Getting Caught in the Trap? Part I
Evaluating Silverleaf Resorts (SVLF)


As value investors, many of us know what it’s like to be caught in the veritable “value trap”, when a name looks cheap and enticing, but there’s more under the hood then we bargained for. Most of us have been caught here a time or two (being generous in my case), and hopefully experience brings with it the benefit of knowledge. Perhaps we can avoid making the same mistake thrice.

As deep-value microcap investors, we probably see an even proportionately larger share of traps. They are especially prevalent in the land of net/nets (companies trading below net current asset value) where we expend a great deal of research effort.

Recently we stumbled on an excellent example of a potential value trap. While we are not making a judgement on this company at this point, we thought it was an excellent example of when to dig deeper.

Silverleaf Resorts(SVLF)
Dallas based Silverleaf is a small timeshare company with a market cap just shy of $83 million. Trading at just 3 times earnings, the company currently trades below its net current asset value. At first glance, it appears too good to pass up. It may ultimately be a steal at $2. Or, it might be a trap.

We covered this company a few years back (search the archives), and at the time it was also trading below its NCAV. Silverleaf subsequently ran to $7 (a five bagger), and has since given back a lot of that ground.

In evaluating a company such as Silverleaf, we first look at the company’s enterprise value. Equity market cap is a poor indicator of the value the markets are placing on a company, because it does not reflect the entire capital structure. We find that Silverleaf’s enterprise value is $425 million—a far cry from its $83 million market cap. As it turns out, Silverleaf is highly leveraged, to the tune of $352 million in short and long-term debt. Couple this with the fact that it’s in the timeshare industry, not a great place to be given the housing bust and current state of the economy, and you can start to see the uncertainty surrounding this company, as well as reasons it trades so “cheap”.

Next we examine the balance sheet. Here we find that current assets ($546 million) are comprised primarily of inventories ($183 million) and receivables ($304 million). The receivables are potentially more troublesome. Referring to the notes, we find that the receivables are used to finance the purchase of timeshares by consumers.

From the 3/31/08 10Q:

Note 4 – Notes Receivable

We provide financing to the purchasers of Vacation Intervals in the form of notes receivable, which are collateralized by their interest in such Vacation Intervals. Such notes receivable generally have initial terms of seven to ten years. The average yield on outstanding notes receivable at March 31, 2008 and 2007 was 16.4% and 15.9%, respectively, with individual rates ranging from 0% to 17.9%. Notes receivable with an interest rate of 0%, originated primarily between 1997 and 2003, have an outstanding balance at March 31, 2008 of $89,000. In connection with the sampler program, we routinely enter into notes receivable with terms of 10 months. Notes receivable from sampler sales were $3.4 million and $2.9 million at March 31, 2008 and 2007, respectively, and are non-interest bearing.

We consider accounts over 60 days past due to be delinquent. As of March 31, 2008, $4.2 million of notes receivable, net of accounts charged off, were considered delinquent. An additional $26.0 million of notes receivable, of which $22.9 million is pledged to senior lenders, would have been considered to be delinquent had we not granted payment concessions to the customers, which brings a delinquent note current and extends the maturity date if two consecutive payments are made.

Furthermore, we find that the company’s debt load is financing the receivables. Silverleaf makes money on the spread between the interest charged on customer timeshare loans, and the interest the company pays its lenders. This amounted to more than $14.5 million in the first quarter, nearly double net income. Clearly the net interest margin is wide. But what happens if Silverleaf’s customers can’t pay? For more on that, we turn to the 2007 10K and find this note:

We may be vulnerable to the change in the credit markets which could adversely impact our results of operations, liquidity, and financial position.

Because we use various mass marketing techniques, a certain percentage of our sales are to customers who may be considered to have marginal credit quality. During 2007 and 2006, approximately 21.6% and 19.6%, respectively, of our sales were made to customers with FICO® scores below 600. In addition, we have experienced an increase in defaults in our loan portfolio as compared to historical rates. Due to deteriorating conditions in the sub-prime mortgage industry there can be no assurance that defaults have stabilized or that they will not worsen. These and other recent adverse changes in the credit markets and related uncertain economic conditions may eliminate or reduce the availability or increase the cost of significant sources of funding for us in the future. Specifically, if default rates for our borrowers were to rise, it may require an increase in our estimated uncollectible revenue.

This tells us that a relatively large amount of the customer base may be at risk of default. Given the current credit and housing market conditions, this is another risk factor for the company, and further explanation of the “depressed stock price”.

Finally, the Q1 income statement gives us more evidence: Of $65 million in sales for the quarter, $14.3 million was deemed uncollectible. This was up sharply from the same quarter last year ($8.5 million on sales of $53.4 million). Clearly, conditions are deteriorating. All of this adds up to uncertainty at best. But if you look at the bottom line alone (earnings of $.19 per share, net profit margin of 11.4%),SVLF looks like a steal. It's rarely ever that easy.

In Part II of this piece, we’ll explore the company’s assets.

*The author does not have a position in Silverleaf Resorts (SVLF). This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Clyde Milton Revealed

One of the most frequent questions we receive at Cheap Stocks is the identity of the site's phantom editor/writer/founder Clyde Milton. We've made no secret that the site has been written under a pseudonym since it was launched in 2003, in fact we've also revealed the meaning behind the name.

My name is Jonathan Heller, CFA, aka Clyde Milton. I started this site as an outlet; a way to keep my writing and research skills sharp, following the closing of the finance magazine (Bloomberg Personal Finance) I'd been writing for. Initially, this site was not intended for anyone other than me, but interestingly enough, it has developed a following over the years.

Here's my background: I spent 17 years at Bloomberg, ran the Equity Fundamental Research Product for several years, than the Equity Data Research Department for several more. Somewhere along the way, rather "late" in life (age 30) I discovered that I loved to write. This meshed well with my passion for investing and fundamental analysis, and after several years, I gave up the management track for a dream job: to write/edit for a major finance magazine. (Unfortunately, Bloomberg Personal Finance was closed shortly after Mike Bloomberg became Mayor of New York City.)

After leaving Bloomberg, I served as Director of Investment Communications for SEI (SEIC). I am currently President of KEJ Financial Advisors, a start-up fee only financial planning firm.

I have an MBA from Rider University, where I have also been an adjunct faculty member, and a BA in Financial Planning/Economics from Grove City College.

Finally, thanks to Clyde and Milton, my grandfathers. This site was and is dedicated to their memory.

PICO Rising

Since hitting a 3 year low in the sub $29.00 range back in March, shares of PICO Holdings(PICO), which we've called the "Poor Man's Berskshire Hathaway", are up 45% on normal volume with little news.

The company held a call with investors on May 19th-a first for PICO- and perhaps this is another step to take this previously under-followed company mainstream. Certainly, there's more analyst coverage than ever before, and Fidelity taking a stake a couple years back also may have advanced the ball in this regard.

Here are some of the first quarter highlights:
*The Fish Springs Ranch pipleline project is nearing completion. While bad weather delayed completion of the surge tank, the 28.6 mile pipeline passed pressure tests. All other testing should be completed in June. This pipeline will deliver 8000 acre feet of water annually to the northern valleys of Reno, Nevada.

*Company is building water right holdings in western Nevada (Carson City/Lyon County), and have acquired/have option to acquire 4366 acre feet.

*Launched new business in the real estate segment, Union Community Partners, LLC which will acquire building lots in California, where long-term prospects are favorable. Company acquired 40 finished lots, 73 partially entitled lots, and unentitled land (possibly 960 lots), in and near Fresno, CA.

*Sold long-term holding Jungfraubahn Holding AG (Swiss publicly traded company) for $75.3 million, pre-tax gain of $46.1 million (will be booked q2). Estimate compound annual return of 20% during 12 year holding period

*Still owns 456,000 acres of Nevada land (712.5 square miles)

*$85 million in cash, $29 million debt as of 3/31/08

*Company reported net loss of $1.6 million for the quarter.

We continue to hold PICO shares, and believe this is still an excellent water play, with a variety of additional assets thrown in at a discount, and perhaps for free.

The company has vastly improved its website, and quality of information provided, including presentations and the recorded shareholder call. Its well worth a look if you want to learn more about this seemingly confusing array of assets.

*The author has a position in PICO Holdings. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Who Ate All the Ice Cream?: The Hidden Inflation Factor

Like many Americans, our household enjoys a dish of ice cream now and again, but rising milk fat prices, and the commodity run-up in general has pushed carton prices skyward. We continue to buy the frozen treat, but have adopted the "only on sale" rule.

So, last week, when your Cheap Stocks editor was accused of single handedly devouring an entire container of Edy's, I had to remind my accuser of the following: What used to be the standard half gallon container was downsized a few years ago to 1.75 quarts. Hardly noticeable. But now, it seems as though the standard has shrunken even further, to 1.5 quarts. This, is noticable, at least it is to me. My accuser quickly apologized.

This is perhaps the worst kind of inflation: Inflation by "Deflation". The price stays the same, but the package gets smaller. Have not seen it this bad since the early 1970's.

Ice cream is certainly not the only product undergoing "package resizing". Many economists deny that inflation is back, but in this case, the consumer is the expert.

JG Boswell Update (BWEL)

Shares of cotton and farming giant JG Boswell, owner of an estimated 142,000 California acres, and another 30,000 in Australia, have bounced around quite a bit this past year, from $760 in June to $1175 in November, closing last week at $980. The stock still trades "by appointment", so if you don't like illiquidity, this company is not for you.

The appeal of Boswell (BWEL) is not in its farming operations, which although impressive in their own right, merely represent the current use of assets which might ultimately be much more valuable used for other purposes.

The company continues to develop its Yokohl Ranch project, a master planned community of 35,000 acres in Tulare County California which may have a 10 year life. The Eastlake project, a master planned community in Chula Vista, California is near completion.

But, as we've stated several times before, the real gem may lie beneath some of Boswell's land: massive amounts of water that may be worth several billions. ("May" being the operative word. Ultimately, in order for value to be realized, assets must be converted, or have a good probability of being converted into cash. Water is a touchy and political subject, especially in California)

We recently obtained a copy of the company’s 2007 annual report, and here are the highlights for the year ended June 2007:

Current Price: $980
Current Dvd Yield: 1.43%
Quarterly Dvd: $3.50/shr
Revenue: $338.958 million
Net Income: $13.96 million
Diluted EPS/shr: $14.20
Current Assets: $203.038 million
Cash: $3.891 million
Total Assets: $645.909 million
Current Liab: $150.506 million
Short Term Debt: $88.272 million
Long Term Debt: $0
Stockholders Equity: $450.221 million
Shares Out: 974,105
Book Value Per share: $441.65
Market Cap: $954.6 million
Enterprise Value: $1038.98 million
Enterprise Value/California Acre: $7317 (estimated)

Based on just the California land, we estimate Enterprise Value/Acre to be about $7300, and that ignores any value in the Australian land. We continue to be intrigued by the Boswell story. Buyer beware, though: Shares are difficult to obtain, information is scarce, and there is little liquidity.

*The author has a position in JG Boswell. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

A Brief Review of David Einhorn's book: "Fooling Some of the People All of the Time"

One of the tangible things (and there were also a multitude of valuable intangibles) we walked away with from the Value Investing Congress West was a copy of David Einhorn's new book "Fooling Some of the People All of the Time". A long wait at LAX before a Wednesday night redeye back to Philly left plenty of time to crack open Einhorn's 379 page work. Unfortunately, once I started reading, I could not put it down.

Einhorn presents a very detailed account of financial shenanagins happening within Allied Capital, a midcap darling of the high yielding, rising dividend "subculture". Seems that, among other transgressions, the investment company was very reluctant to mark down securities (primarily debt)on its balance sheet that were impaired. Instead of being marked to market, these were "marked to fantasy".

What you will find within the pages of this book will blow you away. This is a tale of deceit, fraud, misrepresentation, cloak and dagger antics, millions and millions of wasted taxpayer dollars, and an unbelivable amount of effort expended by Einhorn and others to bring it all to light. Unfortunately a mounting pile of evidence still falls on deaf ears--far longer than you'd imagine in the post-Enron, Sarbanes Oxley world of today.

Einhorn often takes his lumps in the press for being a hedge fund manager and short seller, (which comes with the territory), and he's been short Allied for years. But don't let that cloud your judgement as to his motives for writing this book: all profits from it's sale, as well as any from his Allied short positon are going to charity.

Einhorn's attention to detail is one of the great attributes of this book, plus he's got a great "voice". This book may go down as one of the classic financial forensics books of our time. CFA wannabe's would do themselves a great service by giving it a read--its a great testament to the propensity of many a modern day analyst to stop well short of the in-depth analysis many aspire to provide.

The Allied Capital story is not over yet, but thanks to David Einhorn for having the guts to bring us in on what's transpired to date. Of course Allied Capital will tell you a much different story--I'm waiting for their book.

I've never met David Einhorn, have never spoken with him, just traded a few emails. (we tangled over a piece we published on St. Joe's back in August. Einhorn believed his analysis had been misquoted, and we subsequently published his response). But I could not walk away from this book without believing that Einhorn has a great deal of character. The fact that he's a hedge fund manager, or profits from short sales does not diminish that character.

*The author does not have a position in Allied Capital, long or short. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

Value Investing Congress West: 2008

We're just back from another excellent Value Investing Congress in Pasadena. A lot of great speakers and great ideas; some a bit contoversial. Rather than go into detail, there's a summary of the events on the Value Investing Congress blog.