SA Interview: Investing In Orphaned Stocks With The Boyar Value Group

Summary

• The Boyar Value Group uses a private equity approach to public markets.
• What are orphan stocks, what creates the opportunity and how to find them are topics discussed.
• The Boyar Value Group shares a long thesis on Acushnet.

Feature interview

The Boyar Value Group was established in 1975. Through their research division, they publish Asset Analysis Focus and Boyar's Micro Cap Focus which provides some of the world's largest hedge funds, family offices, mutual funds and sovereign wealth funds with in-depth research reports utilizing a private equity approach to public markets. In addition, since 1983 Boyar Asset Management has been managing money for institutions, individuals, and family offices. We recently emailed with The Boyar Value Group to learn more about investing in “orphaned” stocks which is a strategy that they have been implementing for their money management clients. Readers can view a presentation they recently gave where they detailed four high conviction stock ideas.

Seeking Alpha: What constitutes an orphaned stock?

The Boyar Value Group: An “orphaned” stock is a stock that analysts and investors have for the most part disregarded. A stock can become “orphaned” via a variety of ways. A stock may not be included in one of the major S&P indices (S&P 500, S&P 600, etc.) and therefore cannot be bought by index funds as well as “closet” indexers, which tend to focus on stocks included in the major indices to ensure that their performance doesn’t deviate greatly from their respective benchmark. Some of the reasons why companies may be ineligible for index inclusion include companies that are listed in the U.S., but maintain headquarters outside of the U.S., companies with super-voting share class structures and tracking stocks.

These so-called “index orphans” are not limited to small companies. In fact, a comprehensive report that our flagship publication Asset Analysis Focus produced at the end of last year found that there were ~750 companies with market capitalizations of over $1 billion that are not included in either the S&P 400, 500 or 600 indices and there were nearly 60 companies with market capitalizations of over $10 billion that were not part of any of the S&P 400-600 indices.

Recent corporate actions such as spin-offs or post-bankruptcy reorganizations can also cause a stock to become “orphaned” as the traditional sell-side community which is largely focused on maintaining their existing “coverage list” often times is slow to pick up coverage on these types of situations. Since many fund managers rely heavily on these research reports for idea generation, these stocks end up largely being ignored.

Companies with complex ownership structures are also a fertile hunting ground for finding “orphaned” stocks as these types of situations are often put into the “too hard” category for investors to analyze and are simply forgotten. Most investors are not willing or do not have the time to put the work in to analyze these companies and therefore they are neglected by the investment community. This can cause significant valuation discrepancies to occur. Through our over 40 years of being in business, we have often found that the hardest companies to analyze often times offer the biggest reward for those willing to do the work.

SA: Why is there an opportunity to invest in orphaned stocks?

TBVG: The U.S. stock market has been led, in part, by fund flows into passive investing strategies driving up the valuations of stocks such as Amazon (AMZN), Google (GOOG) (GOOGL), Facebook (FB), and Netflix (NFLX) to levels that we believe to be unsustainable and that are starting to become eerily reminiscent of the dot-com era.

At the same time, the sell-side investment research community is continuing to reduce coverage of micro/small to midsize companies as well as stocks outside the major indices. This has caused many of these “orphaned” stocks to sell at levels that we believe are significantly below their intrinsic or private market value.

These factors have created an opportunity to invest in “orphaned” stocks that are either not part of a major index, or are not well followed on Wall Street or are neglected for one reason or another. We believe a portfolio of intrinsically undervalued “orphaned” stocks should lead to superior returns for patient, long-term investors going forward. Our money management arm, Boyar Asset Management has always tried to pepper our portfolios with investments in “orphaned” securities, we now have begun to offer a dedicated strategy solely consisting of “orphaned” stocks.

SA: How do you find stocks like this during your idea generation process?

TBVG: There is no systematic way to find “orphaned” stocks. As referenced earlier, you can screen for companies with appropriate market capitalizations that are not part of an index. You can also go a step further as we did and filter the list to only include companies with low passive ownership. The reason why we believe having low passive ownership could be significant is we hypothesize that these companies have not been artificially inflated in value by index funds that are essentially forced buyers of securities included in their respective index. Interestingly, our research led us to discover that on average companies outside of the major indices are meaningfully cheaper than companies within them. According to a 2012 study by Eric Belasco, Michael Finkie and David Nanigian entitled “The Impact of Passive Investing on Corporate Valuations,” stocks within the S&P 500 are on average 1.8% more expensive on a P/E basis than stocks outside of the S&P 500. This valuation discrepancy we imagine has continued to widen given the strong flows into passive investing since the study was conducted.

Other than the previously discussed screens, finding “orphaned” situations is a manual process and it just involves a lot of reading and turning over a lot of rocks in order to find a hidden gem. One of the areas we are currently finding a lot of value in is micro-cap stocks. We were finding so many compelling ideas that we ended up forming a research service called Boyar’s Microcap Focus. Many micro-cap stocks, despite having solid business models, are all but forgotten by the investment community, which has led us to find some unbelievable bargains. Many institutional managers are not able to purchase shares in these companies because of liquidity constraints and therefore we believe this has created inefficiencies for us to capitalize on. One of our key investment themes within the micro-cap space is to focus on companies with large insider ownership, which tends to compound the liquidity issue.

SA: Can you give an example of an orphan stock idea that worked out?

TBVG: One orphaned idea that has worked out spectacularly is Madison Square Garden (MSG) which was spun out of Cablevision in 2010. One share of MSG when we initially profiled it in 2010 has increased by 383% (vs. a return of 131% for the S&P 500), which reflects the value of MSG and MSGN (MSGN and MSG separated in 2015). While MSG shares have appreciated nicely, we still think the company trades at a significant discount to our estimate of intrinsic or private market value.

Madison Square Garden exhibited the classic characteristics for a successful spin-off situation. At the time of the 2010 spin-off, Cablevision had an enterprise value of ~$18.5 billion versus a market cap of ~$1.6 billion for MSG. In addition, shares of Cablevision were included in the S&P 500, but MSG was not included in any major index following the separation. We believed that many larger shareholders of Cablevision were forced to sell shares as MSG did not meet their investment criteria in terms of size.

At the time of the spin-off, several additional factors contributed to the significant overhang on MSG shares:

• The prospect for heavy capital expenditures due to upgrading the Madison Square Garden Arena
• The potential for a NBA strike
• Competition from a new arena in Brooklyn (Barclays Center)
• The misperception that the Dolan family were bad partners to invest alongside
• Disappointing team performance as the Knicks had made the playoffs just once in past 8 years

In our opinion, the negative perceptions of the Dolan family were largely unfounded as the Dolans had demonstrated shareholder-friendly initiatives at Cablevision prior to the MSG spin-off, including the payment of a large special dividend of $10 per share and Cablevision’s initiation of an industry-leading dividend in 2008.

In addition, Wall Street did not accord any value to the Company’s valuable air development rights, which were carried on the Company’s balance sheet at $0. Wall Street did not view this non-income-producing asset favorably. However, we believed the value of the Company’s real estate approximated the entire enterprise value of the Company. MSG’s real estate sits right in the middle of a very attractive area of New York City where prominent developer Vornado has been accumulating properties over the years.

We did not believe the value of the Company’s sports franchises were properly reflected in the Company’s valuation either. During 2009, Forbes valued the Knicks at $586 million and the Rangers at $416 million. Today, Forbes values the Knicks at $3.6 billion and the Rangers at $1.5 billion. While we did not anticipate the magnitude of the rise in valuations of professional sports teams, we did recognize the value of sports media rights and signaled out MSG as a primary beneficiary in an April 2012 report we published in Asset Analysis Focus that focused on the underappreciated value of sports media rights.

SA: What factors indicate that a stock can gain favor again with the market (to avoid buying into a value trap)?

TBVG: Avoiding value traps is critically important. The way we try and avoid them is by attempting to identify catalysts for every company we analyze that we believe could make it ascend in value over a reasonable period of time, which we usually define as 2-3 years. Potential catalysts include prospects for divestitures or accretive acquisitions, the ability for a company to significantly raise their dividend or buy back a meaningful amount of stock. It is also worth mentioning one of our long-held beliefs: if the public markets do not recognize the disconnect between a company’s share price and its intrinsic value, then someone else (an acquirer) will. This is why a large percentage of all the securities featured in our flagship publication Asset Analysis Focus since its inception in 1975 have been acquired after being profiled.

SA: What is an actionable “orphaned” stock idea now?

TBVG: In our view, Acushnet (GOLF) is an actionable orphaned stock idea. It is also one of the companies in the presentation that we have made available to Seeking Alpha readers. Since Fila Korea owns 53% of the company, this concentrated ownership position prohibits the company from being included in the major indices.

Acushnet boasts two of the most revered and recognized brands in the golf industry: Titleist and FootJoy. Titleist has been the #1 ball in professional golf for 68 years, while FootJoy golf shoes and golf gloves have been the leading brands on the PGA tour for over six decades and three decades, respectively.

GOLF’s target market is the so-called dedicated golfer comprised of ~8mm globally (~3.5-4.0mm in the U.S.). These dedicated golfers devote considerable time and resources to their game, playing 25 or more rounds a year and spending about $1,200 a year on golf equipment - though outside of the U.S., in key Acushnet markets such as Japan (14% of total revenues) and Korea (11%), the dedicated golfer spends about twice this amount. Although dedicated golfers account for just 15% of the ~50 million global golfers, they represent ~70% of industry spending, and their spending has proven resilient historically.

The ongoing rationalization of retail space dedicated to golf equipment in the U.S. (51% of sales) should ultimately portend a more rational industry pricing environment, and it bodes extremely well for the industry’s remaining participants. Nike’s (NKE) 2016 exit (golf equipment) and Adidas’s (OTCQX:ADDYY) 2017 sale of its TaylorMade golf division to private equity should also result in a more favorable industry landscape. Meanwhile, golfer participation is finally showing signs of stabilizing (the number of committed golfers increased by 3.1% in 2016, according to the National Golf Foundation), and the number of rounds played has experienced modest growth in each of the past 2 years (2015 and 2016) following several years of declines.

Applying an 11.0x multiple to our 2019E EBITDA projection, we estimate GOLF’s intrinsic value to be $32 a share, representing over 50% upside from current levels. Fila Korea’s CEO Yoon believes that there are “incredible new opportunities” for Acushnet in Asian emerging markets, and we would not be surprised if that company ultimately acquired the rest of GOLF. If Fila Korea were to muster the resources required, shares would likely command a significant premium to the current market price.

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Thanks to The Boyar Value Group for the interview. If you'd like to check out or follow their work, you can find the profile here.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Check with individual articles or authors mentioned for their positions. The Boyar Value Group is long MSG and GOLF. This interview does not constitute a complete description of our investment services and is for informational purposes only. It is in no way a solicitation to buy or an offer to sell any securities or investment advisory services. Any statements regarding market or other financial information is obtained from sources which we believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. All investments involve risk, including the loss of your principal investment. Past performance is no guarantee of future results and there is no assurance that any targets or forward-looking statements will be attained. This article represents the views of Boyar Asset Management as of the date of publication and may change without notice. As of March 1 2018 affiliated companies, clients and employees of Boyar Asset Management own positions in The Madison Square Garden Company, and Acushnet.