Consolidated Mercantile: Cheap in Terms of Cash

On February 21, I reported here on what I believed to be an outstanding special situation in Consolidated Mercantile (CSLMF). Now released, the annual report reveals $3.11 in cash/equivalents/short term investments net of liabilities, plus $0.13 in long term investments and note receivables. My estimated intrinsic value range for the company is $2.75 - $3.72. The stock last traded at $1.60.

Recap

CSLMF is a cash rich Canadian microcap holding company which has recently divested its two deficitary holdings (Distinctive and PolyAir), uncovering substantial hidden assets. The resulting entity, I argued, would have a book value of $16.05M or about $3.16 per share - most of it in cash/equivalents and short term investments. This would be revealed in their annual report to be filed in March. The stock had traded around $1.40.

Recent Events

The company did report Friday after the close and its annual report can now be retrieved at sedar.com. So let's see how accurate the estimates were and whether there is still an investment case to be made.

The New Balance Sheet

The balance sheet shows cash/equivalents at $11M, short term investments at $5.5M and $0.8M in notes receivable (this is the Distinctive debt), which has already been repaid subsequent to the report for a total of $17.4M in liquid current assets. On the liability side, we have $0.7M in accounts payable (management did grant itself a very generous $0.5M bonus for the successful PolyAir sale - and yes, it was a good sale) and $0.8 in income taxes for a total of $1.5M. Subtract $0.1M for the preferred shares and we come to $15.8M in liquid assets net of liabilities. This gives us $3.11 per share in cash and short term investments net of liabilities.

Additionally the company has $0.4M in long term investments. Accounting for the secured note CSLMF received as part of the Distrinctive divestiture (remember 10 yearly payments of $100k) hides much of the value of this note since it is recognized over time. So you'll find a $420k deferred gain offsetting the discounted present value of the note ($457k). As I said before, I'm not sure that the company will receive more than say $300k in present value from this note.

How did we do? In total, for the current market price of $1.60 per share, you get $3.11 in cash/equivalents/short term investments and about $0.13 in long term investments and the Distinctive note. Overall, our previous analysis of $3.16 per share was resonably close.

Still a Buy?

Buying dollars for 50c generally seems like a good idea - but could this be a value trap and just stay underpriced? One way to get an answer to this question is to look at relative pricing of similar stocks. A filter of all US listed stocks with market cap "> $5M, price/book 10c and cash/equiv/short term investments net of liabilities more than 1.5 x market cap with positive earnings returns 2 companies:

• Alpine Group (APNI.PK) - in which the picture is distorted by massive dilution (2x outstanding shares)
• Eternal Techs (ETLT.OB) - which is a shady company which has most of its cash in "restricted" form in China (this may be a fraud as has been hypothesized elsewhere)

In other words, even at around $2.10 (vs the current $1.60) per CSLMF share, there is no other solid US traded company that is this cheap by the metric of cold, hard cash. Rationally, given no operative assets, you would value a company like CSLMF at NAV with a premium/discount commensurate with the value added by management vs their cost. Depending on your assumptions you might come up with a range.

This is analogous to closed end mutual funds which currently trade within NAV-15% and NAV+15% (excluding some extreme examples like the cornerstone total return fund which seems to employ strategies to inflate its share prices returning capital under the guise of dividends and comes at a +50% premium). Following this approach, and using the adjusted NAV of $3.24, a reasonable range for the company value may be $2.75 - $3.72. In this light, and in my personal judgment, this remains one of the most promising opportunities.

Caveats

Please consider all risks I highlighted in my previous post. In particular, if you do buy, use limit orders since the issue is traded thinly at times.

Disclosure: The author is long CSLMF.

Comments

[earflea:]

Sounds good, but what if the management wants to just sit there and rake in their generous remuneration as long as the cash lasts. This turns on whether the shareholders would allow it - and that raises the question of who the shareholders are. Nothing about that in the analysis.

2008 Mar 16 11:18 AM

[Joe Lucid:]

earflea, you may want to check out the earlier post I was referring to. I did discuss that the CEO owns the majority and that there's the typical potential conflict of interest. However after talking to management, given how the players have behaved in the past and given the significant discount I'm comfortable.

2008 Mar 16 01:42 PM

[valuemanager03:]

Did you see the notice of delisting.... this was already an illiquid stock, and now it won't be trading on Nasdaq anymore (see delisting notice). Wonder if this company will really even trade anymore? Perhaps it will return to oblivion... back in the $1 range... but no one will care.

2008 Mar 25 02:34 PM

[Joe Lucid:]

The stock is still traded OTC with very similar bid/ask spreads as before on nasdaq - but I agree liquidity is a concern with this stock. Frankly in my view the most rational next step would be for Fred Litwin to take the company private. Given their small asset base and the high costs of being public this would benefit Fred (CEO and majority holder) as well as us shareholders.

We'll see how it pans out. For me the value is more important than the ability to trade - so I'm very comfortable where we are.

The CEO Litwin is a good and charitable guy (see www.mtsinai.on.ca/publ...). We're in good hands.

2008 Apr 01 04:45 PM

[RJM2:]

The biggest issue with this stock is its canadian and Its controlled a small group of people whose interests may not be aligned with shareholders. A company Im familar with, its founder sold controlling interest to someone else for $4ish per share. The founder got it all in cash. Nobody else had an opportunity to sell to the new buyer.

Now, that stocks near $1. The founder made out and the new buyers got control without paying for all the shares.

Finally, theres the cost of being public and the wages & salaries of the insiders while its just a shell. Over time, they can add up.

And CSLMF has not communicated very well their intentions.

How about you send me $100k, that I promise to sit in a bank account untill such time as I decide to invest it.

I wont give you any details about what Im considering investing it in and I will take a salary, but I wont tell you how much.

To make it more of a comparision, lets say I live in Boca Raton, which has almost as many scams as canada !

Whats the intrinstic value of an investment you have ZERO control over, whose controllers may have different motivations ?

Hypothically, someone could come in and buy controlling interest in CSLMF by paying these guys out at say $3 per share.

The rest of us would still own our shares. But the stock may be sitting about where it is right now.

Dont get me wrong, CSLMF has speculative appeal, but there is a valid reason that it trades at a large discount to its net asset value.

Given how long its traded at a large discount to its NAV, one can presume the insiders arent particulary worried about where it trades. One may be able to presume they would be willing to accept a sweetheart deal for their shares thats not so sweet for the outside shareholders.

2008 Jun 25 10:44 PM