3 Mispriced Micro Caps

by: Weighing Machine


Market cap less than $500 million.

Sell at a 30%+ discount to NAV estimate.

Offer the potential for 50% upside over the next 12 months.

My favorite place to dig for value is in the microcap space (defined here as sub $500 million companies). There are a number of reasons why the greatest market inefficiency exists in microcap-land. First, mutual funds and most hedge funds have limited interest in microcaps. The reason is simple - the quickest way to riches in the asset management business is to grow the size of the asset base. If an asset manager is targeting managing a $10 billion pool of assets and wants to own on 50-100 stocks, the manager needs to be able to purchase $100-200 million (on average) of each company. This means the manager would have to own 20%+ of a microcap company (which would make the position very illiquid - particularly troublesome for a mutual fund manager offering clients daily liquidity). Similarly, limited buyside interest (a cynic might also note the relatively limited investment banking needs) preclude sell-side analysts from spending much time analyzing these companies. With limited buy and sell side interest (as well as having a higher level of inside ownership), microcap management spends less time preparing glossy presentations (or even detailed discussion of factors driving business results) and hosting conference calls (let alone making presentations at investor conferences). This makes the microcap space a fertile hunting ground for the fundamental analyst. Today I will highlight 3 companies with the following characteristics:

  1. Market capitalization less than $500 million
  2. Sell at a 30%+ discount to estimated NAV
  3. Potential for 50%+ return within the next 12 months

Brazilian private equity firm GP Investments (OTC:GPIIF) could prove to be a big winner for investors in 2015. While shares are well off their 2014 lows, the stock continues to trade at a 25% discount to stated NAV. Further, GP Investments holds an 18% stake in insurance brokerage Par Corretora which it carries at cost. Since GP has been involved with Par, the company has increased its profit fivefold. Valuing Par at 15x earnings brings GP's NAV to ~$4.25/share. In October, Par filed to for an IPO which could serve as a catalyst for investors seeing the value in GP (that said, given the turbulence in emerging markets, I wouldn't be surprised to see this postponed). Further, investors own the general partnership (fee-generating businesses - think Blackstone (NYSE:BX) or Apollo (NYSE:APO)). Though investors have fled Brazil (and most emerging markets) in 2014, at some point this is likely to reverse. When investors become excited about investing in Brazil again, it is reasonable to think that GP Investments could raise $2-3 billion from outside investors. Assuming 1.5% annual management fees + a 20% performance fee, GP could generate $50-90 million in revenue (which would be $20-45 million in operating profit). Assuming an 8-12x multiple, this could potentially be worth another $2+/share. Taking into account the potential value of the general partnership and marking Par to fair value, GP Investments could be worth 3x its current price of $2.10.

Trading at a 30% discount to book value, Imperial Holdings (IFT) continues to fly under investors' radar despite making strong progress over the past 18 months. Imperial provides liquidity to owners of life insurance policies so that they can enjoy their death benefits while living. Unlike most companies selling at a significant discount to book value, not only does Imperial have the potential to earn high returns on equity (25+% IRRs from new business), it also should be able to grow at a relatively fast pace due to 1) demographic support as the population ages and more people look to get cash from their life insurance policies and (2) the factors which weighed down Imperial caused many players to scale back operations and/or exit the industry. Ultimately I think that IFT will trade at or above book value. IFT shares have been purchased consistently by multiple insiders over the past 12 months which I believe is indicative of good things to come. At some point, this is a business which could excite investors - it operates in a profitable niche and has the potential to grow rapidly. The Chairman Phil Goldstein seems to agree - he has persistently purchased shares of IFT throughout 2014.

Having fallen 25% from their recent high, BFC Financial (OTCQB:BFCF) shares are on track to end 2014 roughly flat. BFCF is a hodge-podge of assets including 1) real estate (2) a portfolio of distressed debt (housed in BBX) and (3) a timeshare business called Bluegreen. Bluegreen has produced strong cashflow over the past few years (on track to do $150 million in EBITDA this year) and is likely worth more than the market cap of the entire company (after deducting recourse debt) meaning shareholders are receiving other assets (with a likely value of $3-5/ share) for free. Shares have been held back by 1) a delay in the merger with BBX (in which BFCF already holds a controlling stake) due to a lawsuit against the Chairman (and controlling shareholder) Alan Levin (2) the continued delay in the merger between BBX and BFCF (and subsequent uplisting to NASDAQ) and (3) shareholder frustration with BFCF's unwillingness to close its valuation gap (a share repurchase would be a sign of good faith). While the delay is unpleasant, ultimately, I believe these issues will be resolved leading to the eventual completion of the merger and uplisting. Moving to NASDAQ will bring new eyes to BFCF and likely cause the valuation gap to narrow, if not close.

I believe these three companies will meaningfully outperform benchmark indices over the next 3-5 years.

Disclosure: The author is long IFT, GPIIF, BFCF.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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