Credit Acceptance Corporation (CACC)

CACC is an indirect subprime auto lender operating since 1972. CACC offers automobile dealers financing programs that enable them to sell vehicles to consumers, regardless of their credit history. Their financing programs are offered through a nationwide network of automobile dealers who benefit from sales of vehicles to consumers who otherwise could not obtain financing.

CACC has a remarkable track record, as evidenced by the following:

	GAAP        EPS	% Change	Adjusted    EPS (1)	% Change	BVPS	% Change
2001	0.57		0.57		6.50
2002	0.69	21.1%	0.70	22.8%	7.29	12.1%
2003	0.57	-17.4%	0.55	-21.4%	7.91	8.5%
2004	1.40	145.6%	1.37	149.1%	7.34	-7.2%
2005	1.85	32.1%	1.74	27.0%	9.51	29.7%
2006	1.66	-10.3%	1.59	-8.6%	5.96	-37.3%
2007	1.76	6.0%	2.03	27.7%	8.52	42.9%
2008	2.16	22.7%	2.65	30.5%	10.86	27.4%
2009	4.62	113.9%	4.03	52.1%	15.73	44.9%
2010	5.67	22.7%	5.70	41.4%	15.82	0.6%
2011	7.07	24.7%	7.34	28.8%	20.30	28.3%
2012	8.58	21.4%	8.58	16.9%	24.29	19.7%
2013	10.54	22.8%	10.43	21.6%	31.24	28.6%
CAGR		27.5%		27.4%		14.0%
5 Year		37.3%		31.5%		23.5%
10 Year		33.9%		34.2%		14.7%

(1) See CACC's annual report for the meaning of this term. They adjust for asymmetries in US GAAP treatment of earnings and are adjustments that I agree with.

Business

CACC provides financing to dealers through two programs: (1) the Portfolio Program, and (2) the Purchase Program. In the Purchase Program, CACC buys loans originated by dealers directly. For 2013, the Portfolio Program accounted for 93.5% versus 6.5% for the Purchase Program. Under the Portfolio Program, as compensation for the loan, the dealers receives (a) an upfront "advance", and (b) payments that depend on the future performance of the loan ("dealer holdback"). Subsequently:

• Consumer sends CACC principal plus interest
• CACC is reimbursed collection expenses
• CACC takes 20% of remaining amount as a servicing fee
• CACC uses any remaining amount to reduce advance dollar for dollar (i.e., not according to some "advance" amortization schedule) until the advance balance is zero
• Any remaining amount is paid to the dealer

One can think of CACC owning an ABS with a 20% coupon where the dealer takes the first loss position. Dealers are incentivized to place more loans with CACC by providing that they be able to pool every 100 loans placed and receive accelerated dealer holdback payments related to these loans. 

CACC insists on a margin of safety in pricing the loans as illustrated by the following:

Consumer Loan Assignment Year	Forecasted Collection %	Advance       %	Spread       %
2004	73.0%	44.0%	29.0%
2005	73.7%	46.9%	26.8%
2006	70.0%	46.6%	23.4%
2007	67.9%	46.5%	21.4%
2008	70.1%	44.6%	25.5%
2009	79.2%	43.9%	35.3%
2010	77.0%	44.7%	32.3%
2011	74.1%	45.5%	28.6%
2012	73.5%	46.3%	27.2%
2013	73.3%	47.6%	25.7%

The spread is a very important metric to track. The trend of late has been downward which is a concern. This is a function of the competitive environment, which I discuss further below.

The forecasted collection percentages shown in the table above are based on a statistical model. Accurately forecasting collection rates is critical to their business, and the following illustrates their forecast performance:

	Forecast as Of			Variance from
Consumer   Loan Assignment  Year	Dec 2013	Dec 2012	Initial    Forecast	Dec 2012	Initial    Forecast
2004	73.0%	73.0%	73.0%	0.0%	0.0%
2005	73.7%	73.6%	74.0%	0.1%	-0.3%
2006	70.0%	69.9%	71.4%	0.1%	-1.4%
2007	67.9%	68.0%	70.7%	-0.1%	-2.8%
2008	70.1%	70.3%	69.7%	-0.2%	0.4%
2009	79.2%	79.5%	71.9%	-0.3%	7.3%
2010	77.0%	77.3%	73.6%	-0.3%	3.4%
2011	74.1%	74.1%	72.5%	0.0%	1.6%
2012	73.5%	72.2%	71.4%	1.3%	2.1%
2013	73.3%	--	72.0%	--	1.3%

On average, their forecasts have been conservative by 1.3%.

Discipline is critical for any lender. As Charlie Munger mentioned, "The first chance you have, to avoid a loss from a foolish loan is by refusing to make it; there is no second chance." I think the following table tells the story of a disciplined underwriter.

Year	Average Unit    Volume Per Dealer	% Change
2001	52.5
2002	59.1	13%
2003	64.7	9%
2004	61.2	-5%
2005	46.2	-25%
2006	41.3	-11%
2007	37.7	-9%
2008	37.2	-1%
2009	35.0	-6%
2010	42.7	22%
2011	44.5	4%
2012	35.7	-20%
2013	31.6	-11%

There's some noise in this table (e.g., 2008 and 2009 volumes per dealer decreased as a result of capital constraints rather than the willingness to write business), but it shows that CACC is more inclined to grow unit volume by adding dealers rather than by adjusting pricing to drive per dealer volume levels. Of course, all else equal, they would prefer to see per dealer unit volumes increasing.  But I think management behaves prudently.

The below table shows the total unit volume and active dealer growth through time.

	Unit Volume	% Change	Active Dealers	% Change
2001	61,928		1,180
2002	49,801	-19.6%	843	-28.6%
2003	61,445	23.4%	950	12.7%
2004	74,154	20.7%	1,212	27.6%
2005	81,184	9.5%	1,759	45.1%
2006	91,344	12.5%	2,214	25.9%
2007	106,693	16.8%	2,827	27.7%
2008	121,282	13.7%	3,264	15.5%
2009	111,029	-8.5%	3,168	-2.9%
2010	136,813	23.2%	3,206	1.2%
2011	178,074	30.2%	3,998	24.7%
2012	190,023	6.7%	5,319	33.0%
2013	202,250	6.4%	6,394	20.2%
CAGR	10.4%		15.1%
5 Year	10.8%		14.4%
10 year	12.7%		21.0%

Growth has been very strong, but has of late been slowing. This too is a function of the competitive environment which I discuss below.

Competitive Environment and Market

The competitive environment is characterized by (1) saturation - there are many competitors (NICK, SC, CPSS, commercial banks, savings banks, credit unions, WFC moving more into subprime space etc), and (2) reduced volumes due to trailing off of pent up demand during the crisis. This combination of forces is a concern. Are we at the top of the cycle with a slow motion crash ahead (rates decrease and losses rise slowly, but dramatically)? I'm not one to predict cycles, but I actually don't think this would be so bad for CACC because they strike me as very disciplined, and over time it would weed out weaker players and tighten supply. Anecdotal commentary I’ve read though indicates that (a) on the supply side, while loose historically, it is still tighter than 2006-2007, and (b) losses in subprime credits remain at historical lows.

Overall, while a very legitimate concern, I take comfort in the fact that management has navigated these cycles successfully in the past by sticking to their principles and staying disciplined on price. I also take comfort in the ‘skin in the game’ portfolio program approach CACC takes (rather than outright purchases). This significantly reduces credit risk relative to the alternative, and gives dealers an additional revenue source.

As Don Foss (the founder and chairman) mentioned, while there are not barrier to entries, there are plenty of barriers to making money. Operationally, CACC seems very well positioned relative to its competitors. Below is a table comparing return on assets (unlevered capital) achieved by CACC and it's 'pureplay' competitors.

ROA	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	Latest Qtr
CACC	7.47	11.99	8.72	6.59	6.45	12.63	13.5	12.12	11.29	11.08	10.05
NICK	5.39	7.21	7.81	7.18	5.33	2.43	5.28	7.34	8.88	7.65	6.91
SC	—	—	—	—	—	—	—	3.96	3.75	3.09	3.09
CPSS	-2.52	0.35	0.92	0.69	-1.33	-4.23	-3.74	-1.77	7.2	1.73	1.84

And below is a table comparing efficiency ratios.

	Operating Exp to Int Income
CACC	23%
NICK	35%
SC	18%
CPSS	33%

These two tables combined paint a picture of a company that is extremely well run as compared to it's competitors. While SC has a lower efficiency ratio than CACC, it operates with much higher leverage (which allows it to earn greater interest income; raising the denominator, lowering the ratio) to achieve this. Note their are many competitors that are not listed here (banks etc), but it is still worthwhile to compare figures against the "pureplay" competitors that the data is easy to obtain for.

CACC has a very small share of the market. There are approximately 40 million used cars sold annually, 60 million adults with sub-prime credit scores and 60,000 dealerships. In 2013, 6,168 dealerships originated 202,250 loans with CACC. The opportunities for CACC remain large.

Management

CACC management appears to be quite shareholder friendly, focused, and rational. Their communication and annual letters are clear and full of useful information. They also accumulate commonly asked investor questions and present the answers in writing on their website. From reading managements communication, three themes jumped out at me: focus, discipline, and rationality.

An interesting video with management being featured is here: http://youtu.be/wah9p824nYg. Some of this video seems quite scripted, but it does give a decent picture of the management style. 

Share Repurchases

The company is also a regular purchaser of it's own shares:

	Diluted         Shares
2001	43,150,804
2002	43,362,741
2003	43,409,007
2004	41,017,205
2005	39,207,680
2006	35,283,478
2007	31,153,688
2008	31,105,043
2009	31,668,895
2010	29,984,819
2011	26,600,855
2012	25,598,956
2013	24,009,593

Since year end, the company has purchased an additional 637,420 shares, and announced a tender for 915,750 shares. Repurchases have the effect of raising financial leverage.  Below is CACC's leverage as compared to competitors.

	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013	Latest Qtr
CACC	2.0x	1.7x	3.5x	3.6x	3.4x	2.4x	2.8x	3.3x	3.4x	3.2x	3.6x
NICK	3.8x	2.6x	2.6x	2.5x	2.4x	2.3x	2.2x	2.1x	1.9x	2.1x	2.0x
SC	—	—	—	—	—	—	—	8.8x	8.5x	9.8x	9.9x
CPSS	11.0x	15.7x	15.5x	20.0x	18.2x	30.0x	163.1x	—	16.9x	14.8x	14.1x

None of these competitors have sticky deposits that would justify obviously higher ratios. So while CACC is quite leveraged, they appear to be on the more modest end of the spectrum.

Risks/Concerns

1. The main risk that CACC faces in my view is funding. They are highly dependent on the capital markets, which no question is not ideal. While I cannot dismiss this risk entirely, the 2008 credit crisis was a very good stress test of their business model, and they passed with flying colors. They grew adjusted earnings per share 30.5%, 52.1%, and 41.4% in 2008, 2009, and 2010 respectively. This is in spite of decreasing loan volume in 2009 due to capital constraints imposed by the crisis. 
2. As discussed, the competitive environment poses a persistent threat.
3. Collection forecasting accuracy is critical to their success. Competition threatens the accuracy of their forecasts by way of adverse selection. They regularly present backtests and have historically been conservative in their forecasts.
4. Specialty finance companies do not sell for premium earnings multiples. I'm not sure if this is due to some stigma, or just the fact that they're balance sheet lenders (commodity). Other than companies in trough/unusual earnings situations, only a couple companies currently trade at earnings multiples in the high teens (e.g., FCFS at 17x).
5. Don Foss (founder and chairman, age 69) is selling all of his shares. Mr. Foss owns roughly 4.4mm shares, and per disclosures in recent tender offers, he intends to sell 100% of these. I'm not exactly sure what to make of this, but I think it's doubtful that he is opportunistically selling based on his view that the price as currently high, and also doubtful that he thinks the company’s prospects long term are poor (after going for 41 years, through multiple cycles, and recent performance etc). Mr. Foss has been selling for a long time, somewhat consistently. I haven't gone through all the tenders, but he was tendering large quantities of shares both in October 2006 and July 2010 (two totally different points of the cycle).
6. Regulation - Dodd-Frank established the Consumer Finance Protection Bureau (CFPB). While the CFPB is a potential wildcard, at the moment it does not seem to be cause of much concern from CACC's perspective. To date their main focus seems to be fair lending practices (i.e., not discriminating based on race, religion etc). Something to keep a close eye on. 

Conclusion

I purchased CACC based on:

• Track record: Their track record is very strong. The last 5y/10y, they have compounded BVPS 23.5%/14.7%, adjusted EPS 31.5%/34.2%, and unit volumes 10.8%/12.7%.
• Management ethos: I am very impressed by management. They (a) strike me as very rational, focused, and disciplined; operate on margin of safety/value investing principles, (b) strong capital allocation; have also bought back a lot of stock (24%/42% of the stock the last 5y/10y), and (c) seem to be shareholder friendly; quite clear and transparent communication
• At 11.9x TTM NI (management’s “adjusted” earnings), the price seems reasonable, or at least not unreasonable. For context, historically CACC has sold for 13.5x-14x earnings on average the last decade; competitors currently trade in ranges of 9x (CPSS) to 15x (SC). My thinking is you're not paying a lot, if anything, for growth which they have delivered plenty of. 

For me, this is a company that I can say that were it to fall dramatically in price, all else equal (mainly management remaining in place, and access to funding), I would feel comfortable allocating a very large percentage of my net worth to.

Disclosure: Long CACC

CIBL, Inc (CIBY)

CIBL is a company I've owned since mid-November 2013, but have not written about it. I sometimes do not write about something I bought/sold because it has been written up all over the blogosphere (e.g., HNFSA/HNFSB, SHFK, SODI, CDU.PT, BRK). This is easy to rationalize because putting a writeup together usually requires a fair amount of effort, and my day job consumes 12 hours +/- a day. However I've realized this is usually a mistake, because one of the main goals for me with the blog is to improve decision making, and writing the thesis out undoubtedly (a) significantly improves focus by forcing you to think about each idea more thoroughly, (b) provides a track record of one's rationale for future scrutinizing / progress tracking, and (c) helps greatly in deciding if it's time to sell something. While writing things down will obviously not eliminate poor/expensive decisions, it facilitates improvement in more ways than one, making it well worth the effort. So there are several other buy/sell decisions in the backlog to write up.

Anyways, this is an idea that has been written up by some of my favorite bloggers to track, e.g., here, and here. Shares currently trade around $1,400 (with 19,332 shares outstanding). The idea is fairly simple, CIBL was spun of from LICT late 2007 and has since sold the majority of its operating assets (wireless towers and TV stations), and now consists of the following assets:

	Per Share	Basis
CIBL cash, net of tax (1)	1,030	Book
TV station sale receivable	394	Book
ICTC (39.95% stake) (2)	180	Market
LICT note receivable	25	Book
Solix (1.36% stake) (3)	5	Book
Total	1,633

(1) ICTC is consolidated in the financial statements of CIBL. This item represents only CIBL cash, net of ICTC cash.
(2) At cost, the ICTC investment represents $186 per CIBL share.
(3) The historical cost of this investment is disclosed in Note 4 of the 2007 Auditor's Report.

The above figures do not match the press release linked above because they have been updated to reflect the recent repurchase of approximately 10% of the outstanding common stock at $1,300.  It is worth noting that the board and management of the company elected to not sell shares as part of the tender. Also worth noting is that Mario Gabelli, founder of GAMCO Investors, is Chairman of the Board and has a 34% stake in the company. Mr. Gabelli also owns large stakes in both ICTC (investee of CIBL) and LICT (former parent of CIBL).

ICTC is a telecommunications company not that dissimilar to the pre-asset-sale CIBL, which Mr. Gabelli has been buying for CIBL. Mr. Gabelli also controls ICTC, through a combination of direct and indirect (through CIBL) investments. I believe it is quite possible that he plans to monetize the assets of ICTC in a similar fashion as CIBL. The posts referenced above provide additional insight into the potential value of this investment.

The Solix investment is also somewhat of a wildcard. While on the books at $100k, there are indications that this investment could be worth significantly more than this. One of the blogs posted above observed that Solix has annual revenues around $91m, so for the 1.36% stake, a value of $600k-$1.2m is probably a conservative range ($32-$64 per CIBL share). Depending on Solix's margins and growth rates etc., a value up to $3m ($160 per CIBL share) is entirely within reason.

The operative word for this investment is safe. Given the current asset base, the upside is not tremendous (I estimate best case maybe 35-40%, but most likely only 20% from the recent price of $1,400). However the potential downside strikes me as very limited. For example, suppose ICTC and Solix are both worth $0, there are still $1,403 of after-tax assets per share to cover the price. ICTC is after all in an extremely tough and declining business. The real question is what management does with the cash.  Usually the concern is that management, in one way or another, will set this on fire. In this case, with Mario Gabelli at the helm of capital allocation, this risk seems highly mitigated. More likely, I think having Gabelli manage the capital is potentially a large opportunity. To date, he has consistently acted in a minority-shareholder friendly manner, at both LICT and CIBL. He spun off CIBL which has proved rewarding to LICT shareholders, has monetized assets at attractive valuations, and repurchased shares (both at CIBL and LICT).

Despite the limited upside with the current asset base, the limited downside combined with Gabelli managing the capital were the deciding factors for me. I own shares with a cost that is just about 10% lower, and I have an open order (has been open for maybe two months) to purchase more if shares dip back towards this price.

Disclosures: 

(1) Long CIBY with an open order to purchase additional shares

(2) Long LICT and may purchase additional shares at any time
(3) Considering an investment in ICTG, may purchase shares at any time

*Edit: I should have disclosed that I am long BRK, HNFSA, SODI, SHFK, CDU.PT that are also mentioned.

Immediate about face - Groupe Athena, Inc. (GATA)

Following the recent post related to GATA, I was made aware of some research posted here. It is good disconfirming evidence arguing essentially that GATA is quite possibly a fraud. While this is a pretty serious allegation, the author actually makes some good points and has done a decent amount of legwork. 

The risk indeed seems elevated to me (even more so than other microcaps), but for a few reasons I limited my search to googling people (serves me right for not waiting to hear back from management and looking into the fraud angle as much as usual). Maybe preemptive, and feel a little foolish to do such an immediate 180, but I feel the risk is real and am more comfortable selling quite possibly for good, but at least until I hear back from management about some of my questions that could shed a little light on this.

Groupe Athena, Inc. (GATA)

Subsequent edit: I don't know if there's anyone other than me that actually reads these, but before reading below read this.

GATA is small relatively young, unlisted company, with high insider ownership. It helps firms in India obtain FDA approval for pharmaceuticals, medical products and devices for export to America. They help their clients pass FDA inspection by assisting them from concept through development, with consultation through all the regulatory requirements, filings, and processes to achieve FDA compliance and approval. 

GATA is a profitable net-net, with a negative enterprise value. Shares currently trade at $0.20.

Below is the latest balance sheet, and the last several years of income statements. "Adj inc" in the below table is defined as net income plus depreciation less capital expenditures.

(000s)	9/30/2013	Per Share
Cash & Equivalents	226.9	0.00
Deposits and Invest.	11,890.1	0.25
Accounts Receivables	1,009.7	0.02
Prepaid exp	0.8	0.00
Inventories	27.7	0.00
Total Current Assets	13,155.3	0.28
Gross PP&E	12,320.4
Depreciation	-8,094.4
Net PP&E	4,226.0	0.09
All Liablities	76.8	0.00
NCAV	13,078.5	0.28
NCAV + PP&E	17,304.6	0.37
Price	9,427.4	0.20

	Year ended June 30,
(000s)	2013	2012	2011	2010	2009
Revenue	56,457.4	44,571.4	25,112.6	12,119.1	7,754.4
COR	-37,651.2	-30,090.4	-17,174.0	-8,035.1	-5,078.3
Margin %	33.3%	32.5%	31.6%	33.7%	34.5%
Selling exp	-7,656.4	-6,009.9	-3,228.6	-1,410.9	-865.5
G&A	-2,193.1	-1,470.0	-960.2	-343.2	-201.0
Total Op Exp	-47,500.7	-37,570.3	-21,362.8	-9,789.2	-6,144.8
Op Income	8,956.7	7,001.1	3,749.8	2,329.9	1,609.6
Margin %	15.9%	15.7%	14.9%	19.2%	20.8%
Dep/Amort	-2,491.1	-1,778.5	-1,240.5	-1,037.5	-1,012.5
Interest	0.0	0.0	-1.2	-10.6	-44.9
EBT	6,465.6	5,222.6	2,508.2	1,281.7	552.3
Taxes	-1,025.0	-805.6	-401.4	-199.8	-91.1
NI	5,440.7	4,417.0	2,106.8	1,081.9	461.2
Margin %	9.6%	9.9%	8.4%	8.9%	5.9%
Effective tax rate	15.9%	15.4%	16.0%	15.6%	16.5%
						Total	Averege
NI	5,440.7	4,417.0	2,106.8	1,081.9	461.2	13,507.7	2,701.5
CFO (does not incude Dep)	5,170.4	4,382.2	1,645.4	1,254.3	350.6	12,803.0	2,560.6
Dep/Amort	-2,491.1	-1,778.5	-1,240.5	-1,037.5	-1,012.5	-7,560.0	-1,512.0
Capex	-1,442.5	-4,656.4	-1,515.8	-2,206.2	-3,291.7	-13,112.7	-2,622.5
Adj Inc	6,489.2	1,539.1	1,831.5	-86.7	-1,818.0	7,955.0	1,591.0
FCF	6,219.0	1,504.2	1,370.1	85.7	-1,928.6	7,250.4	1,450.1
WAVG Shares (adj for 2009 split)	47,136.9	47,136.9	47,136.9	47,136.9	47,136.9
EPS	0.12	0.09	0.04	0.02	0.01
Adj Inc/Share	0.14	0.03	0.04	0.00	-0.04
FCF/Share	0.13	0.03	0.03	0.00	-0.04

Quantitatively GATA looks extremely cheap, and the balance sheet is quite clean.

From my perspective, GATA is qualitatively similar to PDRX written up previously. That is, I don't have much in particular to say about the future of the business itself.  Other things I would note:

• Insiders own 88% of the stock with the biggest percentage of that held by a single director. I consider this to be a positive because, while incentivized with 5% of the equity, the CEO cannot control the board and pick the pockets of shareholders so easily.
• Subjectively, the situation seems slightly speculative to me because (a) I have never invested in India (albeit, incorporated in the United States with upper management in New Jersey), and (b) the level of disclosure is less than desired.
• The nature of the work seems to provide management reasonably good insight into the their pipeline. Below are revenue forecasts (mostly as of Q1 of each FY), which can be compared to the actual performance presented above.

Mgmt Rev Est as of/for	FY2014	FY2013	FY2012	FY2011
9/30/2013	65mm
9/30/2012		55-57mm
9/30/2011			40mm
12/31/2010				20mm

Valuation

Using a very simple and rough method, I estimate GATA's value to be at least $0.54 calculated as follows:

Earnings measure (5y Avg Adj Inc)	0.03
Discount rate	10%
Earning power value	0.34
Excess Cash est.	0.20
Value estimate	0.54

I think this valuation is conservative, given the rapid growth in recent history and management revenue estimates. For example, using managements $65mm revenue estimate, one could estimate 2014 earnings roughly as:

(000s, except per share)	2014 est
Revenue	65,000.0
COR	-20,547.8
Min(5Y Margin %)	31.6%
Op Income	9,705.8
Min(5Y Margin %)	14.9%
5YR Avg Capex	-2,622.5
Interest	0.0
EBT	7,083.3
Taxes (35%)	-2,479.2
Adj Inc	4,604.2
Per share	0.10
Discount rate	10%
Earning power value	0.98
Excess Cash est.	0.20
Value estimate	1.18

Conclusion

While perhaps slightly speculative qualitatively, I think a basket of such stocks at similar levels would perform quite well and so I have initiated a position in the 2-3% of capital range.

I have inquired to management certain questions to better understand the nature of their business and the correspondent risks, as well as certain specific questions (e.g., regarding their tax rate). I may post a follow up if I'm able to get additional color regarding these items.

Disclosure: Long GATA

Bridgepoint Education (BPI)

BPI is an odd lot tender idea posted on a couple different locations already. Here's the offer to purchase. The tender is for 19% of BPI's outstanding stock at a price of $19.50. The offer expires December 11, 2013. Odd lots (less than 100 shares) are given priority. A conditions exists such that BPI may cancel the tender in the event the stock or the general market falls 10% or more. Based on today's BPI price, this would be a fall of 15%. With $432mm in the bank and an expected cost of a little over $200mm, financing is not a concern.

With the stock trading around $17.83, the returns look like this before tax and commissions:

	Success	Fail
Cost	17.83	17.83
Proceeds	19.50	15.17
% return	9.4%	-14.9%
% annualized	166%	-83%

The "fail" scenario is based on the price that BPI would need to reach to trigger the possibility of canceling the tender. Although possible, this seems much lower probability given the stock has risen since the announcement, the limited amount of time to expiration, and an earnings announcement that could cause increased volatility is not scheduled to occur. For such small amounts, that's good enough for me.

With such a large repurchase, it also seems worth investigating a longer term purchase of the stock.

Disclosure: Long BPI

PD-Rx Pharmaceuticals, Inc. (PDRX)

PDRX is a small unlisted pharmaceutical services company. They offer a full spectrum of medications and specialized services. For example, one of the services PDRX provides is a turn-key solution to physicians that dispense medication directly to their patients by providing pre-counted prescriptions. I am not an expert in the medical services field by any stretch - and there is naturally some controversy surrounding prescription dispensing physicians given the apparent conflict of interest - but on a quantitative basis PDRX is fundamentally cheap. Shares currently sell for around $3.00, and as I outline below, I believe them to be worth at least $4.95.

Quantitative considerations

Below is condensed balance sheet over last five years. Net current assets value (NCAV) in the table below is defined as current assets minus all liabilities ahead of the common.

June 30, 2012 2011 2010 2009 2008 Cash & Equivalents 3,885,618 3,083,988 1,818,320 2,144,120 1,952,845 Accounts Receivables 1,506,042 1,984,697 1,603,028 1,862,260 1,532,612 Inc tax Receivables 126,674 0 999 0 200,001 Inventories 1,591,046 1,924,072 1,673,621 1,282,776 1,017,371 Other 170,106 222,770 234,899 123,485 126,194 Total Current Assets 7,279,486 7,215,527 5,330,867 5,412,641 4,829,023 Net PP&E 1,076,973 956,182 966,404 967,249 799,755 All Liabilities 1,238,679 1,759,088 1,014,556 1,349,647 1,511,487 NCAV per share 3.41 3.08 2.43 2.29 1.87 NCAV + PP&E per share 4.02 3.62 2.98 2.83 2.32 NCAV/share CAGR 16.3%

Comments:

• NCAV per share is currently $3.41 relative to the share price of $3.00
• NCAV per share has grown at a compound annual rate of 16% since June 2008
• There is no debt as of June 2012
• 61% of the assets on the balance sheet consists of cash and cash equivalents

Typically a company selling for less than net current assets is one in perpetual decline, losing money year after year and burning substantial cash. PDRX on the other hand has been consistently profitable and cash flow positive. Below is the five year summary of its financial performance. "Adj inc" in the below table is defined as net income plus depreciation less capital expenditures.

	Year ended June 30,
	2012	2011	2010	2009	2008
Net sales	25,553,544	23,887,231	19,358,270	26,919,498	26,426,268
Op Income	1,130,280	1,822,851	390,240	1,474,471	1,093,734
Op Income %	4.4%	7.6%	2.0%	5.5%	4.1%
Net Inc	705,159	1,131,019	242,472	912,952	706,434
Net Inc %	2.8%	4.7%	1.3%	3.4%	2.7%
Tax rate %	39.1%	38.7%	39.8%	38.0%	38.1%
CFO	1,170,319	1,481,124	(133,689)	569,667	205,701
Depreciation	146,597	127,375	115,830	111,863	107,579
Capex	(268,705)	(115,948)	(104,781)	(283,179)	(119,471)
Adj Inc	583,051	1,142,446	253,521	741,636	694,542
Shares Out	1,769,326	1,769,326	1,774,898	1,774,898	1,774,898
EPS	0.40	0.64	0.14	0.51	0.40
CFO/share	0.66	0.84	(0.08)	0.32	0.12
Adj inc/share	0.33	0.65	0.14	0.42	0.39

Comments:

• Earnings, cash flow from operations, and adjusted income averaged 0.42, 0.37, and 0.39 per share over the last 5 years.
• Cash flow has been positive in all except one of the previous 5 years.
• Earnings and adjusted income have been positive in each of the previous 5 years.

Miscellaneous qualitative considerations

• Qualitatively I don't see any obvious reason why PDRX should fail to achieve performance in the future similar to its historical record. Granted, I am not at all a specialist in healthcare or medical services companies.
• Although the financial released seem robust, they are somewhat minimalist and are released only once a year 
• The financials do not include the auditor's (Grant Thornton) opinion, but the company provided this to me upon inquiry and the opinions are unqualified for each of the previous four years provided 

Valuation

Using a very simple and rough method, I estimate PDRX's value to be at least $4.95 calculated as follows:

Earnings measure (5y avg Adj Inc)	0.39
Discount rate	10%
Earning power value	3.85
Excess cash (50% of balance)	1.10
Value estimate	4.95

This ignores the possibility of growth or decline. PDRX has a huge cash balance of $2.20 per share. As illustrated in the above, I assume roughly half of that is excess and distributable. 

Conclusion

Based primarily on the quantitative considerations above, PDRX appears quite cheap. If modest growth assumptions are used instead, it looks incredibly cheap. However I am not an expert in this business, and am not able to conclude if growth or decline is more likely. For these reasons, I have initiated a position but have made it a relatively small position in the neighborhood of 2-3%.

Disclosure: Long PDRX

InfuSystem Holdings, Inc. (INFU)

INFU is a risk arbitrage idea with attractive annualized return potential.

The company has been the subject of a recent activist campaign led by Ryan Morris of Meson Capital Partners. After acquiring an 8% position in the company, he replaced management and appointed himself executive chairman. After taking over the board, Morris attempted unsuccessfully to shop the company. The most likely reason for the lack of interest appears to be the announcement by the Centers for Medicare and Medicaid Services to subject INFU's pumps to a competitive bidding process.

In May, Morris sent a letter to the board expressing interest in putting a bid together to take the company private in May. The board agreed under the condition that Morris take a leave of absence as the executive chairman. Morris agreed, remaining on the board but stepping down from the executive chairman role.

On July 17, Morris sent another letter with a good faith indication of interest to take the company private at a price between $1.85 and $2.00. With the stock trading around $1.75, the gross returns are the following if the deal goes through at the end of the year:

Deal Price	Return	Annualized
$1.85	5.7%	13.4%
$2.00	14.3%	35.3%

A deal is still subject to due diligence, and receipt of third-party financing. The latter appears to be lined up, again subject to due diligence.

The deal looks to have a quite high probability of going through in one form or another. The shareholder base is relatively concentrated, and I think Morris likely knows where they stand. As was made public before the indicative offer, management has also recently adjusted their contracts to include change of control provisions providing for "cash award payments" in the event of a transaction involving greater than 50% of the stock. How convenient for them. The CEO and many of the board were recently appointed following Morris' gain in control, and I suspect they will also keep their jobs.

In any case, there's also reason to think that the deal could get done at a higher price. Morris purchased approximately 60% of his position at $2.25. To avoid the further appearance of conflicts of interest (recall that Morris is still on the board), I think it somewhat likely that the price either goes through at the high end of the range, or gets pushed to $2.25. In its letter responding to the offer, management stated that it "continues to believe that the value of the Company is above your proposed offer range of $1.85 to $2.00 per share." I expect Morris will counter with the competitive bid discussed above, but the incentives appear to be to get the deal done, and even the low range is reasonably attractive.

Worst case and the deal does not go through, the company does not appear to be overvalued. The rebid risk is real, but I'm willing to accept this given the other factors in play.

Disclosure: Long INFU