Wednesday, April 21, 2010

Significant Regulatory Changes

Some regulatory changes make minimal impact on company valuations - at least in the short-term. Other regulatory changes, such as tax rate changes, affect almost all companies equally. But some regulatory changes affect only a small group of companies, and in a big way!

In late 2009, a new federal law was enacted that significantly expands the Net Operating Loss carry-back opportunity for businesses. In effect, this allows companies that experienced large losses in 2008 and 2009 to offset them against gains they experienced in the five previous years, allowing them to recuperate tax payments they have previously made.

For most companies, this regulatory change may mean nothing at all; for companies that broke even or incurred only small losses in 2008 and 2009, or for companies that incurred large losses in 2008 and 2009 but don't have correspondingly large gains in immediate prior years, this tax treatment change makes little difference. But for some companies, the change can turn a company from a sell into a buy!

Consider Chromcraft Revington (CRC), producer and distributor of residential and commercial furniture. The company has had a particularly rough couple of years. In 2008 alone, it lost $25 million on revenue of just $99 million! In previous years, however, it has been rather profitable. As such, the refund the company is to receive based on the regulatory change is $6.5 million. To put this in perspective, the company's market cap is just $15 million! The regulatory change alone turns this company into one that trades at a discount to its net current assets!

Paying constant attention to regulatory changes can be an arduous task. Most changes make little to no difference in the vast majority of company valuations. For those paying close attention, however, opportunities can arise when a regulatory change has a significant affect on a company's finances.

Disclosure: None


Rayhaan said...

hey saj,
i know this might b a bit inaccurate,intrusive or disturbing but y do u guys focus almost exclusively on net-nets?
i mean i see less of turnarounds or stocks undervalued by earning power as compared to net nets.
p.s did u check out the the value investor app on facebok?

Anonymous said...

Hey Saj,

I like the concept. I wouldn't touch this one with a ten-foot-pole though. Over the last 5 years, while CF+ to the tune of $11m OCF / $6m Owners' Earnings, the extinguishment of debt to the tune of $15m, the TBV has still dropped to $31m from $63m AND Shares Outstanding have gone up 10%+ (from 4.2m to 4.7m). If I were a shareholder, I'd be outraged!

Yes, PP&E is admitedly undervauled, where is the catalyst?

I know you didn't recommend this as a buy, just thought I'd share.

Anonymous said...

The company also had $88m of Gross PPE on 12/31/2000 and had $43m of Gross PPE as of 12/31/2009. In 10 years, the company has $55m less Gross PPE but it's statement of CFs show only net proceeds from sale (purchase) of PPE at of $11m. Is the PPE they have left worth more than the stuff they sold for, on average, 25c on the undepreciated $1?

Saj Karsan said...

Hi Rayhaan,

I wouldn't call it 'exclusive', but the market crash did create a number of these traditional value gems. I also tend to like companies that trade at discounts to both assets and earnings, so some net-nets make ideal candidates. I haven't seen the fb app you refer it useful?

Anonymous said...

sure looks like a exclusive club ,its called the value investors network , i guess. The ultimate aim they say is to help atleast some of the members start their own hedge funds, there r regular write ups by the members ( the only problem as far as i can see is that members are encouraged to discuss stocks listed on foreign exchanges but hey u ll eventually go into foreign stocks wont u?).its started by this guy with a funny name (also on fb) mike onghai.

Anonymous said...

p.s did u check out michael lewis the big short( i know shorting can be more trouble than its worth but the book can be used to learn a lot, please check out the cornwall capital management story as well as the part about the clash between mr. joel greenblatt and mr.michael burry guy, i think u ll like it)? ITS SO AWESOME!!!!!!!
hey by the way do u use stuff like LEAPs ( the idea sure looks gr8 4 value guys when the catalysts are clearly visible pluss even mr.greenblatt reportedly likes them
aw8in ur reply,

Saj Karsan said...

Hi Rayhaan,

I don't use LEAPs but I agree that they can be useful. Thanks, I'll check out the book.