The Downside of Net/Net Investing- Lazare Kaplan (LKI)

We've tried to make it clear over the years that there are substantial risks investing in individual net/nets. While some pay off quite handsomely, others can implode, hence the idea of indexing net/nets, as we explored with our Cheap Stocks 21 Net Net Index.

This brings us to Lazare Kaplan International, a company that we have both covered and owned over the years. We closed our position in this perennial net/net in February of 2008 in the $10 range. In July of 2009,we initiated a new position in the $1.15 range. The shares subsequently ran up to $2.50, but in September, trading was halted,and not a share has traded since.

The company has repeatedly delayed filing it's financial reports with the SEC, due to:

a material uncertainty concerning (a) the collectability and recovery of certain assets, and (b) the Company's potential obligations under certain lines of credit and a guaranty (all of which, the "Material Uncertainties").

The NYSE AMEX granted the company several extensions to regain compliance; the latest on April 26th, which gave the company until May 31st to regain compliance with listing standards.

Here's where the story gets either very interesting, or ridiculous. On May 20th, the company filed a lawsuit suing various insurance companies for $640 million regarding "the disappearance of diamonds that were insured by the defendants". And now, finally, we learn what all of this is about: missing diamonds. The company had reportedly received a $28 million payment in January but the insurers are refusing to pay any more. This is not what a shareholder wants to hear, especially when you are stuck with the shares, and information about what is really happening at the company has been next to impossible to get. As of 3/31/2010, some institutional holders were in the same boat; including Dimensional Fund Advisors, which owned 7.54%,royce & Associates (1.16%), Royal Bank of Canada (1.15%), and CALPERS (.55%). A call to Lazare Kaplan CFO William Moryto placed late last week has not been returned.

This story will probably not have a happy ending for shareholders, and it raises many unanswered questions. What happened to the diamonds? Why isn't the company willing to speak with it's shareholders on the issue? Why are the insurers unwilling to pay? And again, what happened to the diamonds?



*The author has a position in Lazare Kaplan (LKI). This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.

What Happened to Cheap Stocks?

It's been 3 months since we last published, and we've been getting many e-mails wondering whether we have a new site, or have just fallen off the face of the earth. The truth is, we've been taking a break while we decide the future of this site, which was originally started in 2003.

Good content takes time and patience to develop, and we are a little short on both these days, especially when it does not help pay the bills. We've considered making this a paid subscription only site, but are still on the fence.

In any event, stay tuned...

Value Investing Congress West: May 4th and 5th

I'll be heading back to Pasadena in early May, to attend my sixth session of the Value Investing Congress, and fourth on the left coast. This is the premier forum for value investors; an extremely well-run event that attracts quality speakers, offering compelling insights and investment ideas. What's more, I've found the presenters to be approachable both during and after the Congress.

Last year, I walked away with several actionable ideas. One of them, Huntsman (HUN), has more than doubled since I initially took a position in early May.

The folks at The Value Investing Congress have been kind enough to extend a discount to Cheap Stocks readers, $1300 off the regular rate. If you are intested in attending, please click here and use discount code P10CS3, which will expire on March 16th.

I hope to see you in Pasadena!

*The author has a position in Huntsman (HUN). This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.

Winding Down The Cheap Stocks 21 Net Net Index; Outperforms Russell Microcap by 1371 bps, S&P 500 by 2537 bps

Two years ago, we launched the CS 21 Net/Net Index, the first index designed to track net/net performance. The index was cap weighted, and comprised of the 21 largest net/nets by market cap at the time of launch. We had a few restrictions on inclusion in the index, including average daily volume and price, but otherwise, this was a very simply constructed index.

We originally intended to replace companies that were acquired, but thought better of it, instead deciding to keep proceeds from acquistions in cash. We also did not replace any names if they no longer met the net/net criteria. This was simply an experiment in order to see how net/nets at a given time would perform over the subsequent two years.

The results are in, and while it was not what we'd originally hoped for, it does lend credence to the long-held notion that net/nets can outperform the broader markets.

The Cheap Stocks 21 Net Net Index finished the two year period relatively flat, gaining 5.1%. During the same period, The Russell Microcap Index was down 8.61%, while the Russell Microcap Value Index was down 9.9%. During the same period, the S&P 500 was down 20.27%.

Here are the index constituents, their original weights, and performance.

Adaptec Inc(ADPT)
Weight: 18.72%
Computer Systems
+7.86%

Audiovox Corp(VOXX)
Weight: 12.20%
Electronics
-29.28%

Trans World Entertainment(TWMC)
Weight:7.58%
Retail-Music and Video
-69.55%

Finish Line Inc(FINL)
Weight:6.30%
Retail-Apparel
+350.83%

Nu Horizons Electronics(NUHC)
Weight:5.76%
Electronics Wholesale
-25.09%

Richardson Electronics(RELL)
Weight:5.09%
Electronics Wholesale
+43.27%

Pomeroy IT Solutions(PMRY)
Weight:4.61%
IT
Acquired
-3.8%

Ditech Networks(DITC)
Weight:4.31%
Communication Equip
-56.67%

Parlux Fragrances(PARL)
Weight:3.92%
Personal Products
-51.39%

InFocus Corp(INFS)
Weight:3.81%
Computer Peripherals
Acquired


Renovis Inc(RNVS)
Weight:3.80%
Biotech
Acquired

Leadis Technology Inc(LDIS)
Weight:3.47%
Semiconductor-Integrated Circuits
-92.05%

Replidyne Inc(RDYN)Became Cardiovascular Systems (CSII)
Weight:3.31%
Biotech
+126.36%

Tandy Brands Accessories Inc(TBAC)
Weight:2.94%
Apparel, Footwear, Accessories
-57.79%

FSI International Inc(FSII)
Weight:2.87%
Semiconductor Equip
+66.47%

Anadys Pharmaceuticals Inc(ANDS)
Weight:2.49%
Biotech
+43.75%

MediciNova Inc(MNOV)
Weight:2.33%
Biotech
+100%

Emerson Radio Corp(MSN)
Weight:1.71%
Electronics
+118.19%

Handleman Co(HDL)
Weight:1.66%
Music- Wholesale
-88.67%

Chromcraft Revington Inc(CRC)
Weight:1.62%
Furniture
-54.58%

Charles & Colvard Ltd(CTHR)
Weight:1.50%
Jewel Wholesale
-7.41%

Cash Weight: 8.58%

We are in the process of putting together a new net/net index, and still trying to decide whether or not we want to disclose the constituents, or keep them under wraps. Stay Tuned.

*The author has a position in Chromcraft Revington (CRC). This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.

Retail Net/Nets One Year Later, up an Average of 146%

This time last year we ran a two part series on retailers that were trading below net current asset value. Retail was all but left for dead then, and as we all remember, market conditons got even worse by March.

One year later, the twelve companies are up an average of 146%. There was just one company in negative territory, Zales.

Here are the companies and returns:

A.C. Moore Arts & Crafts
ACMR
Price Then: 1.47
Price Now: $2.72
Return: 85%

MarineMax, Inc.
HZO
Price Then: $2.49
Price Now: $10.22
Return: 310%

Perfumania Holdings, Inc.
PERF
Price Then: $3.78
Price Now: $6.46
Return: 71%

West Marine, Inc.
WMAR
Price Then: $5.69
Price Now: $8.24
Return: 45%

Zale Corporation
ZLC
Price Then: $2.88
Price Now: $2.12
Return: -26%

Signet Jewelers Ltd.
SIG
Price Then: $9.42
Price Now: $27.00
Return: 187%

Duckwall-ALCO Stores, Inc
DUCK
Price Then: $10.50
Price Now: $12.59
Return: 20%

Stein Mart
SMRT
Price Then: $1.28
Price Now: $8.05
Return: 529%

Shoe Carnival
SCVL
Price Then: $8.04
Price Now: $18.08
Return: 125%

Cache
CACH
Price Then: $2.00
Price Now: $4.34
Return: 117%

PC Connection
PCCC
Price Then: $5.25
Price Now: $6.19
Return: 18%

Tuesday Morning
TUES
Price Then: $1.33
Price Now: $4.95
Return: 272%

At this writing, just two of the company's AC Moore, and Duckwall Alco remain in net/net territory.

*The author has a position in Tuesday Morning. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.

Cheap Stocks 21 Net Net Index Update; CS to Launch New Net Net Index

Back in February of 2008,we launched a rather unique experiment, an index of companies trading below their net current asset value. We laid out our selection criteria and premise in our February 15, 2008 post. Truthfully, this was a rather naive approach to creating an index, a fact we were well aware of.

We did make some adjustments along the way; we did not rebalance annually, nor did we use cash that was the result of acquisitions to replace index constituents. It became a set it and forget it portfolio of companies that were net/nets at the inception date of the index.

Our original intent was to wind down the index at the end of two years, and judge performance against the Russel Microcap Index. As of Friday, the CS21 has outperformed the Russel Microcap Index by 1356 bps. While we'd hoped for better absolute returns than the 6.6% since inception that CS 21 has realized, we consider this first attempt to be mildly successful.

We are busy creating a new index of net/nets, which will be tentatively released in early February. Stay tuned; the new index will have an interesting twist.

Former Net/Net Tuesday Morning Soars

Closeout retailer and former net/net Tuesday Morning, that has graced the ranks of companies trading below their net current asset value for much of the past two years, was up 33% yesterday. The company reported better than expected guidance for Q2, suggesting eps of between $.40 and $.43 for the quarter. Same store sales rose, 5.1% versus the same period last year, and sales were up 6.2% to $289.6 million.

Given yesterday's jump, Tuesday morning is no longer a net/net, but still trades at just 1.12 times NCAV. However, that is based on first quarter balance sheet data, and Q2 won't be announced until January 26th.

If you've never been to a Tuesday Morning store, it is an interesting experience. I've referred to it in the past as a "rich man's dollar store", given the interesting mix of closeout inventory, at reduced prices. You never know what you will find at a store.

Founded in 1975, Tuesday Morning currently has about 850 stores in 45 states. With a current market cap of just $172 million, and almost identical enterprise value, these seem rather small for an 850 store chain. On an EV to store basis, that's just $200,000. The company does not, however own it's real estate.

I've owned shares a few times over the past couple of years, and the only reason that I've closed positions is due to trailing stops I've set. With the extreme volatility retail shares have experienced, stops seemed a prudent way to limit damage, but also lock in gains as shares rose.

I've been back in Tuesday Morning shares since mid December, and plan on seeing how events progress with the company (with a trailing stop to protect gains).

Tuesday Morning
Ticker: TUES
Price: $4.02
Market Cap: $172 million
Enterprise Value: $172 million
Net Current Asset Value (as of 9/30/2009):$153.6 million
Market Cap/NCAV: 1.12

*The author has a position in Tuesday Morning(TUES). This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.