2013 Q3 Review

In Q3 2013, we again posted positive returns.  The return of our portfolio was 1.50%, while the S&P 500 index appreciated 4.66%. In this quarter, we were not able to find too many attractive investments. Some deals on which we invested took longer than expected to close and the portfolio value reflects the gaps that are not closed yet. Furthermore, we were not able to implement our most successful short ideas because our brokerage account cannot short sell stocks.

Municipal Bond Closed-end Fund

We are holding on to NEA. The fund keeps dropping as the market became anxious about the consequences of Fed’s tapering. The current discount is at -2.35 standard deviation from its three-year average discount. The fund is trading at tax-equivalent yield of 10.3% and we still view the investment as an attractive one.

Odd-lot Tender Offers

There were not a lot of these opportunities in Q3. We made some money on COLE (7.8%), WBMD (7.0%) and HAL. In the future, we will actively participate in these offers. I think there will be two deals in the pipeline, and I hope there will be some more at the end of this year.

Going-Private Deals & Merger Arbitrage

It was extremely hard to find attractive deals this quarter. We entered a few positions that were attractive based on raw returns, but took much longer to close. Especially, GLGI suffered from a severe delay in the go-dark process because the company did not have enough employees to handle the filing of 13E3 and 10-K concurrently.  Meanwhile, SPRD experienced a delay in getting government approval because of consecutive holidays in China. I expect the SPRD deal to close in October and the GLGI deal to close by the end of year. In Q3, we briefly participated in the go-private deal or tender offer of DELL, ANTP, MEMS and PVD.  One mistake we made was on INFU, where I did not research the situation thoroughly before I invested a 2% position in the merger arbitrage deal.  The board of directors rejected the buyout offer proposed by the activist shareholder and the stock plummeted subsequently. We think there may be some value in the company because the buyout was rejected as insufficient. Another highly complex deal is RUE. Apax Partners and banks that made financing commitments surely took a huge loss when the teen apparel industry experiences a temporary downturn. However, RUE’s attorney structured the merger agreement which essentially made it impossible for either the buyer or the banks on hook to walk away. While the final outcome remains to be seen, I am fairly confident that the deal will happen.

In the third quarter, I analyzed WH and NLP deals on Seeking Alpha and reached conclusion that neither deal was going to close. WH lost 42% in three days, and NLP dropped 30% in two weeks. It is a pity that my brokerage account cannot short sell stocks.  I paid some attention to CTB and NBG-PRA as well but concluded that these situations are probably too complex for me to choose a side.

On the fundamental investing side, we made a few investments during this quarter as well. In July, I bought DSWL based on the high discount to liquidation value. In September, I followed Carl Icahn and bought AAPL as a short/mid-term investment.  We plan to buy or sell quality or net-net stocks with catalysts from time to time.

Next Quarter

I am optimistic about the next quarter. We will see some of our larger merger arbitrage bets materialize if our judgments prove to be right. There will also be interesting opportunities in corporation liquidation, closed-end fund liquidation, M&A, tender offers, and other event-driven strategies.

Brandon Zhang

Oct 7, 2013

Termination Risks Of NTS Realty Holdings Offer Asymmetrical Risk Reward Profile

Sorry for failing to post this article earlier.

The article was awarded as “alpha-rich” on seeking alpha. The following excerpt is the main thesis of the article.

After postponing a go-private deal several times since the initial proposal over a year ago, NTS Realty Holdings (NLP) has made little progress and will almost certainly miss the upcoming deadline of September 30th. Multiple unresolved lawsuits are blocking the financing and the recent rise in rates gives the financing party incentive to walk away rather than to stay in the deal. As the market incorrectly predicts a 91% probability of the deal to be closed on September 30th, we see a compelling risk reward profile in taking a short position in the stock. In addition, we recommend reducing or exiting the position for current shareholders.

The full-text version can be found at:

http://seekingalpha.com/article/1673672-termination-risks-of-nts-realty-holdings-offer-asymmetrical-risk-reward-profile

Update: NTS Realty Holdings Limited Partnership Announces Termination of Financing Commitment Letter Related to Going Private Merger

AFP Provida: 20% Annualized Return From Tender Offer With Downside Protections

The article was awarded as “alpha-rich” on seeking alpha. The following excerpt is the main thesis of the article.

AFP-Provida (PVD) is an under-followed Chilean pension fund manager that will commence a tender offer to purchase all the outstanding ADS soon. Simply buying the shares and tendering them will generate a 4.52% absolute return if the tender offer is consummated by the end of October. If the offer is closed in November or December, shareholders should receive an additional interim dividend reflecting the earnings in the first half of 2013, which will boost the absolute return to 7.78%. In the very unlikely case that the acquirer of the company, Metlife, decides to walk away from the deal, the company’s fair value calculated from EVA method implies that there is little to lose.

The full-text version can be found at:

http://seekingalpha.com/article/1629902-afp-provida-20-annualized-return-from-tender-offer-with-downside-protections

WSP Holdings Will Reward Short Sellers Soon

The article was awarded as “alpha-rich” on seeking alpha. The following excerpt is the main thesis of the article.

WSP Holdings (WH) is likely to terminate the merger agreement within a month. Judging by the current prices, investors seem to be confident that the deal will not fall through. However, the stock follows the exact trajectory that China Advanced Construction Material (CADC) took a year ago before CADC cancelled the going-private deal. Furthermore, the company has been in breach of the debt covenants since June 2012 and whether the company is a going concern remains a question. Last but not least, the stock is likely to be delisted from NYSE because the company may fail to file its annual report within the 6-month grace period. If any one of the three events occurs, the shares are likely to trade below the price level immediately before the announcement of the going-private offer.

The full-text version can be found at:

http://seekingalpha.com/article/1609142-wsp-holdings-will-reward-short-sellers-soon

Special Opportunities Fund Preferred Shares: 5% Alpha Plus Another 3% Yield

Here is my second article on Seeking Alpha. The thesis of the article is the following:

“Special Opportunities Fund (SPE) is a special-situation closed-end fund managed by Bulldog Investors. Historically a consistent outperformer, Bulldog Investors continues to deliver outstanding absolute returns that are insensitive to markets at Special Opportunities Fund. Investing in SPE PR provides investors with additional dividend income and tax benefits without compromising the upside from the common shares.”

The full-text version can be found at:

http://seekingalpha.com/article/1608882-special-opportunities-fund-preferred-shares-5-alpha-plus-another-3-yield

Prudential Bancorp of Pennsylvania Is Attractively Valued With Imminent Catalysts

This is my first article on Seeking Alpha. Here is the abstract of the article:

“Prudential Bancorp Inc of Pennsylvania is a misunderstood stock. The stock are seemingly expensive at 40x PE and 1.7x PB shown on all the financial websites. However, its low valuations are distorted by the Mutual Holding Company structure. Although the management is mediocre at best, the company has a strong balance sheet. The recently announced second-step conversion would be a positive catalyst to the company by infusing substantial cash and enhancing shareholder values. In the long-term the company is attractive as an acquisition candidate because of its huge potentials.”

The full-text version can be found at

http://seekingalpha.com/article/1603032-prudential-bancorp-of-pennsylvania-is-attractively-valued-with-imminent-catalysts

DSWL Liquidation Valuation Analysis

Deswell Industries (DSWL) offers the opportunity to invest in a net-net whose assets will appreciate as the land in southeast China increase in value over time. The company has seen consistent cash inflows from operations. The stock has 8% dividend yield and trades at 50% discount to liquidation value.

The Business

Deswell Industries is a contract manufacturer of plastic products and electronics based in China. The company has been in business since 1987 and operates factories in Dongguan, China. The product offerings include components of telephones, audio equipment, alarm clock, etc. This market is very fragmented as one would expect and there is almost no economic moat in this market. A decade ago, Deswell would be considered a growth company benefiting from the low labor cost in China, artificially low RMB exchange rates, and strong growth of Chinese economy. However, as all three factors turn against the OEM industry, the company has been suffering losses since 2011. Now, we see a business that has negative topline growth as well as rapidly shrinking margins. Worse still, the local government in Dongguan has planned to raise the minimum wages by 13% each year for the next five years, and RMB still has the potential to appreciate against USD.

Thesis

While the company is currently in trouble in terms of earnings, the stock prices are severely undervalued based on the net asset values. I will illustrate this point later on. Moreover, the negative earnings number belies the fact that the company consistently takes in cash from operations after the non-cash depreciations are added back. Compared with competitors, Deswell also seems to be significantly undervalued. The company trades at 5.3x TTM FCF, while its competitor Plexus trades at 18.5x TTM FCF. The dividend paid out is roughly half of the cash inflow the company generated during the last twelve months. At current prices, we can buy a company that pays out 8% dividend and has the chance to be bought out at more than double the current prices.

Liquidation Value Analysis

If the company is liquidated, there will be substantial value left for its shareholders. We make adjustments to the assets on the balance sheet and deduct the liabilities from the adjusted value of assets.

DESWELL INDUSTRIES, INC Mar-13
USD In Thousands

Original Value   Adjusting Factor   Adjusted Value

ASSETS
Current assets

Cash and cash equivalents 32030           100%                    32030
Short-term investments      16438           100%                    16438
Receivables                       8291             50%                      4145.5
Inventories                        11376           50%                      5688
Prepaid expenses              1152             0%                         0
Other current assets

Non-current assets
Property, plant and equipment
Net PPE                             42694           *                           31960
Goodwill                          392              0%                          0
Deferred income taxes      192              0%                          0

Total assets                      116319                                     90261.5

LIABILITIES
Current liabilities
Accounts payable             3144          100%                       3144
Deferred income taxes      606            100%                        606
Taxes payable                  592            100%                        592
Accrued liabilities             5393          100%                        5393
Deferred revenues            1254           100%                       1254
Other current liabilities
Total current liabilities      10989                                        10989

Non-current liabilities
Total liabilities                 10989                                        10989

Net Liquidation Value
79272.5

Current Market Capitalization
40150

Discount to Liquidation Value
49.35%

This analysis shows that if the company is liquidated today, the shareholders will realize a return of 100%. It’s unlikely that a potential acquirer can pay less than book value to acquire the company. Therefore, if the company acquired, the return for shareholders would be even higher. Here, we used a 50% discount on receivables as the customers of Deswell are mostly reputable OEM companies. Moreover, the inventories are given a 50% discount since a little more than half of the inventories are easily marketable raw materials which we assign a 100% value. Note that we have a “*” on the net PPE item. We only take into account the value of land the company owns in Houjie and Chang’an and assigned zero value to other types of PPE including factories and machines. The company acquired 1.3 million square feet of land in Houjie in 2000 and another 0.24 million square feet of land in Chang’an in 2003. Since then, the land price in Houjie has increased to $22/square foot (based on the listings online) and the land price in Chang’an has risen to about $14/square foot (based on the listings). Therefore, the lands that the company owns carry about $32 million in value at market price. These assets will continue to appreciate since industrial lands at favorable locations close to the export center in China are scarce.

Management & Incentives

The company went public in 1997. In 2000, Michael Burry wrote about the stock and said he was sure that the management was not a scam. Currently, the management owns 22% of the total shares in the company. Therefore, their interests are aligned with the interests of small shareholders.The management apparently finds dividend as tax-efficient way to pay for themselves. The total compensation of the four management members was $1.4 mn, implying the average salary of $0.35mn. On the other hand, the Chairman of the board, Pui Hong Richard Lau, holds 1.9 mn shares, which generated $0.51 mn return in the form of dividends in 2012. This is another reason why we can count on the dividend to be sustainable going forward. Furthermore, the management announced a share repurchase plan to buy back $4 million worth of shares in March 2012. The repurchase plan will enhance shareholder values by repurchasing shares at lower than book value.

Risks

The shares are pretty illiquid as an Asian micro-cap.

The business deteriorates because of the appreciation of RMB(weaken export, higher raw material costs), rising labor costs, and slow down in the global economy

Catalyst

Attempts of liquidation or acquisition

Special dividend or an increase in dividend