The futility of selling early — Mind CTI again

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

446822940_bf49440a9c_b (1)Having read my earlier postings about a programmatic approach to investment by way of MNDO (start here,) the equity of Mind CTI, and my earlier postings about the potential folly of dividend speculation (start here,) a reader of this blog suggested to me that selling ones position of MNDO immediately before the ex-dividend date would be an appropriate strategy, capitalizing on the — and I quote — “stupidity” of the dividend speculators.

Although the notion of capitalizing on the greed and ignorance of dividend speculators does appeal to me, I do not believe the reader’s approach to be long-term viable.

The issue is one of tax, liquidity, transaction expenses, and timing.

Assuming a cyclic behavior consisting of sell-before-ex-dividend-date followed by buy-after-price-drop, which, of course, implies a holding period of less than 12 months, the investor would be subject to taxation on a short term basis, which for me, for instance, effectively would result in a Federal income tax hit climbing towards 40%, supplemented by a state and local tax bordering on 10%, for a total tax bordering on 50%.

Had I, for instance, acquired $100 thousand worth of shares in 2013 at an average price per share of $1.75, amounting to approximately 55 thousand shares, and sold these at today’s rate ($2.30 per share,) my pre-tax yield would be $125 thousand, or so (accounting for transaction expenses and supply/demand pricing issues,) for a net pre-tax gain of $25,000 and a post-tax gain of $12,500.

Naturally, this approach raises demand for liquidity and is impacted by transaction issues and expenses — and, importantly, it is characterized by a per share price risk and the broad assumption that the price will not go up immediately after the ex-dividend date adjustment. Moreover, the ugly pairing of requirement for superb timing (the cause of death of many a trader) and risk comes into play — in particular since it is ultimately impossible to know, for sure that: (1) an initial position can be secured, (2) that the initial position can be sold at a the required premium, (3) that a later position can be secured, and (4) that a dividend will actually occur.

A 12.5% gain on a six to nine months investment is, of course, not shabby when compared to the average 0% interest that your local bank savings account carries, but it does not in any way perform substantially better in the long run than does the pure dividend play, which with more than 55,000 shares, no transaction costs, and, critically, no per share price risk, handily and consistently delivers more than $12,000 after taxes, assuming a dividend taxation of 15%, and produces more shares — and thus more dividends — year after year.

Now, it would, of course, be possible to argue that applying this strategy for a position held in an tax-advantageous retirement vehicle such as an IRA might work (it would certainly negate some of the tax issues,) but, generally, tax-advantageous retirement vehicle are best suited for long term hold strategies and the use of these vehicles for other investment strategies is something that should be thought through very carefully.

Donations, please….

As usual, if you found this posting useful or entertaining — or if it saved you time, you can express your appreciation through donation via PayPal right now.   For this type of posting a one-off donation of $10 is suggested — however, any donation is, of course, appreciated.


Please, sir, I want some more — Mind CTI redux

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

2163042781_29c776780e_oEarlier, I wrote about a programmatic approach to investment related to Mind CTI Ltd and its equity MNDO, laying out a simple formula that would have yielded an estimated 388% gain over a five year period:

(1) settle in for a long run, (2) pony up $100,000, (3) every year re-invest the entire dividend payout (less a mandatory 25% (or so.. the amount varies from year to year) dividend tax withholding) by buying additional shares exactly 90 days after the previous dividend was paid out, and (4) — and this is the really important step — ignore any and all temptation to trade the equity, game the system, or cash in on short term gains in the per share price.

My posting (read it here) generated quite a lot of traffic and follow-up questions, in particular after Mind CTI announced is fourth quarter and full year results for its fiscal year 2013 (read more about this here,) and — again — announced a REIT like dividend.

So without further ado, I provide more information related to my rudimentary modeling.

First, here is the previously published results table, updated with information about an element that I had not commented on: A U.S. tax credit available on top of the discussed position gains, amounting to almost $22 thousand over the period in question:

(c) Per Jacobsen, 2013 and 2014. All rights reserved

(c) Per Jacobsen, 2013 and 2014. All rights reserved

Please note that these computations are really rudimentary, making very simple assumptions about the tax rates and trade viability across the periods.

Ok, now that we got the disclaimer, let’s look at the evolution in position value, not including the $22 thousand tax credit:

(c) Per Jacobsen, 2013 and 2014. All rights reserved

(c) Per Jacobsen, 2013 and 2014. All rights reserved

We note a couple of interesting things…

First, the position value was at its peak ($518 thousand) in april of 2011, immediately prior to the exit of a very large institutional holder, whose position liquidation caused a drastic drop in the per share price.

Second, the position value was at its low ($59 thousand) in March of 2009, reflecting the overall market conditions.

Third, the appreciation since the low (from a low of $59 thousand to a high of $518 thousand) has been enormous, and to deviate from the programmatic approach when the position value dropped in conjunction with the market would have been a blunder of the highest magnitude.

When reflecting on the third point it is important to remember that a proper analysis of Mind CTI would have uncovered a very healthy, debt-free, cash-flow positive, and consistently dividend-paying business, and, so, it should have been clear that the market gyrations were — fundamentally — irrelevant.

So, in the immortal words of Mr. Bumble:

“Come, Oliver! Wipe your eyes with the cuffs of your jacket, and don’t cry into your gruel; that’s a very foolish action, Oliver.”

That’s it. Have a nice day.

Donations, please….

As usual, if you found this posting useful or entertaining — or if it saved you time, you can express your appreciation through donation via PayPal right now.   For this type of posting a one-off donation of $25 is suggested — however, any donation is, of course, appreciated.


Mind CTI is prepared for 2014

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

2178452403_a7ddd24205_o

Onwards and up

Mind CTI Ltd. released its financial results for the fourth quarter of fiscal year 2014 and full fiscal year 2014 on Tuesday, February 25th, 2014.

As usual, I have summarized these results and my commentary on these in a dynamic posting that you can find here. The dynamic posting also provides summaries of previous quarters’ results and associated commentaries.

After several quarters of re-gearing, with added expenses and headcount and lowered operating income, the company ended its fiscal year with a bang, turning in a fourth quarter that was way better than expected, establishing a significant foothold for the 2014 fiscal year, and paying its patient shareholders a significant dividend.

On the back-end of significant wins in the fourth quarter of fiscal year 2013, the company appears very optimistic about fiscal year 2014 and it backed this confidence up with a $0.24 dividend, payable in the first quarter of fiscal year 2013, and constituting a 10% yield or better (read more about the very special dividend situation for Mind CTI here.)

For more information, please refer to the dynamic posting (here.)

Donations, please….

As usual, if you found this posting useful or entertaining — or if it saved you time, you can express your appreciation through donation via PayPal right now.   For this type of posting a one-off donation of $10 is suggested — however, any donation is, of course, appreciated.


A paradigm for programmatic investment — 388% gain with Mind CTI

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

ISO-computer3Tomorrow, February 25th, 2014, Mind CTI Ltd. releases its financial results for its 2013 fiscal year.

As the reader of this blog probably knows by now, Mind CTI is an Israeli company that I follow with a lot of interest and believes yields a significant earnings opportunity for investor.

A quick glance at Mind CTI does not reveal something very exciting. The company is small and its equity is trading at the sub-$5 level of a micro-cap stock.

Look behind the facade, however, and you will find an extra-ordinary dividend investment opportunity anchored in a rock-solid company with a stellar record of producing lots of cash, providing something quite unique: The opportunity to make substantial gains through a programmatic investment paradigm — the holy grail for any long-term investor.

I will explain, but first let me provide some background.

In 2008/2009, the per share price of MNDO, the Nasdaq traded equity of Mind CTI, experienced significant troubles because of the company’s investment of approximately $20 million into inherently worthless Auction Rate Securities (read more about how that came about on Mind CTI’s Wikipedia entry (here) — a tale of fraud and deceit by professionals in the securities industry) and in spite of a rock-solid operation and stable cash-flow.

Had you in 2008, when the company’s shares in a reaction to the Auction Rate Securities debacle reached a per share price level of less than $1, analyzed the company’s situation and fundamentals and reached the conclusion that the Auction Rate Securities issue was annoying, but, fundamentally, irrelevant, you could have acquired MNDO shares cheaply.

Had you also recognized that Mind CTI’s operational and cash-flow performance was not a fluke, you could have laid out a very simple mechanism for generating very substantial long-term gains: (1) settle in for a long run, (2) pony up $100,000, (3) every year re-invest the entire dividend payout (less a mandatory 25% (or so.. the amount varies from year to year) dividend tax withholding) by buying additional shares exactly 90 days after the previous dividend was paid out, and (4) — and this is the really important step — ignore any and all temptation to trade the equity, game the system, or cash in on short term gains in the per share price.

Had you done so, you would today be holding 177 thousand shares, valued at $380 thousand if you liquidated your position now, or — if you were to keep applying the programmatic approach, generating $42 thousand in dividend in 2014.

Moreover, should you decide to liquidate your position, it will be taxed on the basis of a long-term investment at a rate of 15%, making your post-tax payout $338 thousand, for a post-tax gain of $238 thousand, or a 338% return on your investment. More importantly, however, you had achieved this staggering return with near-zero risk, negligible heart-burn, limited transaction expenses, no portfolio oversight, and no exhausting discussions with the IRS — in other words with little or no fuss. It would quite literally be the easiest money that you ever made.

Here is an immensely simplified table showing how this would have gone down:

(c) Per Jacobsen, 2013 and 2014. All rights reserved

(c) Per Jacobsen, 2013 and 2014. All rights reserved

Now, if you had followed MIND CTI in detail, you may also have arrived at the conclusion that the company’s intrinsic value exceeds its market value by a significant margin (read here about Mr. Igor Novgorodtsev’s conclusion that the gap is 40% to 56%) and that the per share price of MNDO would grow to $5, $7.50, or $10 over 3 years, and, so, you may conclude that 177 thousand shares alone (i.e. not including the increase in shares that you would experience over the next three years,) would reach a value of $884 thousand, $1.3 million, or 1.8 million, respectively.

Ok, I hear Hold it a minute buddy…. Surely, the depressed value is a function of the dividend policy and resulting payouts, and, so, there cannot be any gains.

Well, not really. In an efficient market, a conservative no-debt company that consistently throws off the sort of dividends that we are talking about here (a yield of between 10% and 20%) should be worth far more than Mind CTI’s capitalization implies.

Ok, so let’s assume that we put the efficient market aside for a second… If Mind CTI was to suspend its dividend, then the cash being horded would automatically — and dramatically — increase the company’s value (and, presumably, its market capitalization.)

And guess what? If the company did not suspend its dividend, then the worst thing that would happen to an investor would be that he or she would be provided with an option to let the programmatic approach continue to do its job, offering a continuous accumulation of MNDO shares.

Even in an inefficient market, the per share price of MNDO will, of course, eventually, go up, as it did in 2011 when it exceeded $3.45, probably at part of a cycle where the financial market turns away from flashy social media shares with excessive valuation and seek out solid, debt-free, cash-producing companies such as Mind CTI.

By the way. Had you, in our not-so-hypothetical scenario, exited in 2011, at a per share price of $3.45, you would have netted $500 thousand before taxes or $440 thousand on a post-tax basis. Not shabby for an investment that does not have the sex appeal of Facebook, Twitter, or LinkedIn.

Donations, please….

As usual, if you found this posting useful or entertaining — or if it saved you time, you can express your appreciation through donation via PayPal right now.   For this type of posting a one-off donation of $25 is suggested — however, any donation is, of course, appreciated.


Mind CTI steaming ahead

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

…. And, if you find yourself enjoying this posting, consider supporting the blog through a donation. For your convenience, PayPal links are provided to the right and at the end of the posting.

2178405993_acb33153e9_o

Onwards and up

Mind CTI Ltd. released its financial results for the third quarter of its 2013 fiscal year on November 5th, 2013.

As usual, I have summarized these results in a dynamic posting that you can find here.

As the reader of this blog probably knows by now, Mind CTI is an Israeli company that I follow with a lot of interest – primarily because I think that MNDO, the company’s equity, yields a significant earnings opportunity for myself, but also because the trading patterns that were found around MNDO in relation to the annual dividend payouts by MIND CTI during the period from 2009 through 2012 (but, I hasten to say, are no longer be in effect) are intellectually interesting.

The quarter’s results were quite good. Here are some of the highlights from the aforementioned dynamic posting:

Again, this quarter, the results were not in line with the stellar results of the last fiscal year, but, overall, they were not really bad. This quarter brought nice bumps in revenues, operating income, and net income compared to these of the last quarter.

The company continues closing business at a moderate to fair pace, adding one net-new customer and several follow-on orders this quarter.

The growth in the company’s staffing level and associated expenses continue, reflecting the challenge of increasing the number and size of customer engagements to make up for the recent loss of high-margin revenues. …

[T]he company made a tentative commitment to the yearly dividend, announcing that the company would seek court approval for a possible distribution for the year 2013 in the amount of up to $4.6 million, or +$0.20 per share…

[T]he company’s CEO commented on the company’s intent to undertake acquisitions:

“We are well positioned and have the required resources to respond to potentially increasing market needs and at the same time target potential acquisitions that could benefit the company results.”

The progress on a quarter-over-quarter basis is encouraging, and the promise of one or more acquisitions is exciting. Clearly, the company is executing on a well thought-out plan for restoring the bottom-line and boosting the top-line, and the dividend announcement is, I think, a strong indicator of the company’s confidence in its operations and sales.

The key to MNDO and Mind CTI as an investment is, of course, its unique, one in a million, dividend policy, which resembles that of an REIT, coupled with its uncanny ability to maintain profitability and generate huge cash-flow almost irrespective of the top-line.

Novgorodtsev’s second set of finding

Sometime last year, Mr. Igor Novgorodtsev wrote an article about a pattern of speculation around Mind CTI’s consistent dividend (you can read about Mr. Novgorodtsev article and the speculation in one of my earlier postings (here.))

Unfortunately for Mr. Novgorodtsev, the pattern that he had uncovered was a wave-event related to an extra-ordinary dividend paid by Mind CT in a couple of years ago, and, at the time that Mr. Novgorodtsev wrote his article, the waves had more or loss subsided into nothingness.

Mr. Novgorodtsev is now back, having written his second article about Mind CTI and the value inherent in MNDO. This time, however, he is focused on what long time investors has been aware of since before 2010: That Mind CTI is a uniquely consistent operational performer and dividend payer.

You can find Mr. Novgorodtsev’s article here. Although he has the competitive landscape quite a bit wrong, he fundamentally arrives at the right conclusion, so I will simply quote him:

MNDO has an unusual REIT-like dividend policy: it pays out the full EBITDA plus financial income minus taxes on income. Essentially, its payout ratio is above 100% but a strong free cash flow in excess of reported earnings makes it sustainable as it has very little CapEx. It has paid dividends in excess of 10% last 5 years and is likely to pay 14% this year (subject to approval by Israeli court). The management recognizes that MNDO business is slow-growing, so the excess cash should be given to the shareholders via the dividends and stock buy-backs.

There is only one true comp for MNDO valuation: a much larger telecom software provider and direct competitor, Amdocs. While both companies have similar P/E ratio, use no leverage, and few long-term liabilities, MNDO is a true “cash cow” with 15.1% free cash flow yield (Cash Flow from Operations minus CapEx divided by the market cap)….

On a free cash flow and EBITDA basis, MNDO trades at a 40-45% discount to Amdocs. Another way to estimate MNDO value is to use a dividend discount model to calculate its intrinsic value since it has no debt and pays out all its earnings:

Inputs:

Beta = 1.63

Rf = 2.75%

Risk premium = 5%

Nominal growth rate = 2% (long-term inflation)

Dividend = $4.6 million

Value:

$51.7 – 56% larger than its current market price!

By all measures, MNDO CTI is underpriced by the market at least 40%.

Bravo, Mr. Novgorodtsev. Welcome to the club of Mind CTI believers!

Donations, please….

As usual, if you found this posting useful or entertaining — or if it saved you time, you can express your appreciation through donation via PayPal right now.   For this type of posting a one-off donation of $10 is suggested — however, any donation is, of course, appreciated.


Being an Excellent Investor

As it is the case for all postings in this blog, my standard disclaimers apply for this posting.  However, since this posting discusses investments, I urge you to review the disclaimers laid out in the About section with extra diligence. Moreover, even if you have already reviewed these disclaimers in the past, you need to review them again, as they are subject to change without notice.  Do it now, and remember that whatever I say in this blog posting is simply my opinion — it is not science, it is not advice, and it is not an attempt to make you act in any way whatsoever.

I recently posted a reply to a posting on a Yahoo Finance message board for Mind CTI in which the poster asked:

Is Mr. Market valuing MNDO correctly?

How much is MNDO’s business worth? For $20 million ($40 million market cap minus $20 million cash) you are buying a business that generates $4-$5 million in annual FCF and a recurring revenue base. This means an ex-cash FCF yield of 20-25%!

So board – What am I missing?

00292vAs you can read about in a previous posting I have had a long-standing interest in Mind CTI predicated mostly on the market’s inability to — for a period of more than five years — value the company’s equity, MNDO, correctly. My interest in Mind CTI, however, is not limited to its potential value from a fundamental investor’s standpoint, but also includes the way that MNDO has been subject to dividend related speculation for the last couple of years — something that appears to have ended as of this year, but, as they say, that’s another story.

By way of background, Mind CTI’s dividend payouts since 2003 have been spectacular, with, for instance, the yield for this year’s dividend being around 10%. In 2009, for instance, on the tail-end of a per share price of $0.65 at the beginning of the year, the dividend payout was $0.80 per share. Let me say this again… In 2009, you could buy MNDO shares for $0.65 by shares in the beginning of the year and collect $0.80 per share in dividend at the end of the year.

My response to the poster, which started out as a direct answer to the question posed, quickly became a quasi-rant along the lines of Mr. John F. Kennedy’s now famous ask-not-what statement reflecting my overall feeling that being a long-term investor requires more than just moving some money across the table and then sitting back and hoping for the best.

Here is what I wrote, edited only slightly….

Answering the question directly

From a pure fundamentals standpoint, yes, the market is wrong.

However, from pure fundamentals standpoint, the market has been wrong 99% of the time when it comes to MNDO and Mind CTI — perhaps never more so than when the company’s per share price sunk to $0.65 per share, giving a valuation of somewhere in the range of $12.5 million for a company that since 2003 has thrown of several million dollars per year in dividend and has had ample cash reserves.

Rolling with the idiotic $0.65 per share price, I am no longer expecting that the market understands — or even cares — about Mind CTI and its equity. In fact, I am more on the other side on the fence where I am taking a Buffett-like view and saying that the more the market is wrong, the cheaper MNDO is, and as long as it continues to throw of dividend payments at the pace that it has done to date, then it is hard to complain.

You can rationally argue that the market is wrong by looking at fundamentals such as FCF, but until such time that Mind CTI begins growing its top-line, you can also argue that the market is right — assuming that there is a way to achieve more than +10% ROE, something that I believe most investors fool themselves into thinking.

The idea of investing in a sub $100 million micro-micro-cap company with the expectation of a regular +10% yield is simply not what most investors look for. In fact, to the extent that someone is chasing that dividend yield, I think they look for large companies such as, say, utilities, where they — right or wrong — can get some level of assurance that they can’t get from a company such as Mind CTI.

Releasing potential value

The formula for spectacular top-line growth is not nuclear physics: You invest in sales, marketing, and R&D or you invest in mergers and acquisitions, praying (and a prayer it is — always) that you will get a return. The more growth you want, the more you invest, and the more you risk.

And therein lies the rub….

Should Mind CTI’s management and Board of Directors wish to accelerate sales, they must (1) take a risk and (2) reduce the dividend (one way or another,) something which would, I am guessing, lead to a near-immediate drop in the per share price unless orchestrated very carefully from a PR standpoint (needless to say PR is not exactly Mind CTI’s greatest strength.)

To my mind, the answer is to grow the top-line in a measured way, minimizing the risk and the cash outlay, so as to protect the dividend (and, therefore, the capitalization.) This could be through a combination of some sort, but it would need to be a sure-fire, fire-sale kind of things, and those a few and far between.

But, of course, that ain’t sexy, and, since price increase requires market-participation, the return to some balanced fundamentals-to-capitalization may be a ways of.

I genuinely think that this sort of approach is exactly what the company’s Board of Directors and management team wants to take. However, unfortunately, we are now finding ourselves in a situation where the high-margin business is going away, and, so, the company has to focus its attention on replacing this business with something else (and current market logic dictates that the replacement for high margin is high revenue with lower margin) in order to — again — protect the dividend and the capitalization.

Only once the high-margin business is replaced, can new market-capitalization increasing growth kick in.

Personally, I think the challenge of protecting the dividend without running over the cliff because of expenses is a significant one, requiring the company’s full attention. Although anyone can pontificate on how to do that, only a select few of them could actually handle such a challenge.

The P/E reflects, of course, this reality, and if you compare the P/E for MNDO with that of, say, MTSL, the equity of MER Telemanagement Solutions, you can see it clearly reflected. MTSL, an equity far inferior to MNDO is, on a forward basis, considered to be twice as valuable to MNDO, and have over the last quarters rewarded speculators with a huge return.

MTSL’s P/E, however, comes at a price. To get to the current situation, the equity became near worthless (actually, let me rephrase, the equity became worthless,) and even had to go through the dreaded — and totally useless — reverse split, only saved by insiders infusion of cash into the business. This is a path that I, for one, do not want to see Mind CTI follow, because, at the end of the day, once you tip over and head for the ground you cannot be assured that you will be able to pull out of the dive.

There is, of course, an alternative to all this: Selling the company. However, the uncertainty surrounding such an event is vast and with an employee base of 339, I think most potential buyers of Mind CTI would be rather hesitant to pay a premium. Basically, a good premium is achievable, I think, but only after the company’s top-line grows and shows future growth.

The job of investors

At its very core, the reason why investors hire a management team is to navigate exactly these challenges. Certainly, the management team, which is fairly seasoned should be able to do so (yes, there has been mistakes in the past — some of them ugly,) and I, for one, think we have to support the team in its work.

I am not saying that the shareholders should sit passively. As co-owners, I believe, in fact, that it is shareholders’ duty (and in their interest) to support the team, let the team know what they expect, present ideas to the team, promote the company to investors and potential prospects, and generally act as if though they care. Until this happens, I am not sure that that shareholders have the right to wish for a better capitalization.

If you think about it, you, as a co-owner, is the only resource available to the company that is entirely free and have no negative impact on the bottom-line whatsoever. In fact, every ounce of energy that you put into promoting or otherwise helping the company goes directly to the bottom line.

So, my point was that being an excellent investor includes more than just allocating money. In its simplest and most direct form it includes voting on proxy matters, including, yes, the firing of the Board of Directors (much the same way you would fire your attorney or an employee if you found that he or she did not adequately represent your interest,) and at its most sophisticated it includes advocating to and on behalf of the company. In a sense, of course, the demand for advocacy is what makes being a contrarian, value-focused investor most difficult.

By the way, I have written about MTSL in the past, and I will continue to write about it in the future, since it is one of the most interesting examples of speculative market behavior that I have had an opportunity to observe up close and personal. Stay tuned….

Donations, please….

As usual, if you found this posting useful or entertaining — or if it saved you time,– you can express your appreciation through donation via PayPal right now.   For this type of posting an on-going donation of $35 per three months or a one-off donation of $15 is suggested.


The Remarkable Story of Mind CTI – Fundamentals insanity and dividend speculation

This posting discusses investments, and, therefore, I urge you to review the disclaimers laid out in the About section.   You should already have reviewed these disclaimers, but, as they are subject to change without notice, you should do so again.

As I will (probably!) be writing about in another, later post, I believe that — in spite of the constant messaging from the financial industry that there is no room for retail investors, stock-picking, and individual analysis —  there are significant investment opportunities for retail investors in equities that, for reasons having nothing (or very little) to do with the fundamentals of the underlying companies, have temporarily fallen out of favor with the market, resulting in a very low per share price, and will eventually recover to their intrinsic (or higher) per share price level.   These investment opportunities are characterized by, among other things, being discrete in time, and difficult to time-box.

One such opportunity is centered around MIND CTI Ltd. (Nasdaq: MNDO,) a software company out of Israel that is a global provider of billing and customer care solutions for voice, data, video and content services.  MIND has a quite good Wikipedia entry, which you may want to read by way of background.  

In summary, the company was founded in 1995, had an initial public offering in 2000, and grew its yearly revenue base from approximately $8 million (with net income of approximately $1.5 million) in 1999 to more than $15 million (with net income of nearly $4 million) in 2000.   From 2007 through 2009, the company encountered significant difficulties with the investment of a large part of its assets in auction rate securities (ARS,) forcing the write-off of approximately $20 million in investments during the period. However, these write-off were eventually offset through the settlement of an arbitration action against Credit Suisse Group AG, causing MIND to receive a settlement payment of approximately $18.5 million.

The story of how MIND ended up investing, losing, and recovering approximately $20 million is detailed in the Wikipedia entry and is quite interesting as it is a near text-book example of the machinations that went on in the financial industry in the first decade of this century.  However, this is not the focus of this posting, and, so, we will just note that upon what showed to be bad — or fraudelent – advice MIND invested a large portion of its available cash in an investment vehicle called Mantoloking, lost it all, and, through sheer tenacity, clawed the majority back.  

Mantoloking, by the way, is ritzy beach area on the Jersey shore, with the claim to fame of over the last decade having been the the wealthiest borough in New Jersey and having had median house prices of $2.5 million — althought this is not as much of a giveaway as the now  infamous financial vehicle names Chewbacca and Deathstar of Enron fame, clearly there was a hint here.

MIND has an unusual dividend policy in that it pays out ordinary annual dividends amounting to approximately the company’s net income for the previous year.  From 2003 the company has issued both ordinary dividends and extraordinary dividends, including a significant one-time dividend ($0.80 per share) paid out after company received the settlement payment from the ARS arbitration.

Fundamentals Insanity — Making a killing on fundamentals — eventually

Mind's Eye

Image by Amodiovalerio Verde/Creative Commons via flickr

As a consequence of the ARS issue and the associated gradual, forced write-off of approximately $20 million from the balance sheet, the MNDO equity gradually lost market value, touching a low per share price in the $0.60 to $0.70 range in early 2009, in spite of the fact that MIND had healthy operating fundamentals, very nice and consistent free cash-flows, and a stellar balance sheet with no debt.

As a reference point for better understanding the extremity of this range, the equity’s per share price prior to the full unfolding of the ARS issue was above $3 per share and prior to the commencement of the issue, the per share price moved in the $4 to $6 range.

Certainly, some reduction in market value was justified in 2008 and early 2009 given that there could be no assurance that the company would be able to recover its failed investment (and, so, $20 million had to be moved off the balance sheet,) but clearly, given that the scope of the failed investment was fully understood and contained (it could, for instance, never exceed the total invested capital,) a drop in market capitalization amounting to approximately 85% of the pre-failure level, reducing the company’s capitalization from an estimated $70 million, computed on the basis of approximately 21.5 million outstanding shares prior to the failure, to an estimated $12.5 million, computed on the basis of approximately 18.5 million outstanding shares at the crux of the crisis, was the manifestation of a gross over-reaction by the market.   In effect the market issued a capitalization penalty of more than $35 million in excess of the actual loss of approximately $20 million in spite of all other fundamentals remaining unchanged.  

Moreover, the extent of this penalty was, in fact, somewhat tempered by an aggressive move by the company to, at the highpoint (or, perhaps more appropriately, lowpoint) of the crisis, repurchase in excess of 3 million of its, then, hugely discounted shares in the open market.

Mind Share BuyBack – 2009

The market’s over-reaction was, of course, a case of fundamentals insanity resulting from the market participant’s singular focus on the bottom-line of MIND’s earnings and balance statements from 2007 through 2008, which showed a clear and rapid deterioration of the balance sheet and — because of accounting guidelines’ requirements that the write-off on the balance sheet had to be balanced out somewhere — corresponding massive negative earnings – in spite of a stable or growing top-line (the earnings per share averaged $0.23 from 2003 through 2005, but swung to a loss of  $0.55 in  2007 and a loss of $0.30 in 2008 — while revenues grew from an average of  $15.5 million per year from 2003 through 2005 to an average of $19 million from 2007 to 2008).

The earnings picture in particular caused a wholesale flight to safety by investors, which rapidly and markedly accelerated as the size of the write-offs grew and even more investors fled.   Simply put, MIND, a healthy operating company with zero debt and ample cash reserves, fell out of investors’ favor and its equity became dirt-cheap.

With the recovery of approximately $18.5 million in an arbitration settlement in 2009, the situation reversed, and the per share price for the MNDO equity eventually approached $3.50, before experiencing a set-back and settling in to a current price-range of between of $1.65 and $1.75 per share with regular dividends yielding in the 15 to 20% range and one extraordinary dividend with a yield somewhat north of 50%.

Spotting the Opportunity

Had you followed the general litigation and arbitration wave around the specific ARS investments that MIND had gotten itself entangled in, you would have noted a distinct pattern of settlements and you would at the highpoint of the crisis have been able to form a reasonable expectation that the outcome of MIND’s arbitration case would be positive for the company.

Moreover, if you had a good understanding of arbitration and the time-lines involved, you would have been able to — pretty accurately — time-box the resolution, and, so, your only problem would be to figure out when the market would notice this resolution and would reverse its position on the MNDO equity — which, as we know, is an impossible problem to solve.   If you did not, however, concern yourself with the exact timing of the reversal, simply accepting that a reversal was going to occur, and, instead, focused on the timing of the arbitration, you would have a fair chance at buying MNDO at a near-optimum price in 2008 and 2009, but you would have to accept that for some period the per share price of the equity would fall further, and that the timing and the reversal would be arbitrary and, so, you might have capital tied up for a considerable — and indeterminate — period.   You could, however, be reassured of the safety of your capital by MIND’s share repurchase program, under which the company in 2009 repurchased more than 3 million shares at an average per share price between $0.62 and $1.62.

As it happens, the MIND arbitration case settled very quickly with a significant and near-immediate compensation payable to the company, and — most importantly — the company immediately turning around and distributing the substance of this compenstion to the shareholders on record.    This yielded an immediate bonanza for any investor that had accumulated a position after the announcement by MIND of its filing of an arbitration claim related to the ARS issue.  My calculations are raw, but the upshot is that if you had invested $100,000 at the $0.65 (or so) per share price level in 2009, and since 2009 had reinvested 50% of the post-tax dividend yield from MIND into acquiring additional MNDO shares between 7 and 30 days after the ex-dividend date (retaining the remaining 50% of the post-tax dividend for, if you will, shopping-around money,) then your portfolio of MNDO shares would by February of 2011 be worth an astonishing $730,000 or more (at a price of $3.35 per share) and you would have collected more than $81,000 in shopping-around money.

Ironically, if you had abandoned the ship, so to speak, at the $3 per share price level in early 2007, you would have been proven right when the price went below $1 per share in 2008 and 2009.  However, if you had confidence in the company, and retained your investment, you would in 2010 and 2011 be able to demonstrate a capital gain and also have dividend yield of at least 50%.

Dividend Speculation — Creating a new fundamental opportunity — right now

Smarties Graph #3 — Courtesy of sneeu under Creative Commons via Flckr

Normally, the story would have ended here, with  MNDO recovering to the $3.50 per share price level and stabilizing at the $3 to $4 per share price level, in which case investments in the MNDO equity would yield only somewhat quite pedestrian investment opportunity, yielding gain opportunities only through a combination of regular dividends and moderate share price appreciations as the result of growth in the business and overall market improvements.   

However, speculators and the uninformed investors were to play their hands — and, yet again, impact upon the per share price of MNDO.

The extra-ordinary dividend of $0.80 per share was indeed extraordinary.    For a brief moment in time, prior to the announcement of the arbitration settlement and the associated dividend, you could buy MNDO shares for less or near what they would pay out in an extraordinary dividend occuring shortly after you acquired them, effectively getting these shares for free (we ignore taxes for now — a suitable move given the extraordinary advantageous dividend tax situation in place in the United States through 2012.)  And not only could you secure a near unlimited number of shares for free (with almost no buyers in the market, the number of shares that you could secure was more or less constrained only by the capital that you would be willing to put at risk,) but, also, you would over the next two years, or so, receive additional dividend payuouts of more than $0.75 per share — effectively collecting twice the amount of dividend that you paid for the shares.

Predictably, after the arbitration award and the associated divident payout, the per share price of MNDO climbed.. and climbed… and climbed — nearly touching the $3.50 level in early 2011.  Something was bound to happen — and it did.  First, this extraordinary development — and in particular the extraordinary dividend of $0.80 per share and a subsequent dividend of $0.20 per share —  made a new group of retail investors and retail traders pay attention to the MNDO equity, and MNDO became the subject of intensive speculation around the dividends in 2010 and 2011.  Second, Lloyd Miller, the largest outside investor, who had taken a significant position in 2008 and 2009, liquidated his entire position in early 2011, realizing an estimated gain of 500%, but, also, flooding the market with almost two million shares.

Novgorodtsev’s Findings

While the effect of Lloyd Miller’s near perfect execution and timing of disposal of his position of MNDO shares was temporary, the effect of the dividend speculation was — and is — lingering.  

Mr. Igor Novgorodtsev wrote about the speculation in Seeking Alpha article, noting that MIND’s dividend payout in isolation is attractive in the zero interest rate environment that we are now finding ourselves in, that MNDO’s price gyrations around the time of dividend is inexplicable unless it is viewed through a prism of investors’ fundamental lack of understanding of how dividends work (dividend payment and capitalization being, of course, in lockstep,) and that there is an opportunity inherent in the per share price gyrations around the time of dividend and, specifically, there is an opportunity to “stock up” after the time of the dividend.

What Mr. Novgorodtsev had discovered, of course, is a classic effect of speculation, whereby there is a perceived opportunity in an event, X, which leads to increased volume and a run-up in price, followed by a dramatic drop in volume and price post-X — frequently to levels that are lower then pre-X, and — on a side-note — what he postulated was that this speculation was the function of idiocy or ignorance, which should not surprise anyone who have studied trading bubbles.

As value investors we tend to not concern ourselves with speculation and its effect except to the extent that it allows us to buy shares at a significant discount to their intrincic value. Although, for reasons that we will not dwell on here, the MNDO equity is not a perfect candidate for this particular valuation method, computation of the Graham number for MIND is a fair to good way for us to compute intrinsic value.   Using financial numbers for 2011 and 2010 (numbers for 2009 are not suitable because of the earnings skewing inherent in the arbitration outcome) the intrinsic value of MNDO comes out at almost $3 on a revenue-growth neutral basis, implying that the current, post-X, per share price, which is around $1.65, yields a stong buy opportunity (Mr. Novgorodtsev’s comment in his article is that “MNDO is priced absurdly low (about 3-4 times EV/EBITDA),” and I tend to agree,) with a revenue-growth neutral price outlook of up to $3.50 per share and a revenue growth price outlook in excess of $5 per share.

In the case of MIND and the speculation its dividend policy has fostered we are indeed interested in speculation — or rather the aftermath of speculation — because it has created the very opportunity that we were looking for:  A severe over-reaction that caused an equity underlying a company with strong operating results and a strong balance sheet to become available at a bargain price.   Given that the majority of speculators lose money, our hypothesis is, of course, that the speculation wave will eventually die out (since speculation is a zero-sum game based on the premise that there are willing losers, and since this pool of willing losers is finite, the list of willing losers will shrink from speculation iteration to speculation iteration, ultimately causing the speculation to not occur,) giving way to a general, sustainable appreciation of the per share price of the MNDO equity.

The case of MIND and its MNDO equity highlights a category of opportunity for investors who are loyal, so to speak, to companies and equities that fall out of favor in spite of strong consistent operations and — importantly — are outside the focus of institutional investors and traders because of volume, timing , or per-share price limitations, and are able and willing to dilligently and accurately parse financial data and regulatory filings and rules to form an accurate picture of the company’s situation.

On a side-note, for reasons that are not entirely clear (although we do have a working hypothesis,) it is not unusual for the same equity to appear as an opportunity two or more times over the years, such as it is the case with MIND.   This is a particular attractive scenario since we understand the fundamentals and since we have an improved understanding of the path the reversal will take.   In MIND’s case, for instance, the current low per share price for MNDO has already prompted the company to announce another round of share buy-backs, consistent with the decision that the company made in 2008 and 2009, providing a nice cushion under us and a trampolin for accelerating the pace of the reversal.

Chasing the Deflating Bubble

Chasing the Bubble – courtesy of chemisti under Creative Commons via Flckr


What is ironic, I think, is that most investors chase high-performance, high-growth, high-risk companies when there are low risk, revenue and earnings stable micro-caps that have the potential to handily out-compete these on a revenue-neutral basis, and, additionally, have significant upside if they can demonstrate some revenue growth.  

Graham referred to this type of companies and their associated equities as cigarette butts, but I have never liked the underlying simile, because it implies that the company is somehow in a terminal stage and the best you can do is get a couple of more puffs out of it.   I much prefer to refer to them as garage-sales finds, because they, to the untrained eye, is trash, but, to the trained — and accurately prepared — eye, they are gems.

The reason for this, of course, lies in the three-way equation between risk, time, and return.   With garage-sales finds you may know with reasonable certainty that there is an excellent balance of limited risk and significant return, but your exit is dependent on an event entirely outside your control — the return of the horde that previously rejected the garage-sales finds as junk.   Risk and return may be completely understood, but timing is entirely unknown and uncontrollable.    This, however, is exactly why one can make a living with this sort of investment!   While institutional investors are not — in my opinion — risk averse and not, ultimately, unable to dig through regulatory filings and press-releases (although they appear to — frankly — be too lazy to do so in most cases,) they generally abhor investing money in ventures with indefinite, indeterminate, and possibly infinite timings.    

Moreover, since institutional traders cannot make significant earnings from trading in this type of equity, since the trading volume is insufficient, we find ourselves in an environment where we do not have to concern ourselves with the competition with players who have an inherently unfair advantage.

At this point you will probably have inferred that our investment paradigm involves targeting cash-flow positive companies with strong balance sheets, and, further, you will probably have inferred that a history of strong revenue and earnings growth are not of critical importance to us.   Sometimes, however, these garage-sale finds surprise us, exhibiting operational growth that significantly increases and accelerates our  return.  For MIND, for instance, there is a genuine opportunity to over time, on the basis of its superior operations results, grow its business in a measured way, yielding a higher and higher top-line without losing control of its expenses.

Outside MIND

There are a number of companies and equities that warrants our attention under this paradigm — in fact there are far more of these than we can reasonably capitalize on given capital and time constraints.   For instance, Click Software Technologies (Nasdaq: CKSW), another Israel based company with global scope, positive cash-flow, no debt, and a healthy amount of cash in the bank, is trading a $7.50, down from approximately $12.50 earlier this year, having been subject to wholesale investor flight in the earlier part of this year.    

As usual, the event that caused the massive flight by investors had nothing to do with fundamentals (we will not dwell on the event here — it suffices to say that it was a manifistation of how investors think in quarters, while enterprise companies think in years,) and the company’s guidance for the 2012 year is essentially unchanged from what it was when the company’s shares were trading at $12.50.

The intrinsic value of Click Software is certainly above $11 on a neutral revenue-growth basis, and, the company is, in fact, continuing to exhibit significant revenue growth, and so, the CKSW equity, yields a significant opportunity for folks like us.

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