NRCIB/NRCIA - National Research Corp

[yitech]

Yitech, I think you might be reading it wrong.

 

ValueTrap,

I think you are right. Looking it at the second time, I don't think I understand that table completely. Can you please describe it to me? specifically on the economic interest.

[ItsAValueTrap]

It says that class A gets 6/7th of the economic interest of the company, and class B gets 1/7th.

 

There are 6 class A shares for every class B share.  So the underlying assumption is that the economic interest between the A and B shares is 1:1.

 

But I believe that part is from a fairness opinion and has been vetted by a lawyer.

[yitech]

From 10Q:

 

EARNINGS PER SHARE

 

Net income per share of class A common stock and class B common stock is computed using the two-class method. Basic net income per share is computed by allocating undistributed earnings to common shares and using the weighted-average number of common shares outstanding during the period.

 

Diluted net income per share is computed using the weighted-average number of common shares and, if dilutive, the potential common shares outstanding during the period. Potential common shares consist of the incremental common shares issuable upon the exercise of stock options and vesting of restricted stock. The dilutive effect of outstanding stock options is reflected in diluted earnings per share by application of the treasury stock method.

 

The liquidation rights and the rights upon the consummation of an extraordinary transaction are the same for the holders of class A common stock and class B common stock. Other than share distributions and liquidation rights, the amount of any dividend or other distribution payable on each share of class A common stock will be equal to one-sixth (1/6th) of the amount of any such dividend or other distribution payable on each share of class B common stock. As a result, the undistributed earnings for each year are allocated based on the contractual participation rights of the class A and class B common stock as if the earnings for the year had been distributed.

 

I think you guys are right. I interpret things incorrectly. This is some weird animal that doesn't make sense. I will stay away from now on.

[ItsAValueTrap]

That's the thing...

 

The EPS calculation assumes a 6:1 ratio.  The fairness opinion assumes a 1:1 ratio in the chart/diagram.

 

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I think the economic interest is somewhere between 6:1 and 1:1.  It should be close to 6:1 since the B shareholders control the company.  However, freaky stuff can happen such the company going bankrupt.  So I don't think it will be fully 6:1.

[rpadebet]

That's the thing...

 

The EPS calculation assumes a 6:1 ratio.  The fairness opinion assumes a 1:1 ratio in the chart/diagram.

 

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I think the economic interest is somewhere between 6:1 and 1:1.  It should be close to 6:1 since the B shareholders control the company.  However, freaky stuff can happen such the company going bankrupt.  So I don't think it will be fully 6:1.

 

EPS calculation is a GAAP prescription. They have to calculate it that way. As you know GAAP doesn't always conform with economic reality :-)

 

I agree it's between 1:1 and 6:1 depending on expected dividend payout ratio. 100% dividends paid out implies a 6:1. 0% for ever implies a 1:1. If you interpolate from there a 10% payout means 1.5:1, 20% payout means 2:1... You get the drift.

 

Management has recently indicated potential for a 15%-20% payout starting in 2015. If you interpolate away with this future expectation, 1.85 :1 should be the ratio. Check the current price ratio in the market. We have been dancing around that line.

[ItsAValueTrap]

How might shareholders see a return of capital?

 

A- Dividends

B- Share repurchases (oh boy would this be contentious)

C- Merger / takeover that is structured as such.  I think that this is unlikely because the B shareholders can try to block it.  It makes more sense for the acquirer to do a reverse takeover and give the B shareholders some type of premium.

D- Voluntary liquidation where the assets aren't distributed out as dividends.

E- Bankruptcy; shareholders probably won't get anything

F- Regulators force a conversion of A shares into B, and the board agrees.

 

*I don't understand all the legal implications, but is scenario C possible?

 

I just don't see why B shareholders would allow actions that would disadvantage them.  Sure, right now the dividend policy is 10% of cash flow.  But it doesn't really matter.  In the end, the CEO is going to sell his A shares and he will be incentivized to benefit the B shares.  I really think that the correct ratio should be close to 6:1 and I think that's what the CEO intended.  Though maybe he is being uncharacteristically sleazy by deking everybody out into thinking that the shares should trade closer to 1:1.

 

2- I think the history of the CEO is interesting.  His ethics are unusually high.  I really don't think he wanted things to turn out this way.  His original plan was less complicated but was rejected by NASDAQ.  So now we're in this silly situation.  So now how is he going to treat his shareholders fairly?  Considering his integrity, it would seem unfair for him to sell his A shares considering that they're massively overpriced compared to the B shares.

 

(I've blogged about it if you want more information on my thoughts.)

http://glennchan.wordpress.com/2013/09/06/national-research-corporation-nrciab/

 

2b- In terms of fairness, a ~6:1 trading ratio would be fair.  Because if the share value depends on the dividend rate (which it doesn't), then he can unilaterally decide to screw over one set of shareholders.

 

If he insists on 6:1, then everybody is on the same page.  Nobody is going to massively over or underpay for their shares if the correct ratio is supposed to be near 6:1.

[yitech]

Likely you said previously, any Black swan event (i.e. liquidation or take-over), class B holders are screwed to 1:1 liquidation based. There could be an implicit short call (to liquidation or take-over) for class B and an implicit long call for class A on similar events being priced in.

 

Markets are clearly confused as we are and may be using some blend of asset/liquidation-based and earnings-based to value the two classes. The amount of dividend payout ratio may help determine the weight of earnings-based vs. asset-based metrics to value the two classes as a higher payout ratio would increase the PV of future dividends and markets may weigh more toward earnings-based valuation metrics.

 

I may sit this one out as the risk-reward is not so great.

[ItsAValueTrap]

Hmm I guess I might be on the wrong end of this one.

 

Cost to borrow NRCIB:

5.7562%  (a week ago: 2.19%)

 

Cost to borrow NRCIA:

0.35%

 

A greater percentage of NRCIB is short compared to NRCIA.  So it looks like some people are shorting NRCIB and going long NRCIA.

[yitech]

I did a fairly quick/crude estimate using earnings split (1/2 for B, 1/12 for A based on earnings approach due to future div.) with A share forward EPS $0.433 and B EPS $2.554 and liquidation/takeover approach (earnings split 1/7 for A and 1/7 for B). Assign a 15X forward PE for B and 14.5X for A(slightly lower due to less voting power). Weigh the two approaches differently and I got the following:

 

earnings based: liquidation/takeover based percentage

0:100 -> NRCIA: $12.2 NRCIB: $12.6

40:60 -> NRCIA: $9.8 NRCIB: $22.9

60:40 -> NRCIA: $8.6 NRCIB: $28

100:0 -> NRCIA: $6.3 NRCIB: $38

 

At $16, the A share is overvalued in all scenarios. I tend to think 40:60 makes sense as not a whole lot of FCF would be paid in dividends starting 2015, which means B could also be overvalued in some sense. Only when markets believe the probability of takeover or liquidation is zero indefinitely would NRCIB truly reaches approximately 6:1 ratio in terms of value. Notice that the swing of absolute/relative price range due to the method used is actually wider for B than for A... which is something I did not expect.

 

Again, just a quick-and-dirty way of calculating based on the earnings assignments. I ignored any takeover premium or asset discounts during liquidations. And I might be completely off in PE, EPS estimates and various other aspects.

 

In any case, this whole thing belongs to my too-hard pile...

[constructive]

Yes I think you are on the right track in terms of thinking about EPS and probabilities.

 

NRCIA seems more overpriced than NRCIB seems underpriced.

[rpadebet]

I did a fairly quick/crude estimate using earnings split (1/2 for B, 1/12 for A based on earnings approach due to future div.) with A share forward EPS $0.433 and B EPS $2.554 and liquidation/takeover approach (earnings split 1/7 for A and 1/7 for B). Assign a 15X forward PE for B and 14.5X for A(slightly lower due to less voting power). Weigh the two approaches differently and I got the following:

 

earnings based: liquidation/takeover based percentage

0:100 -> NRCIA: $12.2 NRCIB: $12.6

40:60 -> NRCIA: $9.8 NRCIB: $22.9

60:40 -> NRCIA: $8.6 NRCIB: $28

100:0 -> NRCIA: $6.3 NRCIB: $38

 

At $16, the A share is overvalued in all scenarios. I tend to think 40:60 makes sense as not a whole lot of FCF would be paid in dividends starting 2015, which means B could also be overvalued in some sense. Only when markets believe the probability of takeover or liquidation is zero indefinitely would NRCIB truly reaches approximately 6:1 ratio in terms of value. Notice that the swing of absolute/relative price range due to the method used is actually wider for B than for A... which is something I did not expect.

 

Again, just a quick-and-dirty way of calculating based on the earnings assignments. I ignored any takeover premium or asset discounts during liquidations. And I might be completely off in PE, EPS estimates and various other aspects.

 

In any case, this whole thing belongs to my too-hard pile...

 

I think 15pe is low for such low capital businesses with decent growth rates...

 

And I think this business being acquired is much lower probability event as I think it is more likely NRC is going to be a acquiror if anything.

 

Having said that the risk here is more about NRC deciding to change listing exchange or reversing the share class structure or introducing defined convertibility at some point. Those probabilities are inherently incalculable so risk here is not quantifiable.

 

Regarding the cost of shorting the B being higher than A, I think that is partly driven by higher amount of A's being available for borrow given the 6:1 share count and also because the old owners are more motivated to sell A's rather than B's.

[yitech]

I think 15pe is low for such low capital businesses with decent growth rates...

 

yeah, you may be right. It's just that I prefer to pay very little for growth and demands higher margin of safety for companies I don't truly understand and assign some discount for the possibility of another stunt pulled by the management in the future.

 

And I think this business being acquired is much lower probability event as I think it is more likely NRC is going to be a acquiror if anything.

 

Until I see higher dividend payout via FCF, I tend to be more conservative on any "realizable" owner's earnings and default to the basic liquidation rights., so I assigned a lower weight there.

 

Having said that the risk here is more about NRC deciding to change listing exchange or reversing the share class structure or introducing defined convertibility at some point. Those probabilities are inherently incalculable so risk here is not quantifiable.

 

I am not sure you can reverse structures without causing lawsuits... The original pre-capitalization shareholders were given specific number of A and B shares accordingly to the given ratio per share + some cash for the odd share, which should sum up to the pre-recapitulation value per the total economic rights of the equity anyhow and they were not being particularly disadvantaged against as they were free to do whatever they wanted with their shares. Now, reversing the rights sounds to me like putting the toothpaste back in the tube when the shareholder base have definitely changed since the recapitalization. (OK. might be bad analogy.. but you get the idea.) This might be possible, but not without additional compensations from one class to the other and other messy things... so highly unlikely IMO.

[ItsAValueTrap]

http://www.sec.gov/Archives/edgar/data/70487/000114036113038517/xslF345X03/doc1.xml

 

The CEO sells a small amount of A shares.  This is consistent with the thesis that the B shares are undervalued compared to the A shares (???).

 

*Of course, Hays' original plan (before the A+B started trading) was to only sell A shares.

[ItsAValueTrap]

It looks like the borrow on the B shares jumped to 3.25% for some reason.  I don't understand why short sellers are paying so much interest to short the B shares... am I on the wrong side of this trade???

 

NRCIA - 0.35%  6000 shares available

NRCIB - 3.25%  2000 shares available

 

      Was available  Mean rebate / fee        Min                        Max

03-NOV-13 Yes -3.17% / 3.25% -3.17% / 3.25% -3.17% / 3.25%

02-NOV-13 Yes -3.17% / 3.25% -3.17% / 3.25% -3.17% / 3.25%

01-NOV-13 Yes -2.97% / 3.05% -3.17% / 2.86% -2.78% / 3.25%

31-OCT-13 Yes -2.72% / 2.78% -2.94% / 2.56% -2.50% / 3.00%

30-OCT-13 Yes -2.80% / 2.90% -2.80% / 2.90% -2.80% / 2.90%

29-OCT-13 Yes -2.79% / 2.88% -2.80% / 2.87% -2.77% / 2.90%

28-OCT-13 Yes -2.79% / 2.88% -2.79% / 2.88% -2.79% / 2.88%

27-OCT-13 Yes -2.79% / 2.88% -2.79% / 2.88% -2.79% / 2.88%

26-OCT-13 Yes -2.79% / 2.88% -2.79% / 2.88% -2.79% / 2.88%

25-OCT-13 Yes -2.79% / 2.88% -2.79% / 2.88% -2.79% / 2.88%

[ItsAValueTrap]

There are 6X the A shares than B shares.  So a greater % of the B class is sold short compared to the A class.

 

NRCIB short interest data - http://www.nasdaq.com/symbol/nrcib/short-interest

Settlement Date Short Interest Avg Daily Share Volume Days To Cover

10/15/2013 204,617 8,427 24.281120

 

NRCIA short interest data - http://www.nasdaq.com/symbol/nrcia/short-interest

Settlement Date Short Interest Avg Daily Share Volume Days To Cover

10/15/2013 150,132 15,949 9.413255

 

 

[rpadebet]

Wasnt there some sort of rumor going around that they might be bought out? In that case some have interpreted the share structure to result in 1:1 price.

[constructive]

I wouldn't pay any attention to the short interest. The CEO has sold 5.4M shares of NRCIA and 5K shares of NRCIB.

[Hielko]

It's my understanding that the CEO hasn't sold most of those shares, but transfered them to a trust for his childeren.

[ItsAValueTrap]

IB is showing that the borrow on NRCIB is 11%.  It drives me nuts that I can't lend my shares out with Interactive Brokers Canada.

[Otsog]

Been reading everything NCRI the past couple of days.  The only conclusion I can come to is that they really made a hash of the recapitalization and it is almost certainly not going as expected.  The whole purpose was for Hays to be able to cash out/pass on his shares and retain control while being fair to current shareholders and to "do no harm".  The recap gave Hays everything he wanted and every shareholder before hand had the exact same rights and ownership pre and post recap.  But, the incongruency between the rights of the classes of shares and the failure to clarify the intentions of the rights disparity is killing the liquidity.  Having 6:1 earnings rights in favour of the B class while having 1:1 assets rights is monumentally ill-thought out.  Just a quick back of the napkin calculation w/ rough numbers from google finance shows the daily $ volume dropping from $750k pre re-cap to $450k today (combined A+B).

 

Considering Hays' history of integrity and comparison of the re-cap plan to Berkshire's dual class of stock's after reading through everything I was getting pretty confident that the intention was a 6:1 pricing ratio between the B's and A's, which would mean a 50:50 market cap between the two.  I figured the asset rights might be one of the stringent regulatory requirements by NASDAQ and that Hays wasn't really worried about it since a) he wasn't planning to sell the company and b) the re-cap also helped further dissuade any sort of hostile take over. 

 

However, looking at the most recent grant of options to Hays, Kevin and Susan has me concerned.  The January 7, 2014 option grants are the first ones post recap and the ratios are very interesting.  Hays' options granted are Class A: 2,904 and Class B: 266 (http://www.sec.gov/Archives/edgar/data/70487/000114036114001171/xslF345X03/doc1.xml).  A ratio of 10.9:1 A:B.  This ratio came about because options were awarded on a 85.7% to 14.3% total cost basis A:B. 

 

For every $1000 of cost of options granted, $857 was to go towards Class A Shares and $143 was to go towards Class B Shares.  The cost per share used at the time of grant of $18.8/A and $34.15/B.  857/18.8 = 45.59 A shares per $1,000 of options.  143/34.15 = 4.19 B shares per $1,000 of options.  45.59/4.19 = 10.9:1 A:B.

 

What happens if the share price was 1:6 A:B?

857/1 = 857

143/6 = 23.83

Shares granted from options ratio 36:1 A:B

Dividend income from the shares would be 6:1 A:B

Asset rights from the shares would be 36:1 A:B

Market Capitalization would be 1:1 A:B

 

What happens if the share price was 1:1 A:B?

857/1 = 857

143/1 = 143

Shares granted from options ratio 6:1 A:B

Dividend income from the shares would be 1:1 A:B

Asset rights from the shares would be 6:1 A:B

Market Capitalization would be 6:1 A:B

 

The way they are splitting the pool of options really makes me think they intended to have the shares trade at parity, the Class A shares being 85.7% of the market cap and the class B shares being 14.3% of the market cap.  Trying to make the dividend equal after that may have looked good before re-cap to current shareholders ("hey you get 50% dividend income from each stream, so don't worry about selling your A's!"), but it completely disincentives anyone from actually buying the A's post re-cap. 

 

Sorry for the rant, I hope it was at least partially comprehensible.  In the end I do think B's are worth 6x A's, but I think there is too much evidence the management didn't intend for that to happen. 

 

 

[Otsog]

I went through all the comparable companies used in the Craig-Hallum fairness report to see what those companies did with their dividends.  Results attached. 

 

The disparity between NRCI's dividend policy and all the others makes NRCI's recap not comparable to any other recap that has been done.

 

From what I saw all the other recaps were similar in the liquidation rights with each other and NRCI.

 

 

Edit: The Craig-Hallum report was already a bit weird due to all the transposition errors in the tables.  I found that quite odd and makes me curious if both management + lawyers didn't really know what they were doing with the recap. 

[ItsAValueTrap]

I'm not sure I'd read too much into the options structure?  The options grant was for a small number of shares.

 

2,904 options for A shares, 2024 expiration (!!!), $18.8 strike

266 options for B shares, 2024 expiration (!!!), $34.15 strike

 

We're probably looking at options that are worth $10-35k.  For such a long expiration, I don't think that Black-Scholes is reliable.

 

2- The borrow on NRCIB shares is around 10%... ridiculous.

[ItsAValueTrap]

The CEO just sold 15.2k *B* shares.

 

http://www.sec.gov/Archives/edgar/data/70487/000114036114026450/xslF345X03/doc1.xml

 

*Disclosure:  No position.

[ItsAValueTrap]

Anybody still looking at this?  It looks kinda cheap at $31.50 and a PE of 12.26.

 

The borrow on NRCIB is 4.1%

NRCIA borrow is 0.3%

 

The CEO continues to sell A shares (which shouldn't be a surprise).

[Foreign Tuffett]

Anybody still looking at this?  It looks kinda cheap at $31.50 and a PE of 12.26.

 

The borrow on NRCIB is 4.1%

NRCIA borrow is 0.3%

 

The CEO continues to sell A shares (which shouldn't be a surprise).

 

Anyone still following this? My quick take is that the company's actions last year (increasing the quarterly dividend and paying a special dividend) mean that the original bull thesis on the Class B shares was basically correct. However, the "mispricing"/arbitrage between the two share classes still exists, so either the market is wrong or there is another piece of the puzzle that I'm missing.