Friday, 14 February 2014

PFLM - Powerfilm

I must admit I'm not really much of a pure Graham & Dodd guy. I've always thought that not considering the quality aspects of a business and looking purely for the cheapest valuation metrics is a bit like buying a car with a clapped out engine, no doors and only one wheel because "my god it's so cheap compared to book value!" and then being surprised when it doesn't drive. However, on the twin axes of Quality and Value, sometimes I find something so ridiculously cheap on the value axis that I'm compelled to buy it despite significant quality misgivings, like when I bought PVCS because it was quite clear they could pay out the entire market cap in cash and still be a viable business (and they did!). PFLM falls squarely in this category.

Powerfilm floated back in 2006 at 125p. They reached a high of 485p back in 2007 on the back of euphoria about their products and market potential. Since then they have become a member of the -99% club as I managed to pick up some shares at 4.3p back in the end of November (I really need to get faster at doing write ups...). The shares last traded at 7p. I've learned to cease being surprised at how drastic the swings of euphoria and despair can be in equity prices.

Historically, Powerfilm has been the equivalent of a busted flush draw. Their expected explosive growth never happened and sales have, given the recent trading update, been essentially flat since 2007 at $8.2m. Reported profitability has deteriorated too, and the company haven't made a profit since 2008. The company is a ‘developer and manufacturer of thin flexible solar panels’ and their consumer products are quite cool, although the market is pretty saturated and price competitive hence the lack of profitability. The company has made the sensible decision to focus more on smaller niche markets where they can try to achieve pricing power and recent R&D and sales efforts have been in the Military and custom OEM
markets (although trying to sell in to the US military right now isn't the easiest of tasks).

The attraction for me at the current share price isn't the operating business (which looks like it's struggling in a pretty competitive environment) but the assets. Against a last traded price of 7p you're getting 50.3p of tangible assets. Net cash per share is 14.7p. My estimate of a conservative liquidation value (cash at book, property at 75%, non-cash NCAV at 50%, PP&E at 0%, all liabilities at book) is 26.2p. That's a 110% upside to net cash, 274% upside to my liquidation value estimate and a 617% upside to tangible book. This is after the stock has almost doubled from my original purchase price - you can see why I thought the company was (and still is) stunningly cheap.

These are the sorts of figures I expect in scenarios where the company is either a) insolvent b) is burning through assets at a rapid rate c) a fraud (Hi Naibu!) d) has terrible corporate governance issues. The business isn’t insolvent – they have more cash on the balance sheet than the sum of liabilities. Despite the big reported losses (pre tax $2.2m in the trading statement) cash burn is much lower due to heavy depreciation, at $0.5m per annum, so it'd take them roughly a quarter of a century to burn through their current pile. The company have confirmed to me that capex is being deliberately limited whilst they are undergoing the current solar market turmoil and won't be increased unless higher capacity is needed (They also note: "We do expect a need for future capacity expansion and are holding the cash to meet that that expectation").

The company doesn’t appear to be a fraud either, they are American and incorporated in Delaware (the US state most businesses are incorporated in due to it being business-friendly and they have a lot of business case law to draw on) and operate out of Iowa. Muddy Waters won't be chasing them down any time soon.

There’s some concern on the corporate governance front given the two founders own ~2/3rds of the company, however their track record towards minority shareholders has been very good. No insider of the company has ever sold a single share, even at the market peak of 485p when the company was clearly incredibly overvalued and trading on a huge multiple of sales (>10x revenues). Management bought back shares in 2008/2009 explicitly because:
‘The Board of Directors of PowerFilm approved the share repurchase based on the view of the management of the Company that the shares of the Company are undervalued.’
A move that was accretive to NAV per share. In fact, since I contacted the company asking (amongst other things) about share buybacks, they've restarted them:
PowerFilm, Inc. acquired 245,000 common shares in the Company at an average share price of US$.09 per share.  Following this acquisition, these shares are being held in Treasury.  The PowerFilm, Inc. Board of Directors approved the share repurchase based on the view of the management of the Company that the current trading prices of the shares of the Company (on the LSE AIM) were substantially below the inherent value of such shares.
The amounts spent are small but to be fair to the company I can confirm, from experience, that buying stock in any significant quantity for this company is pretty hard. It's more the shareholder value orientation message I value.

The founders aren't extracting value from the company at the expense of shareholders via compensation either. The CEO is paid a measly $131k a year, with the rest of the board on salaries under $25k a year and apart from the CEO leasing a building to the company for $90k a year there are no other related party transactions. Their prime economic incentives are aligned well with minority shareholders.

With dominant insider shareholders there's always the risk of the company being taken private on the cheap, although theoretically Delaware also has laws protecting minority investors from being forced out of their investments at disadvantageous prices (See and a delisting would still be possible. It's a risk, but given management's fair treatment of minority shareholders so far I think it'd be out of character.

So what's going to happen with Powerfilm? Where's the catalyst here, what's the end game? Powerfilm reminds me of a post I read by Bristlemouth which I agree with strongly. There's no obvious great narrative here and plenty of negatives, but investors tend to overpay for narratives and forget how rapidly and unpredictably things can change, both for the better and the worse. Many things could happen to Powerfilm in the future and I make no prediction as to what the likely outcome will be (except to say I'm rooting for all the good ones) but I don't think I need to for this to be a good investment. I'm happy that I'm buying assets at a gigantic discount with a management who are economically aligned with shareholders. To quote the Bristlemouth blog:
Ok. So we bought a stock without a clue as to its future and got lucky. That’s one way of looking at it. But we prefer another. When you buy with a big enough margin of safety, you don’t need to predict the future.

General portfolio update: 

Since my last update I've largely been selling / top slicing stuff which has appreciated towards fair value and/or grown to an uncomfortably high portfolio weighting. This includes some ZIOC, 3LEG, PVCS and JDG.

I completely sold out of VNET after coming round to the idea that they aren't all that cheap when you factor in the fact their exceptionals are anything but exceptional and I'm not all that comfortable with their business given the declining pub market and I'm not convinced they add value to their customers outside of being a policeman for the large Pubcos. Despite the disappointing results they put out, I managed to make a small profit on the sale and collected a dividend along the way so it's not turned out terribly.

The new addition to the list is CMCL, a gold miner in Zimbabwe (yes, I'm feeling perfectly well, thank you for asking). I now have 4 stocks with different natural resources exposure (3LEG - Polish shale gas, SEA - Irish sea oil, CMCL - Zimbabwean gold, ZIOC - Congan iron ore) which all share a common feature of being cash rich relative to their market cap except for SEA, in which I'm largely interested in their software business and the LOGP stake is 'in for free'. This means I now have 22.6% of my portfolio allocated to natural resource stocks (or 13.5%, if you exclude SEA) which says more about the prices available than about my actual level of enthusiasm for the sector in general, which is pretty low. I'll do a write up about CMCL soon as I received a few questions about it after I posted about my purchase on twitter.

I really, really want to top slice SPRP after recent strong rises although I decided a while ago that I was going to wait till the move to AIM to top slice it as I thought the price was likely to appreciate significantly as a much wider range of investors got a look at this company. The stock is doing it's best to tempt me out of my stance but I'm still resisting, for now. The stock still doesn't look all that expensive either if 2014 expectations come close to being met, as it's currently trading at 12.3x 2014F and 17.6x 2013 numbers (which management have confirmed are in line), and those forecast numbers don't include any benefit from the renegotiation of the distribution agreement.