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.