Value Thoughts

Western Capital Resources, Butler National, the "Peter Kamin Complex"

Hello! It’s been a little while since I shared my thoughts, so I thought I’d discuss a few interesting situations playing out in the market. And what a radically different market it is than just a few months ago. Today’s rally notwithstanding, the Russell 2000 has given back all of 2021’s gains and then some. I do think there are plenty of bargains for anyone willing to bear short-term pain. But I’ll also say that investors are reluctant to put a decent multiple on small and illiquid companies in the best of times, and these are not the best of times. It takes time for confidence to return, and we could see obscure and off-the-run securities trade cheaply for quite a while.

Western Capital Resources - A Takeunder Without the “Take”

One of the most unfortunate consequences of last year’s SEC rule change around “dark stocks” is the opportunity it creates for hostile management to shake down shareholders. The first step is deregistering with the SEC. OK, fine. Plenty of companies do this to save money, reduce the compliance burden, etc. Reputable companies then continue reporting financials through OTC Markets and nothing else changes. In most cases shares were not terribly liquid before, so deregistering and switching to OTC Markets reporting does not degrade shareholders’ ability to transact, even if the change involves leaving the exchange. However, if a company declines to publish financials through OTC Markets after deregistering with the SEC, shareholders are left with no effective means of selling their shares or acquiring more. The new SEC rule prevents market makers from distributing quotes in non-reporting companies to retail investors, preventing nearly all trading.

An unscrupulous company can effectively go private by deregistering its shares and then declining to provide financials to OTC Markets (and pay OTC Markets for the privilege.) Shareholders still own their shares, but their value has been seriously impaired as they are completely illiquid. At this point, the company can allow these shareholders to languish indefinitely, or make a lowball offer to shareholders. A great number of shareholders are likely to accept this offer, knowing it could be their only opportunity to realize value on a reasonable time frame. All the usual requirements still apply to deregistering companies under applicable law: shareholder meetings, making financial statements and shareholder lists available to shareholders. But in truth, companies have a massive financial and informational advantage over small shareholders. It is unlikely that retail shareholders will have the means and ability to perfect their rights.

This is what is happening with Western Capital Resources. “WCR” is a holding company that owns various businesses including mobile phone retail stores and seed/garden catalogues. WCR was spun out of a liquidating private equity fund years ago and is majority-owned by a private equity firm. WCR has bought and sold multiple businesses over the years with good success. The firm is strongly profitable and maintains a very large cash war chest. Shares are likely worth somewhere in the low teens, even after adjusting for their extremely low liquidity and the company’s controlled status. But last week, WCR rocked shareholders with an announcement.

On May 17, 2022, a special committee of the Board of Directors of Western Capital Resources, Inc. (the “Company”), comprised of the Company’s sole independent director, approved the deregistration (the “Deregistration”) of the Company’s common stock from the reporting requirements under the Securities Exchange Act. The Company intends to effect the deregistration by filing a Certification and Notice of Deregistration on Form 15 on or about July 18, 2022. Such Certification and Notice will be immediately effective upon filing, after which time, among other things, the Company will no longer file Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q or Current Reports on Form 8-K. In addition, the Company anticipates that its common stock will no longer be traded on any over the counter market or other recognized public market after the Deregistration.

The Company expects that the Deregistration will reduce or eliminate significant compliance costs associated with the Company’s public reporting status. When approving the Deregistration, the Committee considered, among other things, these cost savings, the Company’s limited volume of trading in the Company’s stock and the resulting liquidity discounts experienced by the Company’s stockholders, the fact that the Company has not sold its securities in public markets since 2012 and that it has no intention to do so in the foreseeable future.

The Company intends to wait until on or about July 18, 2022 to file a Certification and Notice of Deregistration on Form 15 and thereby effect the Deregistration, to allow the Company’s stockholders to trade in the Company’s stock in the interim. While the Company currently intends to offer to repurchase shares from stockholders annually following the Deregistration, the Company can provide no assurance that such offers will occur at all or will continue to recur or the prices at which they will occur, if at all.

What a body blow! Come July, WCR’s minority shareholders will no longer have the ability to trade their shares in public markets. They may have the ability to sell their shares to the company once a year, but no guarantee! Even if the company does tender for shares, it certainly won’t offer anywhere close to fair value. WCR could easily avoid abusing its shareholders by filing an annual report with OTC Markets and paying the nominal fee. It’s not a material amount for a company with WCR’s scale and balance sheet. But WCR has decided that its shareholders do not deserve the transparency of public reporting or any trading venue for their holdings, which they purchased with the expectation of being able to sell someday. In doing so, the company is executing a de facto takeunder without actually paying those pesky shareholders.

Anyone would have to consider selling now and taking the loss. By selling today, you achieve some value for your shares. As much as it hurts, it’s better than possibly getting something a year or more from now with no guarantee the purchase price is higher than today’s market bids. Awful. The only shareholders who should consider buying today are those who trust management to continue running the company well and to someday return full value through a sale or re-listing. The first assumption seems reasonable given the track record. The second does not at all.

Quick Value - Butler National

Butler National is having a great year with shares up 13% year-to-date. And yet, I am mystified that shares aren’t up lots more. To summarize, Butler National owns a Western Kansas casino and an aerospace services business that repairs and upgrades small personal aircraft. The casino business is going gangbusters while the aero business has recovered nicely from the COVID lows.

Butler National purchased its casino building and bought out its business partner, putting itself squarely in control. The timing was good as Butler secured long-term mortgage financing and extinguished the minority interest just as the business reaccelerated post-COVID. In the quarter ended January 31, the casino business produced revenue of $9.3 million and cash earnings of $4.1 million before interest. Results for the quarter ended April 30 should be even better. I don’t think most investors know, but the state of Kansas actually publishes monthly results for each casino. Net gaming revenue for February, March, and April totaled $9.6 million, an all-time high. We could easily see the casino business produce EBITDA of $16 million this year.

Meanwhile, things are good at aero. The backlog has been rebuilt after declining during COVID, and the company has invested in new FAA certifications which will allow them to install and service new types of sensors and equipment.

Put it together and you have a company set to earn 16-20 cents per share this year against a share price of $0.88 and >10 cents/share in excess cash. OK, so the casino/aerospace combo is odd and management is on the eccentric side, but 4x earnings for a healthy, cash-flowing company is just too cheap.

Peter Kamin Always Get Paid

I have been a long-time investor in multiple companies controlled by Peter Kamin. Calloway’s Nursery and Rand Worldwide in particular have been major contributors to Alluvial’s returns. My biggest mistake with these positions has been every occasion where I reduced our ownership because the shares looked fully-valued or the short-term outlook diminished. In each case, Kamin & Company made me regret it.

What I appreciate most about Kamin’s leadership is the way he views cash and capital returns to shareholders. Calloway’s Nursery and Rand Worldwide are quality businesses. They each produce strong returns on capital and generate significant excess cash. The same is true of many other micro-cap companies, but at those companies, management seems unsure of what to do with this cash flow. They either let it pile up year after year, seemingly terrified or letting it go, or they blow it all on a mediocre investment at the top of the business cycle.

By contrast, Peter Kamin’s approach to cash seems to be something like this.

1. Can the business make simple investments that are highly likely to deliver 20-30%+ IRRs in the medium-term? If so, make them, even if they reduce profit this year and next.

2. Is there cash left over after making these investments as well as a buffer for ordinary operations? If so, return that cash to shareholders with special dividends.

3. Can the balance sheet accommodate limited debt financing at reasonable rates? If so, take on debt and use the proceeds to offset the equity component of investments and/or supplement special dividends.

Simple, rational and effective. This playbook has resulted in steady growth in profits and a very healthy stream of special dividends. A great recipe of shareholder returns! Calloway’s Nursery has declared dividends of $1.95/share over the last 12 months, 13% of its current share price. Rand Worldwide is no slouch either, paying out $1.50 for a nearly 9% yield. And neither did this while neglecting to reinvest for future growth. Calloway’s opened two additional garden centers earlier this month, while Rand Worldwide regularly performs tuck-in acquisitions of other software resellers.

I doubt Mr. Kamin will ever read this, but if he does, I hope he takes this as a sincere thank you from a grateful shareholder.

Does anybody out there know who the next Peter Kamin is?

Alluvial Capital Management, LLC holds shares of Calloway’s Nursery, Inc., Rand Worldwide, Inc., and Butler National Corp. 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 info@alluvialcapital.com.