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Case
study
Goldfield
by Aaron Brown
Adapted by Prof. Ian Giddy, New
York University
| SUBJECT: |
eRaider's Plans for Goldfield |
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| POSTED BY: |
Aaron Brown
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| POSTED: |
11/17/00
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I first heard of Goldfield through a former student who worked for an
electric utility in Florida. She had been very impressed with a company
called Southeast Power that laid fiber optic cable and constructed
electric transmission lines. Her analysis showed that this was a
growing market opportunity, and Southeast Power was well-positioned to
take advantage of it. She found the company efficient, friendly and
well run. Her analysis of the numbers showed a market value for the
company of $80 million.
One
of the great things about being a finance professor is you train
financial analysts and send them all over the country. They take what
they learned from you and add extensive industry experience and
detailed knowledge, plus their own native intelligence. So you get a
lot of good information and you can take a look back at their academic
work to figure out if you want to believe them. Even so, only about one
tip like this in ten pans out. Sometimes the business is good, but it’s
part of a bad company. Other times, the company is good, but the market
has already figured it out. Sometimes things look good on the surface,
but deeper digging turns up problems.
Southeast Power turned out
to be owned by a company called Goldfield that traded on the American
Stock Exchange. The market capitalization for the entire company was
less than half what Southeast Power appeared to be worth. And it had no
debt at all, practically no liabilities. It had lots of assets acquired
a long time ago for much more than their current book value, and some
of them had appreciated. Then things started getting strange. In
addition to Southeast Power, Goldfield owned St. Cloud Mining Company.
Headquartered in Truth or Consequences, New Mexico (across the White
Sands Missle Range from Roswell), this operation was the largest
producer of natural zeolites in North America (zeolites are handy
minerals used for absorption and filtering, among other things).
Goldfield had some other subsidiaries and a bunch of real estate in
Florida, which I could not find out much about, some precious metals
mines and other odds and ends.
I starting doing some research on
the various businesses, and also trying to disentangle the financial
statements. I think I was pretty successful in the second task.
Goldfield is a classic example of a company that looks much more
complicated on paper than it is in practice. They love to move numbers
around all over the place in unusual transactions. One quarter they’ll
write off some assets and take a loss, the next quarter they’ll decide
they were actually worth a lot after all and show a gain. Their
quarterly net income is actually pretty steady, but in the fourth
quarter of 1999 and again in the second quarter of 2000 it shot up 150
percent because they decided to revalue their deferred income taxes
(these are benefits that may allow them to escape income taxes in the
future, for example, those caused by operating loss carryforwards, but
the valuation is difficult because it depends on unpredictable future
variables). They have complex adjustments for earnings in excess of
billings, billings in excess of earnings, extinguishments of cash
surrender value of life insurance and so on. When you net it all out
and trace the cash, the business is not all that tricky.
The
most valuable business is Southeast Power. According to my numbers
(which add up to something close to Goldfield’s values but are split up
differently in time) its quarterly results look like:
| 2000 Q3 | 2000 Q2 | 2000 Q1 | 1999 Q4 | 1999 Q3 | 1999 Q2 | 1999 Q1 | | Construction Revenue | 7,072,150 | 7,565,191 | 5,211,071 | 4,023,691 | 2,723,281 | 5,410,273 | 4,884,514 | | Construction Expense | 4,959,418 | 6,181,511 | 3,503,451 | 2,712,742 | 2,415,227 | 4,574,925 | 4,599,211 | | Construction Pretax Income | 2,112,732 | 1,383,680 | 1,707,620 | 1,310,949 | 308,054 | 835,348 | 285,303 |
Here was a highly profitable company, growing at over 31 percent per quarter.
Of course, such growth cannot continue for long but my research
convinced me that Southeast Power had a bright future. Pretax income
for the trailing 12 months (October 1, 1999 to September 30, 2000) were
over $6.5 million by my numbers ($3.7 million by the Company’s numbers).
The
next business to consider is St. Cloud Mining. This company makes a
steady $350,000 per quarter in pretax income (again, my numbers, the
Company shows an average of $43,000 with losses in some quarters and up
to $166,000 profit in others). However, the facility is running at less
than 15 percent of capacity. It was built for a large kitty litter
contract (kitty litter is a big consumer of zeolites) that fell
through. It has huge reserves, although most mines claim huge reserves
based on sketchy geologic evidence. This is not fraud, it’s just that
the best way to figure out what you’ve got is usually to try to get it.
So I assume no one really knows how much clinoptilolite they’ve got;
but it’s certainly enough for many years.
The key here is that
the stuff sells for seven cents a pound. That means shipping and
handling costs are very significant. People will buy it from you if
it’s packaged conveniently and close by, but they don’t call you.
Aggressive zeolite marketers, like C2C, have found that it is pretty
cheap to increase demand. You just call people in convenient truck
radius to your mine and pitch your product as a replacement to what
they use now. There are hundreds of applications for zeolites, so there
are a lot of people to call. My research (calling customers and
potential customers) showed that a lot of possible customers had never
heard of St. Cloud.
Maybe there’s a reason for this, or maybe my
information is wrong. But it seems at least possible that an aggressive
marketing staff in New Mexico could increase sales. They already have
the capacity to produce $15 million worth per year and I estimate
variable costs are 60 percent. If I’m right and the marketing worked,
it could add $5 million per year pre-tax income to the company.
In
addition to the assets needed for these subsidiaries, there are a lot
of other assets lying around. Here I had to take a wild stab at
valuation. It could be as little at $10 million, it could be as much as
$50 million.
All of this together would imply a value of $6 to
$8 per share for the stock. But it sells for 10 percent of that. Even
if you think I’m wrong about the growth potential for Southeast Power,
the marketing possibilities for St. Cloud and take the low end of my
asset valuation; it indicates a value of $2 per share. Is the market
crazy?
No. There is a catch. There is $3 million per year of
corporate overhead in Florida. My information is that this overhead
adds nothing to the operating value of the subsidiaries, but allocation
of that overhead is what makes the subsidiaries look much less
profitable. And it gets worse. The Chairman and CEO owns 57 percent of
a Preferred Stock issue that gives him control over any major corporate
decision. He has a golden parachute worth over $4 million. The board of
directors consists of the CEO plus four outsiders. Their expertise is
in real estate and municipal administration, not mining or
construction. Altogether the outside directors own less than $1,000
worth of stock. This company has no need for corporate overhead, and
should have directors who are either large shareholders or have the
expertise and contacts to help with the business.
We have been
trying for two weeks to speak to the CEO. In fairness, he did return
our call once (but everyone was out). However, a CEO should make more
effort to speak to his largest institutional shareholder, especially
with all the confusing things about this company.
As a bonus
surprise, the company announced in its latest quarterly report that it
was continuing its real estate development operations. Huh? This was
the first mention anywhere of such operations. Although they claimed to
have been doing them for nine months, they did not show up on earlier
quarterly reports. Now it turns out the company has embarked on a
six-year luxury condominium development project, representing 75
percent of the market capitalization of the company. It intends to
borrow large sums in this effort, turning it from a debt-free company
to a highly-levered one. No details about the project are available to
shareholders, although it is an entirely new business for Goldfield,
and one fraught with disasters in the past.
The first thing we
want for this company is to pool the knowledge and opinion of more
shareholders. We’ve done our homework, now we want to compare notes.
Second, we need to get some information from management. Third, we need
to free this company of the excessive overhead burden and
antidemocratic corporate governance. Although mining and construction
may not seem to be related, the type done by Goldfield both consist
basically of moving dirt. Digging a ditch for a fiber optic cable and
loading zeolite ore are not so different. But that’s enough diversity
for a microcap company. So fourth, all non-core assets, including the
real estate developments, should be shed.
Let’s try to persuade
management to move in this direction. If that fails, let’s try to get
enough shareholders behind us to force it. |
Questions
1. "The market capitalization for the entire company was
less than half what its wholly-owned subsidiary, Southeast Power, appeared to be worth." How can this be possible?
2. If Goldfield is undervalued, what's to stop a takeover?.
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