wood, logs, lumber

Free Ride With An Activist Investor

If you are a value investor, there is a good chance that you are currently not keen to buy new shares in the wake of the rather overpriced stock markets. However, even in overpriced markets, there are always interesting companies, which are worth looking at. I would like today to present a company: the Keweenaw Land Association (KEWL), which can offer two advantages. Firstly, this company can be considered as a safe asset given the fact that it owns forestland. Secondly, recent developments might help to rapidly unlock shareholder value.

Company overview

The Keweenaw Land Association, Limited is a land and timber management company that owns 185,750 acres of surface land and 401,841 acres of subsurface mineral rights in the western Upper Peninsula of Michigan and northern Wisconsin. The company derives the majority of its net income from the sale of logs harvested from its forestland.

Source: 2017 Annual Report

The Keweenaw Land Association is very thinly traded company and this also only on the OTC markets. This might be the result of the low market capitalization of approximately $134 million. It is a slight disadvantage for investors since the company is not subject to such strict reporting requirement as it would be in case when directly listed on a stock exchange. However, thanks to this fact, the company is not on the radar of investment analysts.

Chart

As the graph above shows, the price of the company has not gone anywhere in the last decade, but that might change soon.

I want to stress at the beginning of this writing that this company is worth noticing because there is a strong believe that the value of the assets (i.e. forestland) is higher that the company’s market capitalization. In addition, the land is not only forestland, but waterfront land and commercial land as well, which have significantly higher value.

From the earnings viewpoint, the situation is not that spectacular. As a rule, the Price/Earnings (P/E) ratio of a timber management company is not very attractive. The main earnings result from selling timber and even in a well managed company, the P/E ration is always very high.

REVENUE & NET INCOME

*values in rounded thousands

Source: 2017 Annual Report

I do not want to spend too much time going through publicly available information, which is easily accessible on the company’s website. You can analyze the income statement, balance sheet and cash flow statement in the Annual Reports, what I strongly recommend. Further, I would like to focus on the bigger picture.

Key Points

The reason why the company is interesting right now is the recent change in the Board of Directors. Up until recently, the Keweenaw’s Board did not seem to act as if they were the owners of the business, i.e. in favor of shareholders.

For years, Keweenaw was not able to unlock value for its shareholders. A combination of systematic under-harvesting and excessive costs, due to operating below scale and unnecessary expenses for non-executive board members, has led to very little cash flow.

Cornwall Capital, the major shareholder of the company, made an extensive analysis by comparing the Keweenaw Land Association with its peers. This view is shared by many shareholders, who ultimately supported Cornwall Capital during the 2018 annual meeting of shareholders (more on that later).

As the Cornwall’s presentation shows, Keweenaw has had an extremely high expenses, given that it is a logging company, which might indicate a poor management. Whereas other peers have Board of Directors’ and similar expenses compared to total revenue below 1%, the number by Keweenaw is an extraordinary 5.4%.

Expenses

Source: Presentation – Cornwall’s Plan to Return Keweenaw to Success

What about other metrics important for an investor?

The same poor figures are visible when comparing the company’s EBITDA margin to its peers. The main reason for the considerable difference is under-harvesting of logs and a very little control over costs. The management of the company underestimated the amount of logs that could be harvested by approximately 25%. This finding results from Keweenaw’s 2017 comprehensive timber cruise, which was performed by an independent third party. It assessed the standing timber on the company’s forestland and concluded that standing timber volume was approximately 25% higher than what the management thought. On one hand, these were positive news for shareholders as this timber can be harvested. However, given that harvesting logs is the core business of the company, this huge deviation clearly underlines its mismanagement.

The company’s strategy has also been confusing. Not surprisingly, this did not bring much added value. For example, the company recently embarked on a debt-financed acquisition program, with over $22 million spent over the last 5 years. Alarmingly, EBITDA has declined over this period. There is no strategic rationale for growing acreage, as the company is nowhere near achieving scale.

So why is this company interesting?

This stock idea is event-driven. After years of mismanagement, the major shareholder Cornwall Capital, controlling 26% of the company, acquired effective control over the Board in April 2018.

This happened after an ugly proxy fight between the old management of Keweenaw and Cornwall Capital. There was a number of unsuccessful attempts to replace the old management in the recent years. The replacement was extremely difficult because of the company’s governance policies that made this task extremely difficult. Some Directors of the company were serving in the Board for decades and literally begged the shareholders to vote for them again as can be seen in the company’s fillings from February – March 2018. However,  the old management lost the fight during the last annual meeting.

Cornwall Capital won 3 additional seats on the board and currently has effectively control of the company. As the major shareholder, Cornwall Capital is focusing on unlocking the shareholder value.

It might be interesting to know that Cornwall Capital was featured in the movie “The Big Short” as it was one of a few investors who saw and shorted the subprime mortgage crisis market prior to the 2007 collapse.

Cornwall’s New Keweenaw Strategy: 4 Point Plan

As soon as Cornwall acquired effective control over the management, the company and shareholders views are finally aligned. Now, Cornwall Capital wants to get some benefits from its long-term involvements in Keweenaw.

One of the first things that is already happening is that the company will convert to a REIT, which will provide significant strategic benefits for the company. This has already been announced by the old management, before the elections took place, but it might be assumed that the pressure from Cornwall contributed to this. The stock might even be listed at a regular stock exchange, which would automatically boost the stock price, but this needs to be further confirmed.

Furthermore, Cornwall presented a 4 Point Plan how to get the company back in shape. For me, this points makes a lot of sense as a credible and reasonable way forward. This is what Cornwall wants to do:

1. Reposition the Company for Cash Flow Growth

A. Increase harvest rates, given sub-optimal historical under-harvesting

B. Align compensation of existing management & other employees with long-term objectives, including cash flow and yield based metrics

2. Implement Cost Reduction Strategy

A.Reduce Board expense, including eliminating Chairman’s salary, and other non-essential board-related expenses

B.Conduct standard, overhead cost review given excessive costs vs. peers

3. Redesign Corporate Governance for Shareholder Responsiveness

A. Eliminate staggered Board and remove supermajority provisions, improving Board responsiveness

B. Conduct review of, and implement, other Board best practices

C. Improved disclosure of timber inventory

D. Regular communication with shareholders

4. Balance Sheet Repair

A. Cease all value destructive acquisitions

B. Focus on paying down debt

C. Monetize non-core assets, including property for sale and investment securities portfolio, among others

Cornwall Capital capital can successfully implement these types of actions as they already did something similar with the American Pacific Corporation, which was ultimately sold at a premium in 2014. Selling Keweenaw might be the ultimate goal for Cornwall Capital. However, the management of the company needs to be considerably improved in order to achieve a reasonable price. Given the 26% stake of Cornwall Capital, I believe there is a strong incentive to ensure that.

Source: 2017 Annual Report

Conclusion

This investment could be particularly interesting in the current market conditions. First of all, the business is extremely simple and involves the ownership of land, which might provide a certain safety net should there be any types of an economic downturn. In addition, the company is not part of any indices (e.g. S&P 500), so a potential market collapse should not result in an automatic sell off. Of course, one might consider whether it is safe to invest in OTC markets, but the presence of a strong investor (Cornwall Capital), betting on the company, provides some degree of certainty.

Hence, I have found this company particularly interesting now as I am not so keen to invest in any cyclical industries or other industries that have enjoyed an extraordinary growth over the last number of years.

However, this is not a recommendation to buy (or sell) this stock. My analysis might be wrong, without sufficient data or biased. Every investor needs to do her/his due diligence and make own decision.



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