Why I Invest In Unlisted Stocks: A Case Study

I invest in unlisted stocks for a number of reasons.

One, I like the thrill of the hunt. Finding these tiny but successful companies is a blast and a great antidote to the boredom that comes of hearing the same ten large cap company names over and over again every trading day. Is anyone else already tired of reading about Apple's bond issuance or JC Penney's dire straights?

Two, I like being a little different. It's a wild world out there! The S&P 500 constituents are dull! Why not buy some shares in your local community bank instead? Or in a tiny widget manufacturer and then call up the CFO and shoot the breeze?

Third, the returns! Nowhere else have I found such abundant opportunities to buy companies at a fraction of their listed competitors' valuations. On average, the investor who pays $1 for an asset will fair much better than the investor who pays $2 for a substantially similar asset.

To illustrate my point, let's look at a company I own and have written about before, Alaska Power & Telephone. APT shot the lights out in 2012. Here are just a few of the company's accomplishments.

  • Achieved record net income of $2.55 per share.

  • Achieved record free cash flow of $5.61 per share.

  • Repurchased 10.4% of shares outstanding, reinstated a dividend and grew book value per share by 7.3%.

  • Reduced net debt 8.2% to $59.4 million. Net debt/EBITDA and debt/equity are at their lowest in the past decade.

The first quarter of 2012 saw further increases to net income and book value and another $1.3 million shaved from net debt.

Despite this laundry list of accomplishments, APT's stock price has not so much as budged. Net income continues to rise and net debt continues to fall and the market takes no notice. The result is a company that trades at barely half the valuation of comparable listed competitors.

APT's revenues are roughly 60% electrical power generation and transmission and 40% telecommunications services. Generating a comparison to peers is as simple as pulling up valuation statistics for utilities and telecom providers and weighting them appropriately.

The chart below compares valuations, yields and leverage for these industries, based on the trailing twelve months. The average telecom services EV/EBITDA multiple is actually 8.32. Since the index includes firms with wireless assets and APT has none, I reduced the the multiple by 2.00 to 6.32. This aligns fairly well with reality. Even troubled traditional telco Cincinnati Bell trades higher at at 6.86 times trailing EBITDA.

val comparison

On average, a business that is 60% electrical utility and 40% traditional telco would trade at 8.35 times EBITDA and carry net debt of 3.29 times EBITDA. APT is much, much cheaper.

val comparison 2

Despite being only slightly more leveraged than our hypothetical competitor, APT's valuation on an EV/EBITDA basis is 40.5% lower. To trade at the industry average valuation, APT stock would have to rise to $62.29, more than triple its current price.

All right, so APT does have a few weaknesses. It is geographically confined to an area of low population density and a harsh climate. The stock is illiquid. On the other hand, how many other utilities and telco firms are gobbling up their own shares while also reducing debt and earning record income and free cash flow? Moreover, APT's power generation facilities are mostly hydro-electric, leaving them immune to the threat of input cost inflation or the environmental issues of coal plants.

Even at just 80% of the valuation of its competitors, APT would be worth $41.18, 111% higher than today's price mid-point of $19.50.

Many investors view the unlisted markets as the exclusive domain of fraudsters and stock manipulators. And there are those. But there are also scores of profitable, well-run companies waiting to be discovered.

I have a position in Alaska Power & Telephone.