A Few Updates and a Look at George Risk Industries $RSKIA
A securities portfolio with an operating company attached.
Hello! Checking in with a few updates, then a quick discussion of an odd OTC stock: a securities portfolio with an operating company attached.
I was quoted in the Wall Street Journal by Jason Zweig on the ramifications of the changes to SEC Rule 15c2-11. Please forgive the self-indulgence in linking; this was a bucket list item for me. Two weeks in, the initial chaos caused by the rule change seems to be abating, but large inefficiencies remain.
I have read my share of Wall Street memoirs. Some were riveting and permanently changed the way I think about investing. Others were so dull or facile that I quit mid-way. The most notable of these was written by an investment manager whose halcyon days were the ‘80s. To paraphrase the first few chapters:
“I would find S&P 500 components with operational issues and a slumping share price. Then I would fly out and took the CEO out to lunch and say ‘So, tell me straight, you guys gonna be OK?’ If the answer was ‘Yes’ I would buy shares and make tons of money. Those were the days!”
To be an institutional investor pre-Reg FD… Anyway, I recently read Damsel in Distressed by Dominique Mielle. It was phenomenal. The book chronicles Mielle’s career in the glory days of hedge funds and distressed investing. It is intelligent, insightful, and really, really funny. Highly recommended.
My largest investment, P10 Holdings, is conducting an IPO. Is this how a parent feels at high school graduation? What a ride it has been, and it’s not over. P10’s roadshow presentation does a good job highlighting the company’s extraordinary business model and its bright future. If my wife and I cave and get the kids a puppy, we should probably name it P10.
And now, George Risk Industries! “GRI” is a cool little family-controlled business wrapped in a securities portfolio, trading quietly and only occasionally on the OTC market. Besides a great operating business, GRI also has a fantastic mid-century modern logo and a nostalgic website.
“grisk.com” still heralds the company’s 2017 acquisition of Labor Saving Devices, Inc. and the champagne toasts that accompanied the company’s 50-year anniversary in 2016. Put simply, this Nebraska company is a little on the sleepy side. And that’s ok! Sleepy and profitable beats the alternative.
George Risk is in the security business. They manufacture components for security systems like custom keyboards, proximity switches, security alarm components, and pool access systems and water detectors. Lots of products. These products are sold mainly through distributors to end users.
Business is good. Over the last decade, revenues grew at an annualized rate of 7.6%, with a strong acceleration over the last couple of years. Some of that is related to COVID, which saw a large increase in personal pool purchases. The other PPP, I suppose. But even without, GRI has a steadily growing growing business. Margins are excellent, with EBIT margins hovering around 30% year after year. And the business requires little capital to run. EBIT/Invested Capital exceeds 50% most of the time.
Naturally, GRI’s consistent profits and low capital intensity result in a lot of free cash flow. Most businesses would use this cash flow to invest in growth opportunities, perform acquisitions, or return capital to shareholders. Unfortunately, George Risk has little appetite for the first and second alternatives, and only tepid interest in the third. Rather, the company has allowed millions upon millions in excess capital to build up on the balance sheet. At July 31, the company’s investment in securities was $34.1 million at fair value, or more than half of GRI’s market capitalization. Equity securities accounted for 80% of the portfolio, with the rest in municipal bonds and a tiny amount in cash alternatives.
The company does pay an annual dividend and typically increases it yearly. September’s annual dividend was 50 cents, compared to 42 cents in 2020 and 23 cents in 2011. An 8% annual dividend increase is really quite good. Problem is, it is not sufficient to put a dent in the company’s excess capital. A decade ago, GRI held $3.85 per share in securities. Today, it has $6.89 per share. George Risk buys back a small amount of shares, but there are just not that many it can repurchase. Descendants of the original George Risk own 60% of shares outstanding.
Ordinarily, I would value a business like GRI at a healthy multiple for its consistent growth, excellent margins, and low capital intensity, offset somewhat by its tiny size, illiquid shares, and reliance on a small number of distributors. Perhaps 12x trailing EBIT would be fair. That would value George Risk shares at $22 compared to the current price of $13.
However, that’s taking far too rosy of view of the company’s capital allocation. Shareholders should not be willing to value the company’s securities portfolio anywhere close to its trading value, because they are unlikely to receive the full benefit of that portfolio on a reasonable time frame.
And that brings me to some of the fundamental questions I ask myself when evaluating the tiny companies that I do. “Why does this company exist? For what purpose and for whose benefit?”
Most (but certainly not all) large companies are run in an attempt to provide a reasonable return for shareholders. If they aren’t, it is only a matter of time before a legion of powerful activist investors and institutions show up to set them straight. This is not at all the case with many small companies, especially those controlled by a family or small group of investors. In many of these cases, the company is primarily used to fulfill a variety of roles not so different from a family office. Namely, to preserve wealth, provide employment, and generate prestige. Some do manage to provide a competitive return for shareholders at the same time. George Risk is one of them. But many others function more like The Bluth Company.
In other words, I have zero doubt that if George Risk Industries were not controlled by the original founding family, it would have long ago distributed its generous portfolio to investors one way or another. But keeping the securities portfolio within the company defers taxes for the controlling family and creates a substantial cushion that ensures solvency through difficult environments. I am all in favor of companies keeping reasonable reserves on hand for just such circumstances, but GRI’s war chest is excessive.
So, sub-optimal capital allocation that is highly unlikely to change causes me to discount the value of GRI’s securities portfolio heavily. I don’t think a 60-70% discount is unreasonable. Using that same 12x EBIT multiple would value George Risk shares at $17-18 or so. Good upside potential versus the current price, but not an exceptional bargain. Nonetheless, George Risk seems to be a fairly low-risk, value-priced place to park capital for the long term.
At the end of the day, all a business is is people. And the people in charge of a business will act in accordance with their motivations and desires. Unless you have the capacity to be an activist investor, you are more or less stuck with current leadership, so you had better be sure they have your best interests at heart. The best way to do this is to ensure their interests are the same as yours.
GRI leadership appears to be more interested in maintaining value than maximizing it. I don’t think this makes a company uninvestable, but it does demand a sober reflection on the cost of those mis-aligned priorities. In many cases, management’s inability or unwillingness to maximize value may be the largest liability a company has, but you won’t see it on the balance sheet. Failing to perform this adjustment has cost me plenty over the years.
As always, happy researching!
Alluvial Capital Management, LLC does not hold shares of George Risk Industries, Inc. for client accounts it manages. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at firstname.lastname@example.org.