I have seen or read dozens of investors pitch their stocks saying, "This is a Ben Graham type pick" or "This is a stock Ben Graham would love." I don't know if those investors have never read Graham, or if that's just part of their sales pitch, but most of those stocks Ben Graham wouldn't go near. Many of them had negative tangible book value, or valuations that depended on strong growth. Let's get through the fog of Wall Street and look at a stock that Ben Graham actually might have owned.
The stock that I'm talking about is Manhattan Bridge Capital (NASDAQ:LOAN). They are a very small company with a market cap of over $4 million. LOAN does two things, it provides bridge loans and it does something called factoring. Factoring is buying a company's accounts receivables for 75 or 85 cents on the dollar, providing immediate liquidity for the company while LOAN makes a profit when they collect the receivables in full. Bridge loans are short term collateralized commercial loans, with higher interest rates. Businesses typically need bridge loans when they are transitioning between buildings and haven't sold their old building to buy the new building yet.
Manhattan Bridge's value is in their balance sheet. As of the end of March, they have about $8.3 million in current assets, and about $.8 million in total liabilities. That makes a net current asset value of about $7.5 million. Compare this to their current market cap of about $4.3 million, and they are clearly a bargain. Selling for 57% of NCAV, they are a typical cigar butt/Graham stock. Almost all of the current assets are receivables from loans made. So the question is, can Manhattan Bridge collect?
At the current price, the market is suggesting one of three things will happen.
1. All of Manhattan Bridge's loans will default and the collateral that they collect will only be worth 57 cents on the dollar.
I consider this scenario extremely unlikely. LOAN has never had a default, NEVER. They have a very diversified loan portfolio and they are very conservative in their lending, and they always resist the institutional imperative. All of their loans defaulting is almost impossible, but if they do, the company will likely get more than 57 cents on the dollar, as all loans are fully collateralized by New York City real estate, marketable securities, or accounts receivables.
2. 43% of the loans will default, and the collateral will be worthless.
Again, not very likely for the reasons I just mentioned.
3. Negative earnings will eventually erode the current asset value down to match the current price.
Of all the scenarios the market is suggesting, this is most possible, but still highly unlikely. LOAN's earnings have been spotty. They do much better in a tight credit market, because companies cannot get the loans from banks they need because nobody is lending, except Manhattan Bridge of course. This leads many high quality customers to Manhattan Bridge. During easy credit, the opposite is true, as everybody and their bankrupt mother can get a loan from just about everywhere.Assaf Ran, the company's CEO, would make an excellent value investor. He does the opposite of what the lending "herd" does. During easy lending times, he doesn't lend to poor quality borrowers as everyone else is doing. During tight lending times, he doesn't refuse to lend to high quality borrowers just because the current economy scares him.
So if the company is so good at lending, why are the earnings so spotty? This is because their SG&A stays the same no matter what the revenue is. Revenue will fluctuate with how many loans the company is able to make, but SG&A stays the same. I think the risk of loss is still minimal here for two reasons. Losses have never been very copious in one single year, and management owns a large amount of shares (almost half of the shares outstanding). They have too much of their wealth tied up in LOAN and they wouldn't let losses ruin the company. They would eventually cut expenses (lay people off and maybe take a pay cut themselves) to match lower revenue, which would likely produce profits again. Also, the boom part of the business cycle is not long enough for negative earnings to sink this company. The previous economic boom was a period of some of the easiest credit in the history of man. This easy credit bubble produced several years of negative free cash flow for LOAN, and yet it never came close to sinking LOAN.
I think an investment in LOAN is a win-win, regardless of economic conditions. That is because their stock price tends to move in the opposite direction of their fundamentals. During good economic times their business does bad because it cannot find enough high quality people to lend to due to competition. Yet, their stock price always rises in these periods, and typically sells at a premium to book value. Conversely, the company does great during bad times when nobody but they are lending, and yet their stock always gets hammered along with the broad market. During the bottom last year, LOAN was selling for 25 cents on the dollar to their loan portfolio minus all liabilities. With such a discount to book value, you'd think they would be struggling, but instead they were making money hand over fist as high quality borrowers had nowhere else to turn to for loans.
So if the economy continues to improve and credit eases further, LOAN may struggle again, but their stock price will likely rise to meet book value as it has in the past, producing gains for the investor. If the economy weakens and credit tightens again, the stock price may once again dip but Manhattan Bridge will flourish once again, increasing their intrinsic value.
Added to a basket of net-nets or cigar butts, I believe LOAN makes a great investment. The low risk profile of this pick makes it very possible that Ben Graham would have owned this stock if he was managing his little partnership today.
*A word about liquidity. With just $10,000 worth of shares exchanged on average day, liquidity is low. However, even someone with a 7 figure portfolio can establish/exit a small position if one takes a few days or even a week to patiently buy/sell. I hate it when people whine about low liquidity in these stocks, you cannot expect great liquidity in net-nets. It comes with the territory. If they had great liquidity they probably wouldn't be this cheap to begin with. If you're scared of liquidity, you probably should not be investing in these types of stocks. You will not find any liquid, billion dollar stocks selling for 2/3 of their net current asset value.
Disclosure: Long LOAN