STR Holdings - A 'Cigar Butt' Worth Several More Puffs

Editors' Note: This article covers a stock trading with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

There is an old joke about two professors walking down the street. One of them says, "Look! There is a twenty dollar bill on the ground." The second professor, an avid believer of the Efficient Market Hypothesis, says, "Don't bother bending. It can't be real. If it were, someone would have already picked it up." It is rare to find $20 bills on the ground, but when an investor spots one she needs to spend a little time exploring the opportunity. This article introduces a stock screen that will direct investors to find the proverbial $20 bill on the ground. It will then focus on one particular company, STR Holdings (STRI). As we will see below, STR Holdings may be the perfect "cigar butt".

In the 1989 letter to Berkshire Hathaway shareholders Warren Buffett wrote: "If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long- term performance of the business may be terrible. I call this the "cigar butt" approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the "bargain purchase" will make that puff all profit."

Negative Enterprise Value

Enterprise Value is the company's market capitalization plus its debt minus its cash. Say you are offered to buy a home that comes with a mortgage of $800,000. The seller offers to sell you the home for $200,000 (In the real world the home would sell for $1 million and the buyer would borrow the $800,000). In this case the market capitalization would be $200,000 and the debt would be $800,000. When you see the home you notice that the house is wallpapered with $100 bills. You count the bills and note that there is $900,000 worth of cash on the walls. The enterprise value of the house is:

Market capitalization + debt - cash = $200,000 + $800,000 - $900,000 = Negative $100,000

In the situation above, the seller is basically giving you $100,000 to take the house. You need not get bogged down with whether the house is in a good school district or if the kitchen has granite counter tops. In fact, once you are certain about the market capitalization (price), debt (mortgage) and cash (wallpaper of $100 bills), you should start writing the check for $200,000 immediately.

But beware. When you buy shares in a company with a negative enterprise value, unlike the house with cash wallpaper, you cannot get at the company's cash. This is a major pitfall of investing in companies with a true negative enterprise value. Furthermore, management's interests may be different than those of the shareholders. They may deploy the cash unwisely such as paying themselves excessive bonuses or making unwise acquisitions. Investors must make sure that management's interests are aligned with shareholders' interests.

On a stock screen on Fidelity Investment's website I recently came up with 18 companies with negative enterprise values. I am not sure how the screen defined enterprise value, but many of the companies should not have been on that list given the definition above. I limited my search to companies in the US with a market cap of at least $50 million. Many of the companies in the screen were insurance companies and banks whose true liabilities can be difficult to value. Along with STR Holdings, Rigel Pharmaceuticals (RIGL), a biotechnology company, also appeared on the list. Rigel is a drug development company with minimal revenues. They have plenty of cash which they use for research and development. Thus, investors cannot expect to get the company's cash. Unlike Rigel, STR does not have its cash earmarked for R & D.

STR Holdings designs, develops, manufactures and sells encapsulants for the solar industry. Below is a summary of the company's balance sheet from MSN Money.

	2009	2010	2011	2012	Q3 2013
1. Cash and Short Term Investments	70	107	59	82	62
2. All other Current Assets	55	89	51	25	27
3. Total Current Assets	125	196	110	107	89
4. Total Liabilities	375	375	72	20	17
5. Shares Outstanding	41.4	41.5	41.6	41.7	41.9
6. Current Assets - Total Liabilities (NCAV)	-250	-179	38	87	72
7. NCAV per Share	-6.04	-4.31	0.91	2.09	1.72
8. Shareholder Equity (BV)	271	328	331	127	115
9. Book Value per share	6.55	7.90	7.96	3.05	2.74

Source: Rows 1, 3, 4, 5, 8 from MSN Money. Rows 2, 6, 7, 9 calculated from data

Shareholder Equity or book value has fallen by almost $160 million over four years. They have returned no cash to shareholders via dividends. Share count has remained close to constant so at least dilution has not been an issue. Essentially this company has destroyed value for its shareholders. On the brighter side, the company has no debt and lots of cash for its size. Currently the stock trades at below its NCAV per share.

Next let's take a look at the company's income statements:

	2009	2010	2011	2012	Q3 2013
1. Total Revenue	150	259	232	95	6
2. Net Income	23	49	-1	-207	-6
3. EPS	0.56	1.18	-0.02	-4.96	-0.14

Source: Rows 1, 2 from MSN Money. Row 3 calculated from data

Yikes! The numbers make it clear that this company is not profitable anymore which explains the precipitous drop in book value. The company's performance has been dismal, and management is very clear and frank about it in their latest 10K filing. Those who remember President Carter's installation of solar panels in the White House will know that solar energy has existed for decades. In the past decade government incentive programs and subsidies particularly in the European Union led initially to industry growth and sales growth for the company. However, due to fiscal constraints, many EU countries, such as Germany and Italy, have been cutting those subsidies. The decline in demand combined with industry overcapacity has led to reduction of selling prices for the company's products and the company's customers' products. In addition during the first quarter of 2013 the company lost its largest customer, First Solar. STR estimates that their global market share has dropped to 10% in 2012 from 30% in 2010. One of the reasons for STR's dismal performance lately has been due to a shift in manufacturing from western manufacturers to Asian manufacturers that were not STR customers. The company makes a case for possible trend shifts, but, of course, investors cannot be sure what the future will hold for STR which is operating in a very competitive environment.

The bullish case for STR is that at the current stock price, the company is very attractive. The poor performance of the company has been mostly due to macroeconomic shifts out of the control of management. A "hiccup" in the environment would drive the stock price considerably higher. If no hiccup materializes, investors can be comforted that loss of their investment is limited due to the company's strong balance sheet. At current prices, STR, like the house wallpapered with $100 bills, presents an opportunity for investors. Average trading volume is over 300,000 shares daily which should allow small investors an opportunity to accumulate a meaningful position.

Warning Signs to watch for

In the same 1989 letter to the shareholders, Buffett continued his thoughts on "cigar butts" as follows:

"Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original "bargain" price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces - never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost. Time is the friend of the wonderful business, the enemy of the mediocre."

Unlike Gencor (GENC), which I wrote about in an earlier article, STR is not profitable. At the current cash burn rate the company will have to declare bankruptcy in about nine years. It is reassuring that insiders have not sold any significant shares. Red Mountain Capital Partners, owner of 6.2 million shares according to the latest proxy, sold approximately two million shares in December of 2013. Perhaps their motivation was harvesting losses for tax purposes, but it put a big downward pressure on the company's stock price.

STR is worth a turnaround chance, but investors must continue watching for new developments. It has not been a wonderful business that has grown shareholder equity. Investors who prefer buying great companies, and not closely monitoring their investment, may be disappointed with STR. Investors should consider exiting their position if the cash burn rate increases or if insiders start selling their shares.

Source: STR Holdings - A 'Cigar Butt' Worth Several More Puffs

Disclosure: I am long STRI, GENC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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