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6 Potential Buyouts

One of the best feelings you can experience as an investor is waking up and reading about the acquisition of one of your stocks. I enjoyed this recently with Met-Pro (MPR), which I held in my Top 20 Model Portfolio and was one of my largest positions in my Conservative Growth/Balanced Model Portfolio at Invest By Model. Unfortunately, this type of windfall hasn't been that frequent of late, at least for me.

While I don't typically make potential acquisition my central thesis, it is a factor that I take into consideration. One part of the market that I think could see some M&A activity is the retailer industry. While retailers don't typically buy other retailers, though there are exceptions, retailers are often acquired by private equity firms. Most recently, True Religion (TRLG) announced that it will be acquired by TowerBrook Capital (5/10 announcement). Earlier this year, Hot Topic (HOTT) announced it would be acquired by Sycamore Partners (3/7 announcement). It wasn't that long ago (2011) when J. Crew Group was acquired by TPG Capital and Leonard Green & Partners.

 I find it easy to find retailers trading at below-market multiples despite having fortress balance sheets. With borrowing costs low, private equity appetite increasing and cheap valuations in the retailer universe, I decided to look for some potential LBO candidates. The following table consists of six companies that met my criteria: <6X EV/EBITDA and a market cap of $300mm to $2 billion:

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MJNA Q1 Report Feeds Bears But Offers Bulls Promise

In what can only be described as a two-minute drill, Medical Marijuana Inc. (MJNA.PK) delivered on its promise to get its Q1 OTC filing with audited Q1 results posted by 5/15, as the company had indicated in its 4/30 press release. I am going to give it a double-asterisk: One for the fact that it posted just a few minutes before midnight in California (where the company is based) and another for the fact that it posted incompletely, with the footnote 4 truncated and numbers 5-12 missing.

Like any report, investors will have different takeaways. The bottom-line from my perspective is that there were many negatives, but I also see some promise in improved transparency. The stock sold off after initially opening a bit higher, but it had run up over the past few days, perhaps due to TD Ameritrade apparently lifting its DTC Chill that prevented its customers previously from being able to buy the stock.

Because the filing is incomplete and because CannaVEST (CANV.OB) has delayed its 10-Q until May 20th, I will share a preliminary review of the quarter. For some background, the company had given its first-ever guidance in February, indicating that it would generate sales in 2013 of $47mm and operating cash flows of $32mm. In early April, it announcedQ1 results of $8.45mm sales and net income of $4.52mm. The press release from today never mentioned sales or earnings, which was quite odd, though it did point to the OTC Market Disclosure. The filing indicated sales of $2.185mm and net income before extraordinary items of just $570K. With extraordinary items of $4.8mm, MJNA reported net income of $5.37mm.

 

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Why the End of QE Wont Kill Stocks

Looking at stock returns over very long periods reveals two key determinants of price: Earnings and interest-rates. While everyone will probably agree that earnings are important, many find the relationship between interest-rates and stocks to be confusing. Many believe that low-interest rates now are causing stocks to be bid up too aggressively and fear that the possible end of quantitative easing by the Federal Reserve could lead to a correction in the S&P 500 (SPY) or even a new bear market.

At a meeting with a client last week, we discussed the dynamics of QE possibly ending soon, and it was a somewhat heated debate. Reasonable people will arrive at different conclusions on this topic. While I certainly acknowledge that rising rates might have a negative psychological effect on stocks over a very short period of time (and I do think that rates will rise), I believe that rising rates, if they reflect improving economic growth, are what we should hope for!

Why Interest-Rates Are Important

 

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MJNA Cash Flow Statement Q4-2012

This is funny:

 

MJNA Doesn't Own Dixie Elixirs - Just The Brand

I have been so focused on transparency and accounting issues that I have missed what may be an even bigger part of the story: Medical Marijuana Inc. (MJNA.PK) gets no benefit from sales of Dixie Elixirs and other Dixie products in Colorado. I first learned of this on a message board where "StevenRisk" suggested this idea. Given that this certainly wasn't apparent to me after almost three months of studying various aspects of the company, I went back to the filings and press releases in order to understand the relationship better.

While it seems that management doesn't go out of its way to clarify the issue, it's all there in black and white: MJNA owns the brand only (60% actually) and not the company. This is very important because many investors seem to equate success of Dixie Elixirs with potential success for the stock, mistakenly assuming that sales in Colorado result in a benefit for MJNA. I had struggled to reconcile what is clearly a rapidly growing product with the lack of revenue for MJNA. In the 4th quarter, 96% of sales came from a licensing fee for PhytoSPHERE of $4.5mm, which I have described as questionable and which was confirmed by the company in their 4/30 press release.

MJNA announced a year ago that it had acquired "all intellectual property, research and development, formulas and recipes associated with medical cannabis brand, Dixie Elixirs & Edibles, from Dixie Holdings, LLC.". The company formed a holding company known as Red Dice Holdings, which is owned 60% by MJNA and 40% by Dixie. 

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How To Use Sum Of The Parts Analysis To Find Cheap Small Caps

With a rallying market that has been driven more by valuation expansion than by earnings growth, bargains are getting more and more difficult to find. With little evidence of earnings acceleration and stocks more fairly valued in aggregate now, the hunt for value is more challenging and requires more effort. One area that has intrigued me recently with respect to potential opportunities is when companies have separate operating units performing differently from one another or have engaged in M&A with near-term dilution (which isn't always negative!). Because most investors apply valuation metrics to the overall company, this can lead them to miss out on a potential bargain, especially among smaller and less widely followed names. As I will describe, the opportunities arise potentially from M&A, expensive internal development or sub-par performance at an operating unit.

An Exaggerated Example

To illustrate the point, let's consider a hypothetical company that has:

• 10mm shares outstanding
• Net income of $5mm ($0.50 per share) expected over the next year
• Sales of $50mm
• Price of $10 ($100mm market cap).
• Cash of $20mm ($2 per share), earning no interest

Based on these assumptions, the stock trades at 20 PE ($10 price divided by $0.50 EPS) or 16 PE adjusted for cash ($10 less $2 is $8, divided by $0.50 EPS). The stock has traded 15-25 PE for the last 5 years, and EPS has grown 15% per year for the past several years and is projected to grow 15% over the next 3-5 years.

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MJNA: How Management Misled Investors Beginning in 2011

I first learned of Medical Marijuana, Inc. (MJNA.PK) in February, when anonymous, self-proclaimed short "Infitialis" called the company a "fraud heaped on top of folly." Fascinated by the story, I spent that weekend learning more about the company and other marijuana-related names, quickly concluding that the stocks were in a bubble. I have followed up with a series of articles that question the company's financials, most recently describing how Medical Marijuana, Inc. appears to have used very aggressive revenue recognition in the fourth quarter last year.

As I continue to dig deeper to better understand this company's history, I am becoming more confident that the management team has indeed been dishonest. While Infitialis raised a lot of issues about the backgrounds of some of the people involved, the article failed to point to what may be the single most alarming aspect of the story: Hemp Deposit & Distribution Corp. (HDDC) apparently misled investors in its promise to deliver assets to the company in exchange for 260 million shares and control of the company two years ago.

 

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5 Sick Healthcare Stocks

The healthcare sector is leading the way in 2013, up almost 19%, and 8% ahead of the S&P 500's 10.94% price return. The third largest sector of the S&P 500 (after Technology and Financials) has 53 members, but the performance has been quite varied. Several biotechs are soaring, and almost all of the stocks are up. The rising tide, though, is failing to bring along these five:

• DGX
• EW
• ISRG
• PKI
• VAR

What ails these laggards? Let's look at each of them to evaluate the prospects for a speedy recovery.

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MJNA: Here's The Smoking Gun

Medical Marijuana Inc. (MJNA.PK) has been selling off for the past two months despite an abundance of good news, including bullish guidance for 2013 and 2014 and a strong Q1. Not even the 4/20 celebration was able to shake the stock out of its downward trajectory, as the stock just tested the low price since rocketing to .50 earlier this year, trading as low as .185 as it sold off on massive volume before closing near .21.

For some background, I have written about MJNA several times since mid-February:

• 2/18: Industry Bubble
• 3/5: Questionable Transaction with CannaVEST
• 4/12: Why MJNA Has Been Weak

My thesis has been that the company has questionable financials, and that is the issue I want to explore more closely now that they have amended their Annual Statement as of 4/24. In my last article, I had suggested that we need to wait until 5/15, the date by which the company intends to file its audited Q1 report, to better understand how it is accounting for its transaction with CannaVEST (CANV.OB) that I described in the second article. Investors should be aware that the company has booked $4.5mm in sales in Q4 on the basis of shares received from an affiliated company in January, weeks after the quarter ended. This revelation is a smoking gun for those of us who have been questioning the financials of the company.

MJNA's Strong 4th Quarter

On January 22nd, MJNA issued a press release with a captivating subtitle:

 

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Will PBI Slash Its Dividend?

After two nasty dividend cuts on S&P 500 stocks earlier this year, it's not surprising that investors are questioning the likelihood of Pitney Bowes (PBI), which offers the 2nd-highest yield in the S&P 500 at 10.5%, sustaining this generous payout. While the CenturyLink (CTL) and Cliffs Natural Resources (CLF) reductions announced on February 13th were surprises that led to sharp declines in their stocks, there has been significant discussion about PBI already. Adding fuel to the fire regarding a potential reduction, the company skipped raising it in January, breaking from its historical practice in recent years. I believe that the recent pullback reflects nervousness regarding this issue, as the company will be reporting Q1 EPS on 4/30 and hosting an Investor Meeting on 5/3. While PBI's board could decide to reduce the payment, it would be unnecessary in my view. Given some concern perhaps that they might be about to do so, maintaining the dividend might serve as a near-term positive catalyst for PBI.

Dividend History

PBI has an impressive history of dividend growth.

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