I last wrote about The Daily Journal Corporation (DJCO) in August of this year, giving a detailed description of the business and an investment thesis. If interested, a link to that article is included here.
In the past week, the company filed the latest 10-K for the fiscal year ended September 30, 2010.
Consolidated results are shown below. With the exception of Sustain, results were very positive.
Pre-Tax Income declined as margin improvement at the traditional business was not enough to offset declines at Sustain. Public notice advertising revenue for the most recent fiscal year was $22,172,000 and about $15,032,000 of this revenue was related to foreclosures. The company’s own description of public notice advertising is as follows:
Public notice advertising consists of about 100 different types of legal notices required by law to be published in an adjudicated newspaper of general circulation, including notices of death, fictitious business names, trustee sale notices and notices of governmental hearings. The major types of public notice advertisers are real estate-related businesses and trustees, governmental agencies, attorneys and businesses or individuals filing fictitious business name statements. Many government agencies use the Company’s Internet-based advertising system to produce and send their notices to the Company. In addition, a fictitious business name Web site enables individuals to send their statements to the Company for filing and publication. California Newspaper Service Bureau (“CNSB”), a division of the Company, is a statewide newspaper representative (commission-earning selling agent) specializing since 1934 in public notice advertising. CNSB places notices and other forms of advertising with adjudicated newspapers of general circulation, many of which are not owned by the Company.
The outlook for this business is not good since the level of foreclosure activity in Arizona and California will most likely continue to moderate, although remain above long term trends over the next few years. It is wise to maintain a conservative posture in crafting forward looking statements, still the outlook given by the company is not encouraging:
Whether the increase in traditional business segment pretax profit will be sustained throughout fiscal 2011 is very much dependant on the number of California and Arizona foreclosure notices and the offsetting effect of a continuing decline in commercial advertising and subscriptions. The number of foreclosure notices decreased by 15% during the three-month period ended September 30, 2010 as compared to the prior year comparable period. Because this slowing is expected to continue, we anticipate there will be fewer foreclosure notice advertisements and declining business segment earnings in fiscal 2011. We do not expect to experience an offsetting increase in commercial advertising as a result of this trend because of the continuing challenges in the commercial advertising business.
Sustain, over time, could become a valuable asset, but it does not appear that it will in the near term since Sustain’s primary customer is the state of California.
The long and short of it is, expect results in fiscal 2011 to fall short of results in fiscal 2010, and long term profitability to be somewhat less than the pre-tax profits of $13,221,000 in fiscal 2010.
Strong cash generation continued in the most recent year. Operating cash flow of $9,324,000 increased 11.5% from the previous year. A decline in Accounts Receivable compared to an increase in the previous year was responsible for increasing cash flow despite a decline in net income. This cash flow allowed for increases in the amount of treasury bills owned by the company and an increase in cash balances.
No purchases or sales of marketable securities were made in the prior year; however, asset price declines lowered the gross value of securities from $54,075,000 to $50,082,000. I earlier argued that the equity securities owned by the company were primarily Wells Fargo (WFC) and a small amount of US Bancorp (USB). The value of these securities has substantially increased from the end of September. Wells Fargo has risen from $25.12 to $31.31, and US Bancorp has risen to $26.95 from $21.62.
The identity of the corporate bond remains a mystery. However, knowing the equity securities owned and estimating the rate being paid on the treasury notes and bills can help us gleam insights. The chart below shows the dividends received from equities over the course of the previous year.
I took the quarterly average of Treasury holdings throughout the year and estimated an interest rate of .25%. I cannot say whether this estimate is accurate, but unless it is grossly misstated it will serve its purpose. I am also assuming that no interest was received on cash holdings. If any was, it was not likely a material amount.
Pre-tax dividend and interest income totaled $867,000, implying that about $497,150 of interest was received on the corporate bonds. When the bonds were purchased in early 2009 for $4,923,000 they were yielding a little more than 10% and today yield about 7%.
As has already been discussed, the outlook for the fundamental business is not strong. Recent results have not been surprising, and so I will not revisit the valuation for the underlying business of $49,980,000 I made in August. Putting together the most recent information for the investment portfolio produces the following revised valuations:
Adding $62,502,236 to $49,980,000 yields intrinsic value of $112,482,236 or $81.46 per share.
The intriguing remaining question is, who will be running the company in five years time? Charles Munger, the Chairman, is about to turn 87, and the CEO Gerald Salzman is 71. The decision of succession is basically Munger’s, who can search for a younger individual to take over the company in the future or find an acquirer. The question of succession at Wesco Financial (WSC) was recently settled when relative valuation between Wesco and Berkshire Hathaway (BRK.A) allowed that company to be folded into Berkshire. The only option at Berkshire Hathaway itself was to develop succession planning.
While I do not know of Munger’s plans, if he has any, it would make a great deal of sense to sell the business if a buyer could be found. Salzman has ran the company for about 30 years now and wears the hats of CEO, CFO, Treasurer, and Assistant Secretary. If Munger had intended to transition management it would have seemed likely that he would have given someone younger the opportunity to learn the business and review their performance in one of these roles (other than CEO). He has not done so. The other board members are J.P. Guerin (age 81), George C. Good (age 88), and Peter Kaufmann (age 56). Kaufmann currently runs Glenair, a private manufacturer. Kaufmann is also the author of the book Poor Charlie’s Almanack.
If Munger does decide to sell the business, who would be the likely buyer? With a market capitalization of about $100 million it is not out of the question that an individual might be interested in the business. Among public companies, the most striking possibility is The Washington Post Company (WPO). Munger’s former law partner Ronald Olson sits on the board, and the further connections to Munger are obvious. The Post is not averse to acquisitions and would be willing to hold Wells Fargo stock after the acquisition.
This is all pure speculation, but it will be interesting to see how Munger handles the issue of succession over the next couple of years.
The most recent trade for Daily Journal was $71.97 on December 22, 2010. Since the operational risks are known and the cash position is substantial, there is not a tremendous amount of downside to the shares. If an opportunity to purchase shares below $70 presents itself (close to a 15% discount to my estimate of intrinsic value, which I feel is conservative), I will likely add to my position, something I have not done in about a year.