Fighting the Family
When management owns a majority interest in a company, other shareholders are potentially at an extreme disadvantage.
By Andrew Feinberg
From Kiplinger's Personal Finance magazine, March 2005
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Beware of values that look too good to be true. That's one of several lessons I learned during my stunningly unsuccessful battle to profit from owning shares in Troy Group, a Santa Ana, Cal., company that makes secure check-printing systems. I lost only $1,400, but, given the propensity for litigation by everyone involved in the Troy saga, I guess I'm lucky I haven't been sued. Yet.
Haven't heard of Troy? I envy you. The company was ever so briefly a highflier, hitting $43 a share in February 2000. When I encountered it in June 2004, it traded at $3.20. What excited me was the fact that highly respected value investor Whitney Tilson had just purchased more than 5% of the company.
Easy Money
I did some research on Troy and quickly understood why he did. For the price of a latte, you got a share in a company that had a dollar in cash, 62 cents in cash flow and 49 cents in earnings before interest, taxes, depreciation and amortization (EBITDA) in the previous 12 months. That meant that when you backed out its cash on hand, the company was selling for only 3.5 times cash flow. Now that's what I call cheap. In fact, according to John Lewis, managing partner of Osmium Partners hedge fund, if you applied the metrics used in a fairness opinion the company had solicited a year earlier, Troy was really worth somewhere between $6.44 to $8.93 per share.
That was the good news -- the lure, if you will. But, as it turned out, two other facts were far more important. The first: Members of the Dirk family and their various trusts control about 67% of Troy stock. And the second: The Dirk family, led by Troy chairman Patrick Dirk, was bidding to take Troy private at $3.06 per share.
Troy was trading at a premium to the bid because Westar Capital LLC had bid $4 per share a year earlier and it seemed painfully obvious (emphasis on the word painfully) that the company was worth much more than $3.06. Besides, Osmium Partners had sued Troy's management for self-dealing, so rational people figured that a fair price would somehow be reached.
In early July 2004, Whitney Tilson filed a class-action suit against Troy alleging that insiders had tried to depress the value of the company so that they could take it private at a lower price, "in essence stealing it from the company's outside shareholders." The suit also alleged that Troy had created a "black cloud" over the company by changing auditors four times in two years and by delaying filings with the SEC -- so much so that the stock had to be delisted at one point. (Troy did not return my repeated phone calls asking for comment.)
When Westar Capital came in with a new bid of $4.50 in July 2004, I figured that my profits in Troy were in the bag. I did the obvious thing: I bought more stock.
All these facts were, alas, irrelevant. Someone who owns 67% doesn't have to sell out to another party simply because it is offering a higher price. In September, Troy sued Westar for interfering with its going-private transaction. Westar scurried away, and its $4.50-per-share bid vaporized. That's when I knew with certainty that I was in big trouble.