It may be time for investors to dust off their copy of Ben Graham and David Dodd's classic Security Analysis. Graham and Dodd paid a lot of attention to the liquidation value of companies as a way of lowering the risk of loss even under a worst-case scenario. They reasoned that even if a company fails as a going concern and is forced to liquidate, shareholders may get their money back -- or even make money -- assuming the company's balance sheet is strong and liquid enough to yield a material amount of cash for shareholders in the event of a liquidation of all of the company's assets.
The Financial Times argues in an article entitled "Liquidation risk grows as finance dries up" that liquidations -- rather than reorganizations under Chapter 11 -- may become more common as bankruptcy financing disappears or becomes prohibitively expensive. According to the FT,
...the credit crunch has severely limited the availability of so-called ‘debtor in possession’ financing that is vital to give [bankrupt companies] this second chance.
With previous big providers of DIP financing, such as GE Capital, shying away from the market, companies may have to rely on their existing lenders...
...there had been no substantial increase in DIP volumes in 2008, in spite of a jump in the number of bankruptcies...
“The lack of DIP financing available is an issue for the American economy because of the potential job destruction that could result.” [according to Steven Smith, global head of leveraged finance and restructuring at UBS in New York]
Debtors also face the highest rates yet for DIP financing. The risk premium a debtor has to pay on the loan has more than doubled since 2001-2002, the height of the last downturn, according to Dealogic. In 2001 the spread over Libor was 429bp versus 900bp now.
Despite the anticipated rise in liquidations, investors following Graham and Dodd principles may do well, assuming they invest in companies trading meaningfully below estimated liquidation values. While such companies are sometimes impossible to find -- and always hard to find -- they do exist, particularly in the small- and micro-cap arena.
We've unearthed 20 interesting Graham and Dodd "net nets" for you. In doing so, we used the following screening criteria:
- Stock exchange: NYSE, Amex or Nasdaq (not Pink Sheets or OTC BB)
- Current assets minus total liabilities equal to at least 125% of market value
- Positive trailing earnings or positive estimated forward earnings
- Market value greater than $10 million
- Net cash equal to at least 60% of market value
- Recent insider buying equal to or greater than insider selling
- Insider ownership less than 20% (we want non-controlled companies, with shareholders able to compel management to liquidate or take other steps to unlock value)
The resulting Top 20 Ben Graham NET NETs should be viewed as a starting point for additional research rather than as a ready-made list of companies to buy. As Ben Graham observed, "net nets" may be most appropriately bought as a basket, because each individual security still retains substantial company-specific risks.