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Jon Heller at Cheap Stocks has a great post on The Downside of Net/Net Investing- Lazare Kaplan (LKI). Says Jon:

In July of 2009,we initiated a new position in the $1.15 range. The shares subsequently ran up to $2.50, but in September, trading was halted,and not a share has traded since.

The company has repeatedly delayed filing it’s financial reports with the SEC, due to:

a material uncertainty concerning (a) the collectability and recovery of certain assets, and (b) the Company’s potential obligations under certain lines of credit and a guaranty (all of which, the “Material Uncertainties”).

The NYSE AMEX granted the company several extensions to regain compliance; the latest on April 26th, which gave the company until May 31st to regain compliance with listing standards.

Pretty standard fare in net net world. Here’s where the going gets weird. Lazare Kaplan International (LKI) is a diamond vendor. It seems that it has been in a trading halt because some of its diamonds have gone missing. Quite a few of them. When the going gets weird, as Hunter S. Thompson used to say before he was shot out of a cannon, the weird turn pro: LKI is suing its insurers for $640M. From the May 20 press release:

LAZARE KAPLAN INTERNATIONAL SUES ITS INSURERS FOR $640 MILLION

New York, NY – May 20, 2010 – Lazare Kaplan International Inc. (AMEX:LKI) (“Lazare Kaplan”) announced today that in a federal lawsuit filed on Monday, May 17, 2010, it sued various Lloyds of London syndicates and European insurers for $640 million in damages arising out of the disappearance of diamonds that were insured by the defendants, including consequential damages. The lawsuit alleges that the insurers breached two “all risk” New York property insurance policies, and an Agreement for Interim Payment under which the insurers made a non-refundable interim payment of $28 million to Lazare Kaplan in January of this year. After making the $28 million payment, the insurers abruptly reversed course and refused to acknowledge coverage or to pay any covered losses under the policies. The complaint alleges, among other things, that the insurers, which also issued separate policies to Lazare Kaplan under English law, created a virtual coverage “whipsaw” by denying coverage under the English policies on the ground that Lazare Kaplan does not have an insurable interest in the largest portion of the property at issue while at the very same time asserting under the New York policies that there is no coverage because Lazare Kaplan insured the same property under the English policies. Lazare Kaplan expects to conduct broad-ranging discovery around the world in the course of the lawsuit.

Jon asks the obvious questions:

What happened to the diamonds? Why isn’t the company willing to speak with it’s shareholders on the issue? Why are the insurers unwilling to pay? And again, what happened to the diamonds?

This is why investing in net nets will always be pure Gonzo investing. Even though the situation with the missing diamonds is ugly, if LKI trades again it might be an interesting lottery ticket. With a market capitalization of $21M, success in the $640M suit represents a 30:1 payout.

Source: Fear and Loathing in Lazare Kaplan International