In addition to holding wide moat companies purchased at a discount, a significant portion of our portfolio resides in profitable businesses selling for substantially less than their liquidation value. As we see it, in these situations, we are not only buying the companies’ assets at a discount, but we are getting its future earnings power for free. We primarily concentrate on micro-cap opportunities, where market inefficiencies tend to be greater, as larger market players are not sufficiently compensated (in absolute terms) to address them. This week we added to our holdings of one such opportunity–KSW, Inc., which the market currently values at $13.52 million (as of 3/13/09’s close), even though it currently has cash and marketable securities of over $20 million (by our estimates) and no long-term debt.
To share a little about the business–KSW, Inc., through its wholly-owned subsidiary KSW Mechanical Services, Inc., furnishes and installs heating, ventilating and air conditioning systems and process piping systems for institutional, industrial, commercial, high-rise residential and public works projects in New York City. Also, KSW serves as a mechanical trade manager, performing project management services relating to the mechanical trades.
As of September 30, 2008, KSW’s book value was $19.32 million, with nearly $17.4 million in cash and $1.6 million in marketable securities. Using data points from the recent press release, the fourth quarter 2008 yielded an additional $1 million in net income. And as of Dec. 31, 2008, KSW’s backlog of work was about $62.5 million.
Though management and the Board could do more to return cash to shareholders, KSW currently has a $1 million share buy back, which was announced in December 2008. Additionally, KSW has paid annual dividends in the past, and last spring they returned a cash dividend of 20 cents per share.
So why is KSW so cheap? In our view, it is likely because new construction projects in NYC are being dropped and current projects halted. In December 2008, KSW announced that two of its projects had been put on hold (the 42nd St and 10th Ave Project for $32 million, and the 56 Leonard Street Project for $24 million). Also, this past week, KSW had one of its customers terminate all of its current trade contracts (on which KSW had about $6 million of outstanding work left).
Yet, does a slow NYC construction market justify KSW’s current share price? In our lights, absolutely not. Its current market price not only values its future earnings power at zero, it values its net cash in the bank at less than 70 cents on the dollar. Basically, the current market price assumes that the company will never earn another dime and will burn through six and half million dollars over the next few years. That proposition strikes us as absurd.
Though some may worry that KSW may not have sufficient work to cover its overhead expenses, it is important to keep in mind that all of its field workers are hired for specific work assignments and hence are not salaried. Additionally, a substantial portion of Chairman and CEO Floyd Warkol’s compensation is paid as a “bonus equal to 9.5% of the Company’s adjusted annual operating profits before taxes, which are in excess of [$250,000].” So, a sizeable portion of KSW’s expenses are not fixed, and should adjust accordingly if less work were available.
All told, KSW’s current market price offers the company’s assets at a significant discount and its future earnings power for free. Though we expect that construction work will decline over the next couple of years in NYC, it will not cease entirely. And if it doesn’t, KSW will likely have work to do, and earnings for its owners.
Disclosure: I, or persons whose accounts I manage, own shares of KSW at the time of this writing.