Value Investors, Value Collectors
|Apr 26, 2017|
I'll be in Omaha May 5-7 for the Berkshire Hathaway shareholders' meeting and the Markel brunch. I have a busy schedule, but it would be great to meet up with any readers who will be in attendance. E-mail me at email@example.com.
In my five years of writing on OTCAdventures, I have had the pleasure of interacting with hundreds of investors in micro-cap stocks and other market niches. I have found that people have different motivations for investing in these companies. Some simply want to make a lot of money. Others get a measure of pride and satisfaction out of owning things that few others do and discovering new treasures to add to their hoard. These I'll dub "Collectors." Collectors desire a good return, but delight in businesses that are unique in some way, or have some historical cachet.
I am one of these. I derive a great deal of satisfaction from owning the truly rare and unusual. Century-old community banks, the leftover husks of former corporate dynasties, industry pioneers now occupying some sleepy niche. Problem is, many of these "Collector Edition" securities are simply not good investments. Either the economics of the business are too challenging or management is out-matched or self-serving. Consequently, these are not often securities I buy for Alluvial's clients and partners. But personally, I really enjoy owning stocks like Ohio Art Company, which until recently was the owner of Etch-a-Sketch. Or St. John Knits, the venerable designer of apparel for wealthy and powerful women.
One of these unusual companies I have never seen being discussed anywhere is Massachusetts Business Development Corp. I have been a shareholder for several years. "MBDC" is a strange quasi-governmental organization dedicated to providing business financing and venture capital in the New England region. MBDC is not government-owned, but it is very much government-supported via various lending and tax incentive programs. Founded in 1953, the company is the nation's oldest Business Development Company. Over the course of its existence, MBDC has invested over $1 billion in small companies and startups, creating untold wealth for the economies of Massachusetts and the neighboring states. MBDC invests directly in companies, providing the full spectrum of financing from senior and mezzanine debt to working capital factoring or equity. MBDC also manages a handful of investment funds and invests in these funds.
MBDC operates as a sort of co-op. While shareholders are the nominal owners of the company, the true power rests with the company's members, a large group of New England banks and insurers who provide the company with capital to deploy. There are 165,382 MBDC common shares outstanding, each with one vote. But, members receive 1 vote for every $1,000 of capital loaned to MBDC. There is presently $56 million in capital loaned to MBDC by members, resulting in 56,000 votes for those members. Shareholders are simply along for the ride.
The company is consistently profitable and does pay a small dividend. But one might expect that with the company's economic growth mandate, it is not a profit maximizer. One would be correct. MBDC's three year average return on equity is around 6%. At year-end, Massachusetts Business Development Corp.'s balance sheet reached $77 million, up from $67 million in 2014. The company has been focused on deploying more capital in support of economic growth in its service region. Book equity is currently $10.3 million, which makes the company appear highly leveraged. But remember that nearly all of MBDC's financing is provided by member banks and insurers, at a very low cost. At year-end, the company's cost of debt was just 1.4%, and the company had borrowing capacity of an additional $163 million. MBDC does experience loan losses typical for an investor in venture-stage and small enterprises, but these losses are easily surpassed by the loan fee income and investment management income the company generates.
Liquidity is extremely poor for MBDC shares, and the bid/ask spread frequently suggests no reasonable two-way market exists. At the most recent trade of $28, MBDC trades at a price to book ratio of 45% and a P/E of 8.2. I am not suggesting this is cheap. Remember that shareholders have effectively zero control over the company and should not expect any sort of meaningful dividend, share repurchases, a buyout or other value catalyzing event. I expect that MBDC will go about executing its mandate, not seeking to enrich a tiny number of voiceless shareholders. The only way I can foresee shareholders doing very well is if the business is for some reason placed into run-off and eventually liquidated. How could that happen? I suppose that like the controversy over the federally-chartered Export-Import Bank, conservative politicians could seek to nix MBDC in the name of opposing "crony capitalism." But frankly, that's pretty unlikely in New England. It's much more likely that MBDC continues to operate for decades, and remains nothing more than a little oddity in my portfolio. And that is fine with me.
I personally own shares of Massachusetts Business Development Corp. I may buy or sell shares of MBDC at any time.