Case study
by Aaron Brown

Adapted by Prof. Ian Giddy, New York University

SUBJECT:   eRaider's Plans for Goldfield    
 POSTED BY:   Aaron  Brown
 POSTED:   11/17/00 
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 Q32000 Q22000 Q11999 Q41999 Q31999 Q21999 Q1
Construction Revenue7,072,150 7,565,191 5,211,071 4,023,691 2,723,281 5,410,273 4,884,514
Construction Expense4,959,418 6,181,511 3,503,451 2,712,742 2,415,227 4,574,925 4,599,211
Construction Pretax Income2,112,732 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.


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?. | | | | contact
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