This is one of the bigger companies that I’ll profile here. It has a market capitalization of about $75 million. Huge in comparison to the sub-10 million dollar companies we’ve been discussing. The trick to Richardson Electronics is explained far better by Danny DeVito than I:
Why Does Liquidation Value Matter?
“Alright”, you might say, “but if Richardson doesn’t liquidate, why does the liquidation value matter?”
That’s a good point, this is the whole unproven bit of the theory behind value investing. If you could sum up value investing in one sentence it’d be, “Shares of a company are worth what a private buyer would be willing to pay for the whole company divided by the number of shares outstanding.” So what does that mean?
If a private buyer would be willing to pay $110 million for Richardson Electronics, then we should divide that by the number of shares outstanding (12.5 million), then the theory of value investing suggests that the fair price for shares ought to be about $8.80. This would leave us with roughly 50% upside for Richardson.
Why should a company be worth what a private buyer would be willing to pay for it? Well, there’s not a good answer. Other than, the statistical evidence seems to bear it out.
What would a private buy pay for Richardson Electronics?
Well, that’s a better question. I value Richardson Electronics’ cash, inventory, and net receivables at full value. There are perhaps arguments that this shouldn’t be the case. Perhaps some of the cash deserves a 20% haircut for being overseas and it is therefore still taxable if brought back to the US (suppose a 10% haircut on all of the cash, as maybe half of it is overseas). The net receivables maybe get the same discount plus a little because there is counterparty risk (say 15%?). Perhaps some of the inventory deserves a discount, as they might not be able to get what they paid for it. The inventory doesn’t get the same tax discount as the cash and net receivables because it is held at cost, and is therefore tax deductible. We may want to give the inventory a haircut, as Richardson might not be able to move all of it just because they paid a certain amount for it.
If you toss all of that in a spreadsheet, and subtract off all of Richardson Electronics liabilities at face value, then you figure that even if the operating company was worth $0 as a going concern, at a bare minimum Richardson Electronics would be worth $90 million to you. You would probably want to throw in the $8 million of long term CD’s that the company also owns. The rest of the land, equipment and so on you get for free. So call it an even $100 million, like Danny DeVito, I too like round numbers. So, to a private buyer shares are worth at least $8.
Could anything go wrong?
Very many things.
First off, management appears to be overpaid. The CEO’s base salary went from $630,000 to $700,000 over the last two years, a period during which Richardson electronic’s operating performance substantially deteriorated, and the stock price was cut in half. Including bonuses the full management team made $3 million last year. $3 million is a great deal of money when the gross profit for that year was only $41 million. The actual owners of the company were paid $3 million as well, in the form of dividends over that year.
Why is management so overpaid? Well, management’s is the only vote that actually counts. Richardson electronics has a special share structure which allows the CEO, Edward Richardson, to control a majority of voting power in the company despite only owning about 20% of the company’s stock.
There are two classes of shares, A and B. The B shares have 10 votes, while each A share only gets one vote. The B shares do only receive 90% of the dividend and have rights to only 90% of the earnings that the A shares do, but are convertible into A shares at any time.
This means that the CEO wins every vote that matters, and should a private buyer make that fair offer to buy Richardson Electronics the CEO can simply say “nope, I’d rather keep my million dollar per year salary.”
This might mean that management could continue to run up losses, and burn through the net cash, receivables and inventory we are counting on to give value to the company. This could certainly go to zero, and it’ll be a long painful slog to get there.
The Ray of Light
On the upside Richardson Electronics is slowly liquidating. They pay out $0.24 in dividends every year, giving RELL a 4% yield. In principle this could continue until they paid out all $8 of value in the company, or the company returns to profitability. This means that investors don’t merely have to sit on their thumbs and hope for the best, and they probably won’t end up with nothing to show for their investment. All in all, I think Richardson is a strong bet.
Disclaimer: I am long RELL (This means that I own Richardson Electronics stock, or that I profit when the stock goes up. Short would mean that I profit if the stock goes down.). 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.
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