now, obviously investing in very small and illiquid companies comes with risk.  It is totally inappropriate if you expect to need the money you’re investing at some point in the next 20 or 30 years.  But if you’re investing for the long, long run I expect that analyzing tiny companies, buying good ones, and waiting until you’re very old will be more profitable than investing in the S&P 500.

Disclaimer

I have no positions in any index funds mentioned. I wrote this article myself, and it expresses my own opinions. This is not a investment recommendation. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article.  Always do your own research before making any trade, buying or selling any stock mentioned.

Jul 7 2016

Sitestar Corporation (SYTE): Part II

By |July 7th, 2016|Stocks|0 Comments|

Now to get up to speed on the latest developments.

Now to get up to speed on the latest developments.

Here’s the second part of the Sitestar story as promised.  For those of you who missed it, here is part 1. Since our story left off a great deal has happened. First off, a group of shareholders sent a demand letter to the company. The demand letter basically says that the company needs to provide this shareholder group access to the books as well as the shareholder record.  This was the warning shot in a fight that would eventually topple the CEO.

The Shareholder Group

The shareholder group at the beginning of this episode is comprised of an independent director on Sitestar’s board, Jeffery Moore, and two hedge funds, Arquitos Capital Partners, run by Steven Kiel, and the Aleisa Value Fund, run by Jeremy Gold and Christopher Olin.

Management

The company at this time (2014) was run by Frank Erhartic, and the CFO is Daniel Judd.  Frank Erhartic started essentially another dial-up company called “Lynchburg.net”, it was acquired by Sitestar back in 2000.  He evidently worked his way up and became CEO in 2002.  The company has largely been winding down since then. Interestingly, the salary that Mr. Erhartic was taking between 2010 and 2014 was actually quite small, less than $50,000 per year.  Considering that at the time Mr. Erhartic was really running the whole show at the company, this actually seems like a relatively small salary.  This wasn’t the only money that Mr. Erhartic made from the company however, there were many related party transactions over the years, and there is some question as to whether Erhartic used these to extract money from the company. That question is central to the drama that unfolded over then next two years.

Related Party Transactions

A related party transaction is basically when the company has a transaction with someone who has decision making power or the implication of decision making power related to the transaction within the company.  For example, if the company rents office space from a major shareholder.  In this case, Erhartic loaned the company a relatively small amount of money (about 50,000) at a 10% interest rate.

Formation of the shareholder group

As far as I can tell Mr. Moore (a board member of sitestar) became concerned when board meetings were not held, and his name was signed to SEC filings that he hadn’t seen.  These SEC filings had all kinds of errors, for example adding 20-30 years to Mr. Moore’s age.  Furthermore, Moore was concerned with the lack of progress in the company’s real-estate portfolio.  Shut out of board meetings, he formed a shareholder group with two value funds hoping the agitate the company to be more transparent, and improve returns.

A proxy battle?

At this point the shareholder group initiates a proxy battle in order to force management to start holding an annual meeting, turn over the books, and improve operations. A proxy battle reminds me of an old fashioned circa 1800’s US election.  Two groups (parties) are trying to get a hold of the company (country) so they print their own ballots (yeah, that was totally a thing) and mail them to shareholders (hand them out to voters), along with advertising material explaining why their group is really the best for the company (country).  This is serious business for management, as often proxy-battles can result in management losing their jobs.  A problem with small companies is that this process can often take long enough that management can sometimes drain the money from the company before the outside shareholders can obtain control.  Often the threat of a proxy battle can convince management to accommodate the outside shareholder, assuming that the shareholder isn’t simply out to get rid of management.

Fortunately for both sides, management and the shareholders were able to come to an agreement, the shareholder group withdrew its proxy.  Basically the deal was that Sitestar increase the number of people on the board from 3 to 6 and that 3 members should come from the shareholder group and 3 members were appointed by management.  In the event of a deadlocked board the president (Erhartic) was allowed the tie-breaking vote.  This allowed management to retain control of the company, barely. In addition the shareholder group got basically everything it wanted, regular board meetings, reimbursement for its proxy battle, and an agreement to more closely look at the way the real-estate was being handled.  If you’re interested you can read about the settlement in detail here.

As a quick aside, the reason board seats are important is because the board members are the representatives of the shareholders (always remember, the shareholders are the people that own the place, it is for their benefit that the company exists).  The board basically acts as the boss of the CEO, and it is they that the CEO ultimately needs to answer to.

A Blogger and An Audit

On December 3rd 2015 a blogger, Inelegant Investor, posted information about the $50,000 loan from a related-party transaction. He was told that CEO Erhartic’s mother, had loaned the company $50,000 at a 10% interest rate.  This seemed odd because the company didn’t seem to have any need for the money at that time, and On the same day, apparently Sitestar’s board was informed by Sitestar’s auditor that there were several related-party transactions for which the auditor had requested more documentation.  Evidently the auditor did not receive this documentation.

At this point Erhartic, who masterminded the strategy for Sitestar’s transition to real-estate, resigned from the board, and then was summarily fired by a majority of the board.  At this point the shareholder group of Moore, Kiel, Gold, and Olin had effectively taken over the company. Moore replaced Erhartic as chairman of the board and Kiel ended up replacing Erhartic as CEO of the company. The company investigated Erhartic’s transactions and later sent a demand letter for restitution based on the results of that investigation.

Looking Toward the Future

Sitestar’s future at this point is a little uncertain.  There haven’t been any financials released since the change of control, and the financials are quite late at this point.  That could mean any number of things.  Many reasonable investors do not invest in any company with late financials, figuring that no one waits to release good news. Also, the company has issued a statement of non-reliance on previous financials.  These related party transactions apparently cost the company money in ways that weren’t captured in previous financials.  Quite frankly it is hypothetically possible that the amount of money the company has is substantially less that they previously claimed.  Personally, I think its reasonable that they haven’t released financials yet, and I think when financials are released the news will be basically neutral, so I don’t worry very much about this.

Another important thing to keep in mind is that Erhartic was simply not charging very much for his services, $50,000 per year isn’t very much for a CEO.  The book value of Sitestar is roughly 5 million dollars based on previous financials (which the company has stated cannot be relied upon).  If Sitestar can earn a 10% return on equity (a dubious prospect), then we’re looking at a company earning $500,000 per year.  If the CEO’s salary goes from $50,000 to $150,000 (the median CEO pay), that would represent a very significant portion of sitestar’s earnings.  If the board members start to get even token compensation for their work (which would probably be reasonable) it would eat even further into the profit available to shareholders.

There are two updates that one should be aware of as well. First, I mentioned in the previous article that there was roughly a million dollar liability on the books that the company contended that it would not have to pay.  This has been settled for about $90,000, so at the very least we should see that go away on the next set of financials. Second, the company has formed an HVAC investment company and seeded it with $1,000,000.  This is a good news, bad news.

The good news is that the company had a million dollars, Frank Erhartic didn’t run off with all of the cash. I’m not terribly surprised as he never really struck me as the sort of person who would.  The improprieties going on here look a lot more to me like someone being lazy about documentation, and trying to avoid some payroll tax, (essentially compensating himself with company expenses, like rent/loans, rather than through salary, when he could have just had a larger salary) rather than any sort of serious thievery.

The bad news is, what does Steven Kiel know about running HVAC companies?  Presumably whatever HVAC company they acquired would come with its own management team, but I don’t really get the point here.  I still have limit orders open in the 4.x cent range and I wouldn’t be surprised if they get filled at some point in the next month.  I do check on the company regularly however as any bit of news could certainly mean a big move for the stock in either direction.  I’d hate to fill my limit order because terrible news came out the night before and the company traded down to a penny.

Disclaimer: I have no positions in any stocks mentioned, but may initiate a long position in SYTE over the next 72 hours. I have open limit orders between 4 and 5 cents per share. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article.  Always do your own research before making any trade, buying or selling any stock mentioned.

 

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