Following up on yesterday’s post on Starett (SCX), a “hidden” net-net with an activist shareholder in Gabelli, I thought I’d post on another Gabelli controlled net-net today.
The company is LGL Group (LGL), and they are pretty interesting. Gabelli is the Chairman of the Board and owns 16% of the company, and another activist (John Winfield, the chair of Intergroup (INTG)) owns another 5%. ***Update- as I mentioned here, it’s actually Gabelli’s son Marc who is the chairman****
On a quantitative basis, the company looks pretty good. I have NCAV coming in at $6.35 per share and book value at over $9.50 per share (no goodwill here, so book value = tangible book) versus a current stock price of $5.35 per share. The company has an incredibly liquid balance sheet, with $10m+ in net cash. Against their current market cap of $14m, that’s quite a bit!!! And w/ TTM Revenue coming in at almost $35m, a potential acquirer could pay a pretty significant premium and still acquire LGL at a very low EV / Sales.
Finally, the company has been EBITDA positive (albeit barely) for the past year, and if their Q1 results presentation is to be believed, they are predicting solid growth in the back half of 2012 and into 2013. Given their earnings announcement specifically highlights their operating leverage, growth should deliver some pretty strong profits!
However, for me, the positives are somewhat outweighed by the negatives. Basically, despite being in a pretty simple sounding business and trying to compete in a niche (read the 10-K for more info), LGL’s results are ridiculously cyclical. Check out this clip from their 10-K
I’m also a bit concerned about the quality of the net-net here. My friend Geoff (from gannononinvesting) used to have a simple rule about net-net quality- it was better to be a net-net that had a large retained earnings balance than be a net-net with an accumulated deficit but big paid in capital balance.
Why does that matter?
Having a large retained earnings balance is a sign of a business built up on past profits. Being a net-net with an accumulated deficit is a sign of a business with a lot of past losses but good timing with issuing shares at a high price.
So, which is LGL? Here’s there most recent balance sheet.
And that drives with my observation- LGL has been very successful in issuing shares when the market gets excited about their business. For example, in early 2011, the stock had a big run up (well above $20 per share), so LGL increased their share count by 15% and issued shares at $20 per share.
Is that great timing? Yes. And when you add the fact they announced a share buyback six months later (at much lower prices), it also shows great capital allocation.
But it’s also not sustainable.
For comparisons sake, let’s compare that to ADDvantage Tech (AEY), one of my favorite net-nets right now. Here’s their most recent balance sheet:
That’s the sign of a business w/ a lot of past profits!!!!
Does that make AEY a better net-net than LGL? Not necessarily. I think LGL probably has more upside if it catches an up-cycle like they seem to be hinting at in their investor presentations.
But I think it does make AEY a safer net-net. Not to mention AEY has also shown an ability to consistently deliver operating profits and strong ROIC in more normal economic times.
So I couldn’t fault you for an investment in LGL. But I personally think there are safer net-nets out there!
Disclosure- Long AEY
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