KSW: In the Bargain Bin

In addition to holding wide moat companies purchased at a discount, a significant portion of our portfolio resides in profitable businesses selling for substantially less than their liquidation value. As we see it, in these situations, we are not only buying the companies’ assets at a discount, but we are also getting their future earnings power for free. We primarily concentrate on micro-cap opportunities, where market inefficiencies tend to be greater, as larger market players are not sufficiently compensated (in absolute terms) to address them. This week we added to our holdings of one such opportunity–KSW, Inc. (KSW), which the market currently values at $13.52 million (as of 3/13/09’s close), even though it currently has cash and marketable securities of over $20 million (by our estimates) and no long-term debt.

To share a little about the business–KSW, Inc., through its wholly-owned subsidiary KSW Mechanical Services, Inc., furnishes and installs heating, ventilating and air conditioning systems and process piping systems for institutional, industrial, commercial, high-rise residential and public works projects in New York City. Also, KSW serves as a mechanical trade manager, performing project management services relating to the mechanical trades.

As of September 30, 2008, KSW’s book value was $19.32 million, with nearly $17.4 million in cash and $1.6 million in marketable securities. Using data points from the recent press release, the fourth quarter 2008 yielded an additional $1 million in net income. And as of Dec. 31, 2008, KSW’s backlog of work was about $62.5 million.

Though management and the Board could do more to return cash to shareholders, KSW currently has a $1 million share buy back, which was announced in December 2008. Additionally, KSW has paid annual dividends in the past, and last spring it returned a cash dividend of 20 cents per share.

So why is KSW so cheap? In our view, it is likely because new construction projects in NYC are being dropped and current projects halted. In December 2008, KSW announced that two of its projects had been put on hold (the 42nd St and 10th Ave Project for $32 million, and the 56 Leonard Street Project for $24 million). Also, this past week, KSW had one of its customers terminate all of its current trade contracts (on which KSW had about $6 million of outstanding work left).

Yet, does a slow NYC construction market justify KSW’s current share price? In our lights, absolutely not. Its current market price not only values its future earnings power at zero, it values its net cash in the bank at less than 70 cents on the dollar. Basically, the current market price assumes that the company will never earn another dime and will burn through six and half million dollars over the next few years. That proposition strikes us as absurd.

Though some may worry that KSW may not have sufficient work to cover its overhead expenses, it is important to keep in mind that all of its field workers are hired for specific work assignments and hence are not salaried. Additionally, a substantial portion of Chairman and CEO Floyd Warkol’s compensation is paid as a “bonus equal to 9.5% of the Company’s adjusted annual operating profits before taxes, which are in excess of [$250,000].” So, a sizeable portion of KSW’s expenses are not fixed, and should adjust accordingly if less work were available.

All told, KSW’s current market price offers the company’s assets at a significant discount and its future earnings power for free. Though we expect that construction work will decline over the next couple of years in NYC, it will not cease entirely. And if it doesn’t, KSW will likely have work to do, and earnings for its owners.

Disclosure: I, or persons whose accounts I manage, own shares of KSW at the time of this writing.

Comments

[Suh551:]

Ok. So I own KSW. I bought some today (03/16/09, the day this article came out) before I saw this.

Here's why I think KSW could very well be a value-trap.

1) Their receivables have no reserve for deadbeats developers. Assume 10% losses on their receivables, this is a $3 million loss. I believe the lack of provisioning for losses on receivables is their greatest risk.

2) I know the blogger brought this up before, but their backlog is shrinking -- and quick. The two projects that the company lost in December were close to half of their reported backlog. They have enormous concentration risk.

Obviously, I think the company will do OK, otherwise I wouldn't have bought it. But the assets on their books are pretty low quality. I find it hard to justify valuing receivables from real estate developers at 100 cents -- that's like saying their credit is better than AAA, which it almost certainly isn't. So 70 cents for assets (or 50 cents for receivables, assuming 100 cents for the cash) isn't a bad place to start.

Mar 17 12:40 AM

[Prudentbear:]

Agree completely with Suh551. Just a a quick glance at the company's current projects via their website shows project after project in... condominiums. It is a near certainty, as Grantham might say, that condo construction in NYC now and for the forseeable future is a very, very scary place to be. Developers are trying to get out of deals desperately and selling unfinished units (pre-construction sales) at plummeting prices just to cover their construction loan obligations. Developers that have strong balance sheets are conserving cash and only just recently have they even begun to talk about looking for land deals to set up future projects. It's really just an ugly place to be.

Does the company have cash? yes. Will they survive? most likely. But don't underestimate how long the economy -especially construction in NYC, which is arguably at the heart of the pain- can just drag along the bottom. All the while, a few million here... and then a few million there... out of 20 million isn't that much. And thus we may have one very pretty by-the-numbers value trap. And I mean one heck of a VALUE TRAP. Look at this way - bring their cash level down a notch and their share price down a little, and wow, you get the same beautiful looking discount to book value that you get now. Keep doing that exercise, and you'll lose virtually every penny... with a stock that looks beautiful on paper. But if that isn't enough to make you hesitate, just consider....

This is one lightly traded stock. And for novice investors, take note: "lightly traded" may sound grand when you think you're the first person to uncover this "undiscovered" stock, but you learn real quick that when you want to sell... hey that's funny... there's no one paying attention to your stock, which means no one to buy it. Don't think that carries water? Just imagine the folks that bought into KSW recently at around $2. For the past week, all they've heard about is the great rally (bear or real, whichever) going on. And KSW hasn't done squat. So... you have your answer right there. The market has already spoken. The entire globe is rallying right now. Except KSW.

Nice little company. CEO does some great charity work. I wish them the best. But considering everything... do you really think that KSW -a construction related concern in condos in NYC- is really the place to be going long?...

One more thing: High P/E stocks have been holding up better than low P/E stocks, which is pretty much in line with past recessions and whatnot. Not surprising, high P/E means the market thinks you have "good assets", while low P/E means they value your assets, well, lower. It's not rocket science. So... the market seems to have a pretty low opinion of KSW's assets. Again, I like the company as a company and all, but with all the bargains that abound out there, why should I risk my money with this venture?

Ok, this really is the last thing: If the article's author's screen name is WideMoatInvestor... why write about this company? Please... show me a moat. I dare you to make me laugh.

Good hunting to us all. Stay smart. It's ugly out there.

Mar 18 04:27 AM

[Wide Moat I...:]

Thanks for your comments.

@suh--I expect that you are right; they will likely have delinquent accounts. This is a risk for most companies in this economic environments, and you have to figure that managers are keeping a shorter leash on accounts receivable. 50 cents for receivables seems very low; do you know of any companies or previous instances where write-offs were that high?

@prudentbear--I agree that the stock price could go lower. If they were to write down receivables by five million, then you could imagine the stock price falling 30% (which would represent a similar discount to tangible assets).

You may have better, less risky places to put your money. You're welcome to share, but I haven't found many decent companies selling at this much of a discount to their cash, without long-term debt.

And finally, KSW's moat is twofold: their construction contacts, and their value engineering. The company's assessment from the 10-K reads: "The Company provides value engineering assistance, whereby the Company uses its experienced staff to recommend economical changes to streamline HVAC and process piping systems. These changes reduce costs, but still yield the same results as the original plans. The Company's ability to provide this service has become increasingly recognized in the industry and has resulted in the Company's ability to secure projects without competitive bidding."

It may not be a wide moat, but I would not scoff at the ability to procure contracts without competitive bidding.

Mar 18 03:04 PM

[blonde molly:]

good write up by theauthor and the commentators.

Mar 19 09:59 PM

[Suh551:]

A little late on the reply...

50 cents on the dollar is very conservative. But look at it this way: receivables are pretty much short-term loans. These loans are given to developers, hardly of high creditworthiness and without a ton of collateral to recoup losses. Traditionally, defaulted loans were assigned 70% recovery in case of default, but developers have probably close to zero. The landscape of the world is changing where recovery on bad assets is plummeting-- no one would ever have guessed GM bonds would be worth 11 cents on the dollar.

Another way to look at it -- if a real estate developer wanted to borrow money from you even for 90 days, how high would the interest rate have to be? I'm thinking it would have to be usurious. That developer will spend the money to finish the building, and you wouldn't get paid until customers came through to buy the units. That can take quite a while, and you'd definitely not be assured of getting your money back. This is why 50 cents is not a bad place to start.

Another thing of mild discomfort: the fact that receivables have been steadily rising. Those receivables haven't been put on a tight enough leash. Yet.

I know it sounds like I'm dumping on KSW. But even with a 50% loss in receivables, the company is still worth plenty more than zero -- I would guess closer to the $2 range.

As for the illquidity, I don't see why that's a big deal. If anyone is buying it for the same reason I'm buying it, I wouldn't sell it at $2.80 or even $4.00. This company has the potential to unlock a lot of value that would put it closer to $6 or higher. I'm happy to let it sit here -- if it goes below $2, I'll be sure to buy a whole lot more.

Apr 07 05:53 PM