Thursday, September 14, 2017

DEWY: Real Estate, Change, and Survival

Dewey Electronics (DEWY) has annual revenue of about $6M and a BV of $2M. On top of that, their 22 acres of land and facilities has been appraised at $4.5M and completely depreciated. Next to their facilities they have another 68 acres of excess land whose sale for $18M fell through in 2005 due to restrictions put in place by New Jersey's Highlands Water Protection and Planning Act.  You get all that for a market cap of only $1.9M.

The company has recently changed their tune, stating the stock is undervalued and claiming they are working to correct the situation. An 18% shareholder joined the board a few months ago.

I love a tiny company reinventing itself and DEWY is doing just that as they diversify away from their decades long main product, a 2kW rugged military generator.

The DEWY story has more than one chapter.  We have the company operations, real estate, change, and the future.

Some quick numbers before we get into it:
  • rev $5.8M in 2016 vs $6.6M in 2015
  • BV $2.1M vs $2.0
  • net income $116k vs $-120k
  • shares out 1.36M
  • no preferred or warrants
  • long term debt is a pension liability
  • market cap $1.9M
  • stock price $1.35

Operations:
Forgive me if you’re heard my "tiny companies often survive" rant but this idea is a major component of my investment style. Little companies with revenue of only a few million dollars often exist due to one or two products and if you look far enough back in the past you will see those products change. These little companies, if run without taking on loads of debt, can survive the bad times as they change or refresh products. They will find one product that works and live off that for years, meanwhile thinking forward to what is next. While the company transitions revenue takes a hit.  Profits vanish, losses mount, and the stock drops. During these times we don't know if the company will survive or drop into bankruptcy and investors hate uncertainty. If you find the right opportunity with potential, and some protection, you may get a favorable risk/reward ratio. Some of these companies will die off. The ones that make it can see huge stock gains as public perception changes from death to bright life.

DEWY was founded in 1955. Until 1997, a single program, the ADCAP torpedo program with the U.S. Navy was the primary source of the revenue.  In 1996 the company was awarded a contract with the U.S. Army to provide diesel operated tactical generator sets and these became the company’s main revenue source for the next two decades.  It's amazing what a single contract can do for a small company.  The generator program started in 1996 with a $1M order and delivered $84M in revenue by the time the second sole source contract ran out in 2014.  

In 2013 DEWY bought up assets from Goodman Ball in an attempt to diversify away from the generators.  I think the company saw the end was near for their generators so they moved into survival mode.  It turned out to be a good move as the generator contracts ended.  Goodman Ball assets generated about half their revenue in the most recent FY.  It looks like the company is heading in the right direction but there is more work to do.  Gross margin has come up as the company diversifies away from generators but at the same time revenue is dropping.  See the table below (company classifies generators and their accessories as "power products").  


If we look at a long range chart of revenue we can see the contracts come and go.  In the late 90's revenue drops off as the torpedo program comes to a close and the generator program picks up steam.  Over the past few years revenue has been dropping but not at nearly the rate of the late 90's.  As you can see the company has hovered around zero earnings forever and they did turn a profit in the most recent FY.  

The company should be putting out an annual report soon but I'm not expecting big things on the operational side.  9 month results show revenue of $2.2M vs $3.7M YOY and earnings -$0.86M vs -$0.33.  Latest reported backlog is $2.1M vs $3.0M last year.  

Real Estate:
This is where it gets interesting.  Let me start by saying I am no real estate expert, just a guy with Google so take my opinion with a grain of salt. 

The company owns their land and building.  These items have been completely depreciated on the balance sheet so they are just icing on the cake.   The company owns 90 acres of land in New Jersey and uses 22 acres of that for operations.  They have a 49k square foot facility.  The remaining 68 acres are unused with 20 of those being flat.  The most recent 10k notes an appraisal of their facility for $4.5M (not including the 68 unused acres).  Property tax records show $2.6M of that is land and $1.9M is facilities.  The company built this building in 1981.  

The unused land is a whole lot of drama due to New Jersey's 2004 Highlands Water Protection and Planning Act.  Basically the law severely limited development on 860k acres in northwest NJ to protect the state's water supply.  There are now very heavy limits on any sort of development, be that commercial or residential.  Only one septic tank is allowed per 88 acres and no development is allowed on sloped areas.  I'm not sure the commercial terms.  Homeowners are still allowed to add on to their own house but that's about it.  The problem, and main source of friction, is landowners have never been compensated.  The minute this law was signed property values dropped like a rock and landowners have been forced to eat it.  There has been talk of a water use tax to compensate land owners but that has never materialized (you know how people feel about tax increases).  NJ has set up some system where property owners can get development credits which I think they can sell to developers who are able to use them to increase the density or intensity of projects elsewhere, but this does not make up for the lost value.  

This water protection act is a tough pill to swallow.  Everyone wants clean drinking water and people want to limit urban sprawl but it's not fair to make highlands landowners pay for it all.  Imagine you are a farmer in the highlands who needs a loan to make it through a tough year or buy some new equipment.  When your dad owned the farm he could easily get a loan with the land as collateral but now the banks won't give you the time of day.  Or imagine your entire retirement plan was to sell off your land, what do you do now?  

Below is a picture of the DEWY facility and their plot at 27 Muller Rd, Oakland, NJ 07436.  I'm not sure which is "used" land or "unused."

The Highlands Water Protection and Planning Act splits up the area into the Protection area and the Planning area.  Again, I am no expert, but it seems the severe development restrictions are in place for only the Protection area.  Below is a map showing the areas, you can see DEWY is in the Protection area (green) with the Planning area (yellow) just across the freeway.  So close!

The most amazing part about this real estate talk is the potential value of the unused land.  In 2005 DEWY got an offer of $18M for the unused land.  The company put out a proxy and shareholders approved the sale.  A property development company was going to put in 174 homes.  The end price was dependent on how many homes they eventually got in with a minimum of $12M.  Unfortunately the offer was withdrawn half a year later.  A reason for the termination is not given but I bet it's due to restrictions from the Water Protection and Planning Act.  The property developers had to get all the required approvals and I think once they got into it they realized it would be too difficult, or maybe not possible.  The interesting thing is this offer was agreed to after the Water Protection Act was put in place so it's surprising the developer wouldn't know what they were getting into.  

The question is what's the real estate worth.  We know the used land plus building is worth $4.5M.  The unused land is worth something between zero and $18M.  Actually the minimum is above zero because the land could be sold to a conservation group (development of trails is allowed).  The most recent 10k states, "although New Jersey’s 'Highlands Water Protection Act and Planning Act' currently imposes severe restrictions on development, we believe that there are strong reasons why this property should not be subject to the restrictions on development."

I don't know what has happened to New Jersey empty land value since 2005.  As for the Water Protection Act I know there are ways to file for exemptions.  The act has been in place now for 13 years and I bet there are developers who have figured out how to work the system.  Or maybe the state will finally put in place some monetary compensation for landowners.  We will see.

Change:
I love change and so does the stock market (if it works out).  Change is what finally kicked me in the pants to buy this stock.  Without change products get stale, companies get stale, and companies die.

In Sept 2016 one of the 5% stockholders, Polymathes Capital, put out an offer to buy all outstanding stock at $3 a share.  Actually it wasn't really an official offer.  The filing called it a "tentative offer" but it was never presented to the shareholders.  In the letter Poly talks about how they've tried to push the company in certain directions but have been rebuked.  My guess, and I am only guessing, would be Poly is trying to get the company so sell off all real estate or sell off the whole company and the company is resistant because they want to keep operations going.

In May 2017 DEWY de-registered from the SEC.  They did this for "substantial cost savings" which I bet will be in the range of a few hundred thousand dollars annually.  From various companies de-registering I've heard estimates from a couple hundred grand to over a million dollars in savings.  Also the company will be able to focus more on operations than on SEC compliance.  As of now the stocks trades on the OTC Markets Limited Information tier and I hope it stays there.  I am fine with DEWY de-registering as long as they stay off the stop designation list and keep the information coming.  Since de-registering they have filed one quarterly report through the official channel at OTC Markets and I hope they keep that up.

At the same time as de-registering the company lost one long time board member and replaced him with an 18% shareholder, Wax.  I love this move.  Wax has acquired shares over the past few years and I'm sure he will speak up for us shareholders.  

The main change that has got me excited is the tone from management.  I highly recommend you read the 2016 president's letter as well as the Long-Term Growth Strategy section of the most recent 10k.  You can also read past president's letters to see the difference.  I'd say you should read past versions of the Long-Term Growth Strategy but it didn't exist.  Let me give you a few quotes:
In response to our challenging business environment, we have designed and are rolling out an ambitious, multi-faceted long-term strategy to achieve new opportunities for growth in both existing operations and new directions. Our new long-term strategy is intended to exploit the Company’s existing strengths and build new capabilities in order to increase revenue, market presence and ultimately profitability in both power and non-power products and services.
I believe that now is the time to accelerate and innovate these growth and development efforts. This timing coincides with my heightened belief that our business prospects are underappreciated and the common stock is undervalued. I am committed to correcting these misperceptions by aggressively pursuing our long-term growth strategy and continuously evaluating and enhancing its effectiveness.

We intend to continue to opportunistically pursue selective acquisitions and joint ventures to extend our presence into new markets with new products and realize operational value from our cost-effective facility, among other benefits.

The Company’s long-term strategy includes growth through acquisitions such as the one from Goodman Ball. Beginning last year, the Company increased these acquisition efforts with a focus on other small defense-related companies and/or product lines that fit within the Company’s profile and complement our growth goals.

To the extent that such acquisitions are not financed solely out of cash flow from the acquired business, the Company will consider raising acquisition capital, which may include monetizing certain real-estate holdings, either by debt financing or sale.

As described in Item 2 (Properties) above, the Company’s real estate holdings consist of approximately 90 acres of which approximately 68 acres (including approximately 20 acres of flat ground) are not used in our operations. The Company is exploring avenues to monetize and deploy value that is locked up in these assets. As with the strategic acquisitions described above, the Company would consider prudent utilization of such assets to facilitate operational growth that will be more accretive to stockholders in the long term. Such assets also may be monetized to acquire assets such as product lines as opposed to full businesses. The Company will seek guidance from qualified finance professionals to assist in evaluating and facilitating the Company’s efforts in this regard.
The Future:
Let me look into my crystal ball...  We have a company that has reinvented itself in the past trying to do it again.  It's the good kind of reinvent where they are staying within their circle of competence.  The torpedo business 40 years ago was government defense manufacturing and developing.  Same goes for the generators and Ball assets.  DEWY knows what they are good at.  The company definitely has the assets, capital structure, and shareholder base to think long term and weather the storm.  There is one large shareholder, Poly, shaking things up while another, Wax, joins the board to think longer term.

The CEO has mentioned an undervalued stock for the first time in forever and laid out a new growth strategy.  I think they are looking at options for acquiring another business or business line.  I think they want to sell their real estate and will have to decide if that money goes back to shareholders or into an acquisition.

Chart:
You know we have to check a long term chart.  It's amazing what is there if you look.  You can see the real estate offer being made in 2005.  You can see generator contracts and revenue ramping up in the late 90s. You can see a large shareholder selling out in 2013.  You can see the de-registaration and drop in revenue of the past 6 months.

We are at a low support area that has held up a few times over the past 17 years.


Valuation:
First off this is my kind of company.  Their business sector, government defense, is not going anywhere.  Market cap is $1.9M with only 1.4M shares out.  In fact the float is only about 600k shares since the Dewey family owns 40% with Poly and Wax owning another 25%.  They don't have a lot of debt.  There is high inside ownership and they've been surviving for many years.

The company is hovering around no earnings so we can't use that to value the stock (though earnings is moving in the right direction with their SEC de-registration).  BV is $2M on the balance sheet and once you add in their facility that jumps up to $6.5M.  Revenue is $6M in the most recent 10-k but we know that'll be dropping at least in the short term.  The X-factor is the unused land which almost fetched $18M in 2005.

Before you go salivating on that real estate let's talk about risk.  To me the main risk with DEWY is time.  Look at this chart of large shareholders.  They have come and gone over the years and I bet you each one of them had real estate in mind.


For the final word on time risk I give you the following section from the 1995 10-k:
The Company continues to seek alternative methods of increasing its stockholders
equity. Management intends to put its real estate holdings to their best
possible use. Currently the Company owns approximately 90 acres of land and
the building it occupies in Bergen County, New Jersey which are carried on its
books at approximately $1,000,000 but which are believed to have a
fair market value substantially in excess of this amount. This property is
adjacent to, and very close to a full interchange of Interstate Route 287,
which was completed during the fall of 1993. The alternative methods present
ly being investigated by management include, but are not limited to, the
sale of some or all of this property, a sale lease-back arrangement, or long
term financing. No assurances can be made that any transaction will occur.
So onto the numbers.  I value the operations at about $5M based on revenue and let's go with $4M for their facilities plus used land.  That's $9M value versus the current market cap of $1.9M.  On top of that we have the unused land which I will say is worth  $1M - $10M.  A year ago Poly tried to buy up the company for $3 a share.

I'll go with a company value of $11M = stock value of $8.  The stock is at $1.35.  Now I will hurry up and wait.

--Dan
disclosure: long DEWY
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14 comments:

  1. Very interesting find again. A minor detail: I think you cannot simply add a $5m revenue valuation to a $4m asset valuation to get to a $9m total because both are essentially a valuation of the same company. You need the assets to generate revenue (or at least some of them, I'd say). The combination is probably worth less.

    The good thing: with a $2m market cap it doesn't really matter! Keep up the good work.

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    1. Thanks and yes your thinking is like mine on this point. I thought about mentioning something of that sort but the market cap is so low it doesn't matter.

      They have an appraisal of their 'used' land plus building for $4.5M. My thinking is they could sell this and either lease it back or go lease another facility. At that point they'd have to pay a monthly lease so the business would be worth a bit less. So maybe for their $4.5M sale we would get $3M of value. Still cheap

      The question is will they ever actually do something with the real estate.

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  2. Nice
    Your article made the stock jump 25%. Someone didnt use Limit order i guess.
    So with all the SEC, shareholdres meetings, Consultants and so on, all thta was needed is one article from you and a buyer with no limits (who bought is 5ooo$)

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    1. I don't understand.

      The stocked jumped just because it's very illiquid. There are very few shares for sale so those who want in have to take what they can get, or be very patient. I'm not sure what the bid/ask was when I posted but over the past few months it has been 1.30/2.00, 1.30/1.80, 1.30/1.68, or thereabout. There is a large spread

      This stock went from 1.95 to 1.65 and back to 1.90 over a few days in May. Then in June it dropped from 1.90 to 1.50. In July it dropped to the 1.30 range and has stayed there until I posted.

      This is just how these stocks work.

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    2. With these types of stocks, the last transaction price may never be seen again. Just because it sold for $1.35 yesterday doesn't mean you will be able to buy it for $1.35 today.

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    3. Do you know what bid and ask actually are in these stocks? I mean there is no market maker, right? Is it always some buy and sell order that is out there, or is it just the last transaction?

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    4. DEWY has a bid/ask displayed just like any other stock. You can actually see the whole level 2 tree at the otcmarkets quote page for DEWY

      The stocks that don't show bid/ask are grey market: IOMT, SIMA

      It can be helpful when thinking about these super illiquid stocks to see the recent transactions. The tmxmoney site shows the past 25 trades which can stretch back months or years for some stocks. https://web.tmxmoney.com/quote.php?qm_symbol=DEWY:US

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  3. I think your $5 million valuation is a bit rich. This thing is bumbling along at basically breakeven and has $1 million of pension debt. If you had $5 million, would you buy the whole company (ex the property)? I wouldn't.

    I'm thinking under a million for the operating business (after you net out the debt) plus some kind of value for the land. I'd say the current price is fair given the uncertainty around the monetization of the land.

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    Replies
    1. it's amazing what different interpretations people can have when viewing the same information

      Delete
    2. That's what makes a market. All these companies you look at are so small that I think it makes sense to compare them to private company valuations, and not use some multiple based on other public company values.

      I'm looking at a private business right now that has $5 million of sales and earns under 100k. Asking price is $1.1 million. Given that, I don't see how a minority stake in this biz is worth much more.

      If they monetize the land, you'll have a winner. Heck, if people just get excited about the possibility of monetizing the land, you'll have a winner. If that doesn't happen, you probably won't.

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    3. You forgot some more ways to get a winner. If the operating business improves. If people get excited about the possibility of the operating business improving. Poly coming back with a real concrete offer for all shares at their $3 price. Any person or fund deciding they want to buy into this stock in volume.

      As with many of my other stocks we have a low share count and tiny company. Any bit of news or a new contract can be a big change for the company and send the stock way up.

      I see more ways to win than ways to lose. I see more upside than downside. I think sometime in the future the stock price will be materially higher than $1.35.

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    4. Not sure if you saw this, but the company had a deal to sell 7 acres for ~$200k in 2011 or thereabouts. The deal kept getting extended (and the price was cut to $150k) before it was finally canceled at the end of 2015. At least, I assume it was canceled because there was no mention of it in the last 10-k.

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    5. Thanks and no I didn't know that. Hopefully they can put the real estate to work one of these days.

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