I used to spend a lot of time searching for tiny, undervalued stocks.
I am not cool.
I would still be spending time searching for undervalued stocks, but I’ve been aggressively buying during this latest bear market. I’m very close to fully invested for the first time in years. Some of these stocks are even up. Go me.
Investing in penny stocks is a lot more complicated than investing in Telus or Wal-Mart. You can be relatively assured that a big, blue chip stock is valued relatively close to its fair value. There are thousands of analysts, hedge fund guys, and interested amateurs analyzing the latest results from Telus. There are collectively very few of us looking at Aberdeen International. And out of those few people even aware of the company, most end up passing on the investment anyway.
Smaller companies also have other factors an investor in blue chips never has to worry about. Management teams can often control the company with just a few million invested, so you have to worry about that. Normally, this is good, since management should have an incentive for the share price to go up.
But sometimes, this works out very badly for shareholders. Here’s one of the worst examples I’ve seen in my years of investing.
Gulf and Pacific Equities Corp.
Gulf and Pacific Equities Corp. (TSXV:GUF) came up on a stock screener one day. It’s pretty much the very definition of a tiny, illiquid micro-cap company.
It has a simple business. It owns retail real estate in Alberta, with a whole portfolio of three properties.
It has a shopping centre in the bustling metropolis of St. Paul Alberta, a 65,000 sqare foot mall anchored by a Sobeys and a SAAN store, at least according to the company’s website. There’s also a Tim Hortons and a Petro Canada on the other side of the parking lot. It does not appear to have on-site management.
According to Google Maps, the company’s list of current tenants is wrong. It identifies a Mark’s Work Warehouse, a Giant Tiger, and a Peevy Mart as main tenants. There’s also a Dollar Tree and an Ardene store in the mall.
Its flagship property is the Tri-City Mall, which is located in Cold Lake, Alberta with a square footage of 142,257 square feet. It has all sorts of different tenants, including a Sobeys (for reals this time), Sport Chek, Winners, Bootlegger, The Source, Value Drug Mart, another Dollar Tree, and a ATB Financial and Pizza Hut in separate buildings off the main mall. This mall does appear to have a on-site manager; there’s a phone number at least.
Finally, it owns a stand-alone building in Three Hills, Alberta, which is currently leased to something called The Bargain! Shop. (Jeb! Bush approves of that name). It was originally a SAAN store, but SAAN went to zero back in 2005 on account of it wasn’t Wal-Mart so therefore everyone just walked by and giggled instead of shopping there.
Here is a picture of said shop.
The company used to own a property in Merrit, British Columbia, but sold that to the current tenant in 2014. Naturally, that property used to be a SAAN before an auto parts store moved in. It owns a vacant lot next to that property which isn’t worth much.
That’s pretty much the business. In the full year of 2014 (2015 results aren’t out yet as I write this), the company did $3.06 million in revenue. How much would you pay the guy in charge of this business, knowing that:
- The main property has a manager there
- The secondary property has about six stores
- The third property is stand-alone and doesn’t need hardly any management
- The CEO lives in Toronto, yet the portfolio is in Alberta
- The website is horribly out of date
- It’s not a very complicated business
Personally, I’d make the guy in charge take an office in Tri-City and pay him $75,000 per year or so. It would be a pretty sweet gig, I’d take it in pretty much a heartbeat. It couldn’t possibly take up 40 hours a week.
Well, apparently I’m a cheapass. He gets paid $200,000 per year.
Uh, Nelson? That seems like a lot. Are you sure you didn’t add in an extra zero?
Oh, it gets worse.
Anthony Cohen, come on down
Now maybe I’m being a little harsh on the guy who runs Gulf & Pacific (G&P for the rest of this). Anthony Cohen, the CEO, owns 40.5% of the company as of April, 2015. That’s good, right? Don’t investors like to see management owning a big chunk of the company?
Not only does Cohen essentially control G&P with his shares, but he also lent the company $5.75 million on a revolving line of credit with a $6 million limit. Well, Cohen didn’t. A subsidiary controlled by him, Ceyx Properties Ltd., did.
Let’s ignore the fact Cohen lives a full 3,395 km away from Cold Lake, the closest property. We’ll ignore the fact the company is apparently all about growth (it says so on the website, at least), yet hasn’t bought a property since 2006. We’ll even ignore the fact that at least half of the properties appear to be actively managed by a team onsite.
What we can’t ignore is Cohen obviously doesn’t dedicate all of his time to G&P. We know that because the guy is the CEO of another company, Plato Gold Corp (TSXV:PGC).
Most people moonlight as a server or a bartender. Cohen’s side hustle is a CEO of a publicly traded company.
At least Gulf & Pacific is an actual business. Plato hasn’t recorded meaningful revenue since 2011, when it sold a whole $100,000 of something. It’s not in very good shape, as this paragraph from the latest quarterly earnings release attests:
“The Company’s continued existence is dependent upon its ability to raise additional capital and/or obtaining financing from related parties and develop profitable operations. Management believes that it has the ability to raise the required additional funding. While management has been historically successful in raising the necessary capital, it cannot provide assurance that it will be able to execute on its business strategy or be successful in future financing activities. As at September 30, 2015, the Company had current assets of $116,812 to cover current liabilities of $1,354,167.”
So yeah, it’s basically insolvent.
Cohen has a big investment in Plato too, owning 30,117,385 shares. Ceyx owns some of those shares, and so does another related company, 1338823 Alberta ULC, a company which is 33.3% owned by Cohen.
This seems like a lot until you see Plato’s share price, which is a whole penny per share. That still values Cohen’s stake at a little over $300,000, which isn’t really chump change. Plato has been around for a while, too, spending time above $0.20 per share in 2004. I’m too lazy to check that far back, but I bet Cohen is down quite a bit on his investment.
Naturally, Plato pays Cohen well. He isn’t quite making the same salary as he pays himself at G&P, but he still takes home $150,000 per year from his second job.
And in case that wasn’t enough for you, guess which two companies have the same CFO, Greg Wong? Wong’s deal is actually sweeter than Cohen’s, since he’s making approximately $200,000 per year from the two companies without tying up millions of his own capital in these businesses.
What can we do about this?
Unfortunately, there’s not a lot we can do about something like this. It may be immoral, but it’s not even close to illegal. In fact, I’d be willing to bet if anyone reading this had the opportunity to do so, you’d probably do the same thing. I know I’d sure think about it.
The fact is each year shareholders vote for a board of directors. Cohen is joined by four other people who, in theory, can boot him out of the CEO chair. They don’t, because he controls so many shares and therefore votes. They know if they don’t suck up to him they’re probably gone next year.
So we get the status quo. Which is great for Cohen and Wong, but not so much for small shareholders.
These guys aren’t the only ones doing this. There are countless additional examples on the TSX Venture of management teams doing stuff that would make Warren Buffett blush. It’s definitely not illegal. But it’s still not something I want to encourage with my capital.
It begs the question of just how much executive compensation is too much. I view it kinda like Supreme Court Justice Potter Stewart viewed hardcore pornography, taking a “I know it when I see it” attitude. If you think it’s too much, it’s probably too much.
This is a terrific example of why many investors will avoid micro-caps with extreme prejudice. Can’t say I blame them.