Update No. 50 – 09/03/12

I promised here to review a stock I had passed up when the fund started & review the reasons we ended up going with other options.

Ranked 14 (out of 14) stocks I considered for investment (carefully considered, I looked over a great many more than that and continue to do so on a regular basis) in the lead up to launch in April 2011 was Lemarne Corporation (LMC).  This company is in the small cap, thinly traded area I consider my particular specialty. I like to value these small companies on a ‘value to private owner bases’.  I have talked about this previously with Ludowici (LDW), which subsequently came under a bidding war, driving its price to approximately triple what it was freely available for in the market over the preceding 12 months.  You can never tell what factors might cause the true ‘value to private owner’ to bubble to the surface, but if you own a portfolio of such opportunities, purchased at the right prices, the prospects of superior performance are in my view above average.

Returning to LMC, they are a business based in Malaysia owning an electronics manufacturing business (Lemtronics) as their main asset.  Referring back to my notes, I quote the following excerpt:

LMC – At $3.81, $33m Market Cap. Average EPS over last 8 years of 50.1 cps, average cashflow over last 10 years of 53.5 cps.  Trading at under 8x earnings, their slow, steady and consistent growth is being undervalued.  Net Cash + Receivables – Payables = about $20m, or about 60% of total share price (or in other words it’s trading on about 3.4x ex-cash share price).  Strong insider ownership, with a history of acting in shareholders interest, shares on issue have nearly halved over a 10 year period, however market punishes price due to poor shareholder communications and illiquidity.  Assuming steady business growth at a slower than historic rate, likely per annum gain for LMC 16.88% including dividends from this price.

There was a bunch of other commentary and price explanation, but I thought them very cheap given their cash-backing and ownership of a very good income producing business throwing off genuine cash.  Although I liked LMC, I opted out on a relative value basis, choosing other options as I evaluated their long-term per annum share price growth as being likely to be higher.

From the point I decided not to invest, things started to get interesting.  On 7 October 2011, they announced the sale of their Lemtronics business for US$20 million.  This price was something like 5.5x NPAT, or in any other language, dirt cheap, especially so, when you factor the profit growth from (Malaysian Ringit = MYR) MYR11.1m (2007) to MYR19m (2011), so this was not a zero growth business.  This is the difficulty you face as a small shareholder in a tightly held enterprise… Even with a history of doing the right thing by shareholders, a small company is sometimes prone to doing things which don’t seem to make economic sense.  The Lemtronics business was the sole value driver for LMC, without it they are simply a holding company.  Assuming receipt of the full $20m ($4m is held in escrow subject to provisions for 12 months), they were a holding company with nearly $40m cash, the question remains what would they do with it.  This question was substantially answered when they declared a $3.25 dividend on 1 December 2011, management have indicated they are likely to declare further dividends of 25c and 30c in 2012, as the escrow holdings are released.  The current trading price for LMC shares is $0.69, which when you add back the $3.25 dividend would mean $3.94 in value versus the likely purchase price (from the notes above) which would have ranged around $3.80.  This marginal gain of about 3.5% would have come from what I would describe as close to the worst case scenario for us (had we been holders) of management selling the goose that was laying our golden eggs at a rock-bottom price.  Bear in mind, in this 69c per share price carries with it cash & cash equivalent holdings (assuming full escrow release) of $1.10 per share, yes it is possible to effectively buy dollar coins for about 63c with LMC at present, but with the significant uncertainty about what management intends to do with your dollar coins.  Given management has indicated they will likely pay 55c in dividends this year, assuming share price reflected this (i.e. went to 14c ex-dividend), at that point in time, the 14c would reflect about 55c in remaining cash value, so there could still be value here depending on managements actions…

I demonstrate the above in order to remind fellow holders of how we are investing (or at least thinking of investing in the case of LMC) your money.  The LMC case study is instructive because it reminds us that if we buy an asset at the right price, even in the event of a very poor outcome our assets are well protected from permanent loss of capital, and that is always my starting point – Tony Hansen 09/03/12.

EGP Fund No. 1 Pty Ltd. Up by 6.75%, leading the benchmark by 1.59% since January 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 2.75%, leading the benchmark by 11.62% all-time (April 1^st 2011).