An Unlisted Eccentric - ACMAT Corp. ACMT/ACMTA

One of the reasons I so enjoy the unlisted markets is the opportunity to discover and examine some truly odd and unconventional stocks. Where else in the public markets can one invest in a massive and secretive agricultural empire (J.G. Boswell Co. BWEL), a minor league baseball team (Rochester Community Baseball Inc. RCCB) or even extensive real estate, timber, energy and mineral assets in Michigan or Tennessee (Keweenaw Land Association, Ltd. KEWL and Coal Creek Company CCRK)? It's tough to get bored.

ACMAT Corporation qualifies as one of these eccentric companies. ACMAT is a national provider of surety bonds for the construction industry. Surety bonds are purchased by builders and contractors by necessity. These bonds are sold by insurers, who agree to pay damages in the event that a contractor fails to complete a contract to the agreed specifications or otherwise fails to perform. After all, nobody wants to award a contract to a construction firm without having recourse should that construction firm go bankrupt with the building halfway complete. Which is why things like the CSCS Mock Tests by Construction Skills Test exists, which everyone involved, in the end is glad for. ACMAT specializes in providing bonding for non-standard contractors who otherwise would have difficulty securing coverage from conventional surety bond underwriters. That may sound risky, but the truth is that ACMAT is an exceptionally conservative underwriter. In 2012, ACMAT's loss ratio on premiums was only 10%, and 11% in 2011. That kind of underwriting would be a recipe for amazing profits, but the company uses only a scant percentage of its total underwriting capacity. In the 2012 annual report, the company noted that it could increase premiums more than 20 fold before breaching NAIC guidelines. Due to its conservatism and history of profitable underwriting, A.M. Best rates the company at "A" or excellent.

ACMAT is an insurer that scarcely bothers to insure. In fact, premiums written have declined 85% from a high of $15.7 million in 2004. The company expresses a willingness to increase its activity once the construction market picks up, but it is unlikely that any increase will approach previous levels of underwriting activity. ACMAT's current asset base is 47% lower than it was in 2004, and its equity is 25% lower.

As conservative and limited in scope as ACMAT's insurance operations are, the company could hardly be more aggressive when it comes to returning capital to shareholders. ACMAT is a voracious purchaser of its own shares. ACMAT's formal share repurchase operation was begun in the 1980s, and the company has had a laser focus on reducing its share count ever since. Since 1994, the company has reduced its shares outstanding by a whopping 73%, hoovering up an average of 6.7% of shares outstanding each year. Since 2009, the pace has accelerated to 8.3% per year. A yearly chart of shares outstanding and book value per share is presented below.

From 1994 to the present, ACMAT spent a little more than $77 million on net share repurchases, a figure that is more than four times the company's current market cap. The repurchases were done at an average price-to-book ratio of 1.05.

At this point, I'd love to talk about how ACMAT's share repurchases were some Templetonesque example of superior capital allocation policy and how shareholders have enjoyed high teens level returns for decades on end. Unfortunately, I can't, because ACMAT's returns have been awful, and that's putting it gently. Since the end of 1994, shareholders have seen their investment in ACMAT's class A stock rise by.....151%. Over the same period, the S&P 500 (in terms of SPY) returned 481%. Even the Barclays Aggregate Bond Index returned around 221%. There's no excusing such a poor long-term performance. ACMAT's return on equity has consistently failed to match its cost, costing shareholders millions.

It goes to show that for as much as value investors love to trumpet the benefits of share repurchases, they aren't magical. Satisfactory long-term returns require a comprehensibly sensible capital allocation policy that strives to earn an acceptable return on equity. ACMAT shareholders would have been much better off if the company simply liquidated in 1994, rather than spending the next two decades earning anemic returns on equity. Even today a liquidation would be very beneficial. Company shares trade at a large discount to book value and the company seems unlikely to earn an attractive return on equity any time soon.

But of course, that will never happen due to ACMAT's thoroughly entrenched insiders. CEO Henry W. Nozko and his wife Victoria C. Nozko together own a majority of shares outstanding and control nearly all of the voting power. The last available compensation data for Mr. Nozko is from 2003, where he earned a salary and bonus of $732,000. This may not seem like much, but it equaled fully 29% of ACMAT's pre-tax income for the year. The company's top three officers earned an amount equal to 62.5% of ACMAT's pre-tax income for the year. This data is old, but I see little reason why anything would have changed in the last decade, especially now that the Nozkos control even more of the company's shares through the continued repurchases. Company management also seems prone to vanity projects, including the construction of a brand new headquarters at a cost of $4.3 million in 2012.

That brings me to the second point of this post: management matters. And it matters especially with insider-controlled micro-cap companies, where the major institutions and activists that keep large company management teams nominally in check are absent. Management teams at large companies can and frequently do make bad capital allocation decisions, overpay themselves and pursue vanity projects. But if they do it for long enough, they are typically challenged and either chastened or removed altogether. There is rarely such a check on the tiny and obscure companies that populate the world I play in, and that makes management evaluation all the more important. Some like to talk to management directly and ask questions about strategy, assess ethics, etc. That works for them, but I reason that shoddy or dishonest managers are pros at knowing what investors want to hear and saying exactly that. I'd rather look at what they do. Managers prove themselves to me by aligning their interests with shareholders, then showcasing their skill and trustworthiness by creating track records of efficient operations, astute capital allocation decisions and reasonable compensation.

Perhaps if ACMAT's management team gets serious about improving returns on equity and equally serious about reducing its cost structure, ACMAT will be an attractive investment. But for now, it's just another unlisted oddity.

Alluvial Capital Managment, LLC does not hold shares of ACMAT, Inc. for client accounts.

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