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Notes – 16 Japanese Net-Nets I Put In My Portfolio (#JNets, #NCAV)

Listed below are the 16 Japanese companies that currently compose my “basket” (portfolio-within-the-portfolio) of Japanese net-nets, which I refer to as “JNets”. While most of my picks were classic Benjamin Graham-style companies trading for 2/3rds or less of their Net Current Asset Value (current assets minus total liabilities), some were selected on the basis of being a Net Cash Bargain (trading below the value of the company’s cash minus total liabilities) or as a Cash Bargain (profitable company with no debt trading for less than the cash on the balance sheet).

Strictly speaking, a Net Cash Bargain is a more conservative valuation than a Net Current Asset Value Bargain as there are more assets in front of the liabilities, while a Cash Bargain is a less conservative valuation (it may or may not be an NCAV Bargain) but typically you are getting a higher quality company with stronger earnings power as a result. As Graham noted, equities can be analyzed much like bonds and the true safety of a bond comes from the underlying company’s earnings power, not necessarily the asset values which are a worst-case fall back measure to protect against loss.

The figures in the list below are all in Yen, typically in millions of Yen besides the per share price. At the time of purchase, the approximate exchange value of the dollar against the Yen was 1 USD = 78 JPY. All figures and prices are the most recent available at time of purchase.

For comparative purposes, I summarize at the end of the list the metrics for the entire basket (as if it was a conglomeration of 100% of the equity of all companies included) as well as on an average basis as a representative for an individual company within the basket.

Links in the name of each company take you to their website, if available. Links in the symbol of each company take you to their Bloomberg business bio page, if available.

16 Japanese Bargain Shares (Net-Nets, Net Cash and Cash Value)

Name: Sakai Trading
Symbol: 9967
Industry/product: imports, exports, and wholesales chemical products, synthetic resins, and electronic materials
Market Cap (Ym): 2,210
Share price (Y): 235
Debt (Ym): 0
Cash (Ym): 2,851
EV/EBIT (10yr avg): 12.3x
NCAV (Ym): 4,973
 
Name: Shinko Shoji Co. Ltd
Symbol: 8141
Industry/product: sells electronic parts and equipment such as integrated circuits (IC) and semiconductor devices, liquid crystal (LC) display modules, condensers, ferrite cores, coils, power supplies, thin film transistor (TFT) thermal printers, head magnets, transformers, motors, sensors, and connectors
Market Cap (Ym): 16,905
Share price (Y): 625
Debt (Ym): 3,000
Cash (Ym): 10,610
EV/EBIT (10yr avg): 12x
NCAV (Ym): 41,899
 
Name: KSK Co Ltd
Symbol: 9687
Industry/product: develops computer software for various systems related to telecommunication and LSI (Large Scale Integration), provides data processing services for government and insurance group, sells OA (Office Automation) equipment and computer peripheral
Market Cap (Ym): 3,300
Share price (Y): 450
Debt (Ym): 0
Cash (Ym): 4,461
EV/EBIT (10yr avg): 1.6x
NCAV (Ym): 4,926
 
Name: Daichii Kensetsu
Symbol: 1799
Industry/product: constructs railways mainly for East Japan Railway, constructs infrastructure such as sewage facilities, tunnels, and waterways, builds commercial, institutional, and residential buildings
Market Cap (Ym): 15,124
Share price (Y): 685
Debt (Ym): 151
Cash (Ym): 17,230
EV/EBIT (10yr avg): 2.3x
NCAV (Ym): 19,099
 
Name: Choukeizai Sha
Symbol: 9476
Industry/product: publishes economics, finance, law, accounting, and tax related books and periodical magazines and business related books, operates a planning center which handles advertising on publishes,provides design & production services for sales promotion pamphlets
Market Cap (Ym): 1,434
Share price (Y): 326
Debt (Ym): 0
Cash (Ym): 2,501
EV/EBIT (10yr avg): -0.1x
NCAV (Ym): 2,933
 
Name: CLIP Corp
Symbol: 4705
Industry/product: operates a network of cram schools in Nagoya, operates soccer school and lunch box delivery services
Market Cap (Ym): 4,022
Share price (Y): 886
Debt (Ym): 0
Cash (Ym): 5,029
EV/EBIT (10yr avg): 0.1x
NCAV (Ym): 4,196
 
Name: Noda Screen
Symbol: 6790
Industry/product: processes electrical components such as plastic package substrates and printed circuits boards (PCBs), through a subsidiary, manufactures and sells screen stencils and fluoride chemical products
Market Cap (Ym): 2,849
Share price (Y): 27,000
Debt (Ym): 0
Cash (Ym): 3,641
EV/EBIT (10yr avg): -0.2x
NCAV (Ym): 4,146
 
Name: Kitakei Co Ltd
Symbol: 9872
Industry/product: wholesales housing materials and home furnishings based in the Kansai area, sells housing facility products such as bathroom units, wooden building materials, special wooden products, housing equipment, veneer boards, chemical products, and housing preservative agents
Market Cap (Ym): 2,963
Share price (Y): 296
Debt (Ym): 0
Cash (Ym): 5,045
EV/EBIT (1oyr avg): 16.8x
NCAV (Ym): 5,133
 
Name: Ryosan Co Ltd
Symbol: 8140
Industry/product: distributes electronic components, such as integrated circuits (ICs), electronic tubes, semiconductor elements, and personal computers, manufactures heat sinks
Market Cap (Ym): 47,582
Share price (Y): 1,387
Debt (Ym): 172
Cash (Ym): 36,452
EV/EBIT (10yr avg): 7x
NCAV (Ym): 92,515
 
Name: Daiken Co
Symbol: 5900
Industry/product: manufactures and sells metal and other material parts for building construction and exterior products including curtain rails, exterior panels, garages, and bicycle parking units, provides installation of these products and real estate leasing service
Market Cap (Ym): 2,245
Share price (Y): 376
Debt (Ym): 0
Cash (Ym): 1,753
EV/EBIT (1oyr avg): 5.4x
NCAV (Ym): 4,375
 
Name: Ryoyo Electro Corporation
Symbol: 8068
Industry/product: wholesales electronic components including semiconductors, sells workstations, personal computers, and printers, operates offices in Singapore and Hong Kong, trades semiconductors from Mitsubishi Electric
Market Cap (Ym): 22,205
Share price (Y): 771
Debt (Ym): 0
Cash (Ym): 28,443
EV/EBIT (10yr avg): 1.6x
NCAV (Ym): 54,847
 
Name: Nihon Dengi
Symbol: 1723
Industry/product: designs, constructs, and maintains integrated building management systems for air-conditioning, security, and electrical facilities, develops integrated production systems for industrial factories
Market Cap (Ym): 4,805
Share price (Y): 586
Debt (Ym): 0
Cash (Ym): 6,313
EV/EBIT (10yr avg): 4.3x
NCAV (Ym): 8,613
 
Name: Odawara Engineering
Symbol: 6149
Industry/product: manufactures automatic coil winding machines including micro motor, coreless motor, universal motor, and stepping motor type, provides reconstruction, repair, and parts replacement services for its winding machines
Market Cap (Ym): 4,154
Share price (Y): 650
Debt (Ym): 0
Cash (Ym): 5,411
EV/EBIT (10yr avg): 2x
NCAV (Ym): 6,423
 
Name: Natoco Co Ltd
Symbol: 4627
Industry/product: manufactures and sells various types of paints including paints for metals, building materials, and auto repair, manufactures high polymer compounds which are used as material for liquid crystal displays
Market Cap (Ym): 4,414
Share price (Y): 603
Debt (Ym): 0
Cash (Ym): 5,403
EV/EBIT (10yr avg): 5x
NCAV (Ym): 6,967
 
Name: Fuji Oozx
Symbol: 7299
Industry/product: manufactures automobile engine parts such as valves, valve adjusters and rotators, has subsidiaries in Korea, Taiwan, and the United States
Market Cap (Ym): 6,189
Share price (Y): 301
Debt (Ym): 0
Cash (Ym): 6,884
EV/EBIT (10yr avg): 1.6x
NCAV (Ym): 11,623
 
Name: Excel Co Ltd
Symbol: 7591
Industry/product: sells electronic products, such as liquid crystal devices (LCD), semiconductors, and integrated circuits (IC), including thin film transistor (TFT) modules, TFT-LCDs, cellular phones, car navigation systems
Market Cap (Ym): 6,208
Share price (Y): 683
Debt (Ym): 0
Cash (Ym): 6,679
EV/EBIT (10yr avg): 4.7x
NCAV (Ym): 18,574
 
Total Basket
Market Cap (Ym): 129,974
EV (Ym): -15,499
10yr avg EBIT (Ym): 27,046
Debt (Ym): 3,323
Cash (Ym): 148,796
NCAV (Ym): 291,244
EV/EBIT (10yr avg): -0.57x
P/NCAV: 0.45x
P/Net cash: 0.89x
P/Cash: 0.87x
EBIT yield (EBIT/Mkt Cap): 21%
 
Representative Company (Avg)
Market Cap (Ym): 8,123
EV (Ym): -969
10yr avg EBIT (Ym): 1,690
Debt (Ym): 208
Cash (Ym): 9,300
NCAV (Ym): 18,203

Post-Mortem: KVPHQ Capital Structure Arbitrage Trade ($KVPHQ, #CapArb)

A “valueprax” investment post-mortem explores the aftermath of a portfolio investment, successful or unsuccessful, with the intent of acknowledging the good, accepting the bad and attempting to find humor in the ugly. Success and failure alike carry valuable lessons; in support of the constant effort needed to avoid cognitive bias, the post-mortem is the table upon which all cards are laid and reality is fully embraced, rather than selectively avoided.

The Thesis

The thesis for this trade was elaborated upon in some detail in a series of posts over at CreditBubbleStocks.com. Essentially, KV Pharmaceuticals, the maker of an orphan drug called Makena which is used to treat pregnant women who have previously had complicated pregnancies, was the victim of a poor business model. They endeavored to charge $1,500/shot for a drug that could be easily replicated by pharmacists with generics for $10/shot. Physicians, the FDA and the government healthcare (Medicare/Medicaid) system all frowned on this behavior by the company by avoiding their products in favor of the generic alternative.

The result was a cash and earnings shortfall which left KV Pharmaceuticals with a challenged capital structure, summarized in an early post at CreditBubbleStocks.com:

There are two classes of common stock. The A class has a higher dividend but much smaller voting rights than the B class. The fully dilluted A+B share count is ~90 million, giving the company a $90 million market capitalization. Meanwhile, there are $225 million of senior secured notes due 2015 trading at 60 (market value $135mm) and $200 million of convertible notes due 2033 trading at 16 (market value $32mm). [In addition to various other obligations including payments owed to the previous owner of Makena.]

The nature of capital structure pricing and the legal force of competing claims within the capital structure dictate that discrepancies involving discounted debt and greater than de minimis common equity valuations can not be sustained over the long-run and the prices of these securities should eventually converge toward a common, non-contradictory narrative of the state of the business. Corporate debt trading at a significant discount to face value in the markets implies financial distress and a risk of insolvency, which further implies that common equity has no value, as the financial claims of debtholders are superior to those of preferred and common equity holders. Debt holders are due their principal at time of maturity, so if the bond market is saying they aren’t going to get all of their principal back it implies the equity holders have claims with zero economic value.

The Research & Analysis Process

Unlike an earlier cap-arb trade I did involving the securities of the now-bankrupt Energy Conversion Devices where I performed fairly extensive due diligence work on my own, in the case of KV Pharmaceuticals I simply grabbed the coattails of CBS and held on for dear life. “Research” involved following the postings on KV at the CBS website. “Analysis” involved considering what the posts were about and coming to terms with the argument for the cap-arb trade.

When I felt sufficiently comfortable with the thesis, I decided to place my bet.

The Execution

As with the previous cap-arb I did, the trade itself was theoretically simple but turned out to be technically complex. To set up the capital structure arbitrage the investor wants to buy the distressed bonds and synthesize a short on the equity. The belief here is that the equity is over-valued (assuming it’s worth zero) and the debt is under- or fairly-valued.

If the equity turns out to be worth something, the investor will lose on the equity short but gain on the debt long due to a full recovery. If the company is in fact insolvent and seeks bankruptcy protection with a zero equity value, the investor will gain on the equity short and could potentially lose on the debt long, though in practice it’s more common for the debt, already trading at distressed prices, to not lose a whole lot more in that situation.

I faced a couple challenges particular to this investment, the first being that the particular issue of debt I was looking for wasn’t widely available and took some time to come by. The second challenge was that the company was not that liquid and the options issuance (I wanted to synthesize a short by buying puts) available had wide bid-ask spreads and low volume and open interest.

This second aspect of the technical execution of the trade proved to be my folly.

The Experience & Lessons Learned

I didn’t double check this but I think I put the trade on originally back in May. I finally sold my puts (Sep 22 2012 2.50s) today. I still own the bonds, which are now trading at essentially a de minimis value, having lost approximately 90% of their value. Overall, the trade lasted about four months.

At the time I was placing the trade, I was traveling and not near a reliable internet/computer connection. That made researching securities and placing the trades incredibly challenging and stressful. In the future, I would not advise myself (nor anyone else) to attempt to place anything but the simplest of trades under such circumstances. It ended up resulting in me making a poorly informed decision (explained more below) and stressed me out during what was an otherwise enjoyable trip.

Another issue I faced is that I did not understand the technical details involved in pricing the option securities involved. I had trouble determining how many and which options I needed to buy to properly hedge my bond exposure and create the cap-arb. This is a limitation of my own understanding of option pricing theory which could have been remedied by intensive study of options reference materials which I decided I did not have time to engage in before or since I placed the trade. This is a behavioral issue– I admittedly did not understand the technical details of professionally executing this trade but assumed it would not be a big issue (probably, in my mind, relative to all the imaginary profits I’d be making when this thing went off with a bang).

The experience of being invested, itself, was fairly easy to endure in this case. KV’s business situation continued to deteriorate over the course of the trade. The company went through all the tell-tale signs of continuing, aggravated distress, including: falling share price, falling bond price (!), odd IR boilerplate related to trading activity, unfavorable announcements and news developments from regulators, etc., all the stuff you’d imagine would not be happening at all, especially not simultaneously, with a healthy company.

However, I again faced execution challenges when the company delisted its stock. I wasn’t sure if this was an appropriate time to “cover” and sell my puts, or if I should hold on, imagining they’d become even more valuable once the company delisted as I anticipated the stock price, already nothing more than a bloody stump, would be completely demolished following delisting.

In short, my lesson was that while I can follow the logic of a cap-arb thesis, I have real and continued shortcomings in terms of my knowledge of how to technically execute on the thesis which introduce significant risk into the equation. It is not the trade which was risky, it was me doing the trading.

That being said, I did come away with the sense that, while I am the right “scale” for opportunities like this (these inefficiencies exist because larger players won’t bother with them), without significant leverage, which may in fact be available through careful, expert use of options, these trades represent the opportunity to pick up pennies in front of a steamroller. If things go right and you’re not leveraged, you make a little money, but if you screw something up you can cost yourself even more.

The Outcome

In the end, the thesis was absolutely correct. KV Pharmaceuticals filed for bankruptcy protection in order to restructure their financial obligations. Their market cap fell from an initial ~$90M to the current ~$3.5M and the stock was delisted. Unfortunately, the debt I purchased also fell dramatically in value and right now it looks like the recovery on it will be pretty pathetic, if anything.

The trouble is, I didn’t technically execute well. I bought some in-the-money puts that were earlier dated (Sep 2012). I sat and watched my bonds get eviscerated even as it became clear there was no benefit in being hedged because the company was essentially a one-way trade (short) as they faced a going-concern issue. Meanwhile, the puts just didn’t perform because of what I paid for them– as they traded up a bit I didn’t receive much benefit because I bought at such a wide initial bid-ask spread. I probably could’ve more intelligently bought the puts so as to make a killing at this point in the game, but I didn’t know how to, that was beyond my expertise then and now.

Additionally, there were numerous points at which the puts were worth substantially more than what I ultimately paid for them (40-60% more at various points) but I never took advantage because I was greedy and assumed the share price would keep going down as everyone realized it was hopeless and the puts concurrently traded higher. Instead, volume dropped on the puts as people closed out their trades and the value of the options dwindled as they neared expiration (which is tomorrow). Fearing a total wipeout on the puts, I threw them into the market at market price this afternoon, happy to be rid of them and at a 20% profit.

Unfortunately, this was a fraction of what they had been worth at various points and was not enough to compensate for the loss in the bonds, such that even though the thesis played out as anticipated, I lost money on this trade.

I’ve learned my lesson now. I have one more cap-arb that’s ongoing and I’ll let it play out before selling. But I’ve realized I’m in over my head on this stuff and I don’t have the time and knowledge to get myself up to speed. I am my own worst enemy on this stuff, truly the biggest risk of permanent loss of capital lies within me.

With respect to that, I just won’t touch these kinds of trades anymore.

Good News For Shareholders: Nintendo Contemplating Buybacks ($NTDOY)

Hard to miss the meaning of this press release (PDF):

Nintendo Co., Ltd. (the “Company”) believes a stock trading unit reduction is one of the effective measures to expand the investor base and enhance stock liquidity. However, among shareholders there are arguments for and against the reduction.

Therefore, taking into consideration aggregately the movement of the overall stock market, the level of the Company’s share price and liquidity of the Company’s shares, among other things, the Company will continue to carefully evaluate the feasibility of a stock trading unit reduction from various perspectives.

That was the whole press release. I’m not sure why a company would post that if they weren’t planning a buyback.

Also, they’ve hired a former Disney exec to head up their online marketing efforts at Nintendo of America. I think Nintendo is done clowning around and ready to clean everyone’s clocks again.

*UPDATE* (6/29/2012):

Hard to miss the meaning? Don’t worry… I still managed to. A fellow value investor e-mailed me to tell me this press release is actually a trial balloon for a share split, not a buyback.

I guess my original post stands as a good example of interpreting evidence via confirmation bias, that is, seeing what you want to see. I heard Iwata talking about share buybacks as a possible use of the company’s excess financial resources, saw this press release, put 2 and 3 together and came up with 7.

Math has never been my speciality.

*UPDATE 2* (6/29/2012):

The ever helpful Nate Tobik adds in his $.02 (probably more valuable than the $.04 of myself and Henry at this point):

In Japan stocks trade in blocks so Nintendo has a 15000 ¥ price or so an you have to buy in blocks of 10 or 100 so for a shareholder to buy they’d need to pony up 5000 or whatever for a full block. What Nintendo is proposing is to reduce that so instead of having to buy 10 shares you can buy 1 which means only a 1500 capital commitment to start.

No split, no buyback, just change in minimum block trading size. You can find out what it currently is on the Tokyo exchange website.

Quotes – Generating Good Ideas

The best way to have a good idea is to have lots of ideas.

~Linus Pauling

Latest VPX Momentum Research Report: Banco Santander, STRONG BUY ($SAN)

NOTICE!

VPX Momentum Research is out with a new report on one of our favorites, Spanish mega-bank Banco Santander.

Current rating: STRONG BUY

Thesis: If you’ve been a customer of VPX Momentum Research you know we’ve been following this hot stock for some time. With all of the fear and talk of financial armageddon in Europe and Spain recently, the surprising strength of this stock has told us all along that there could be a big breakout in the mix.

Now, it’s here! Today, one of our favorite picks, Banco Santander, SA ($SAN) is up a mind-blowing 1,085% as of this writing– and we think it’s just the beginning. Clearly, this stock has momentum and it’s time to climb on.

At its newest market cap of $668B (that’s nearly 70% of $1,000,000,000,000, or one trillion), Banco Santander has catapulted into the ranks of the world’s largest companies by market cap, taking the position of #1 from $AAPL without even looking back. And with this kind of size, it can gobble up the next 5 largest banks by size as an appetizer. We think there’s a lot of room to run on this one and you should put in your buy order now before you miss out on 2,000% returns.

Enter a buy order anywhere at current prices. For those with a small risk appetite, consider a stop at $65/share, or a trailing stop of 20%.

And tell your friends!

(this post is written entirely for comedic effect and is not an actual research report nor an actual recommendation to buy this stock or any other. it is sad that we live in such a litigious and stupid society that I’d have to cover my ass like this, but there it is, just in case you’re a moron or trigger-happy with the “sue” button)