Making Use of Resource “Cash Boxes” and “Net-Nets”
Tekoa Da Silva
“Rick, what are your thoughts on Corona Gold Corp.?” I asked. “Have you come across it?”
“Ah yes, the old Dundee Cash Box,” replied Mr. Rick Rule, President of Sprott U.S. Holdings. “I’m familiar with it.”
“It’s trading at half of cash and securities!” I exclaimed.
“Yes, but remember that doesn’t guarantee success,” Mr. Rule added with a usual smile, “However – negative enterprise value is [always] attractive.”
That conversation in early 2014 first introduced me to the term “Cash Box”. In subsequent years working for Sprott Global, I found that resource investment firms usually have a few dormant Cash Boxes ‘laying around’, awaiting future activity.
A Cash Box is a publically listed but inactive company, used for one purpose—to hold cash balances and/or securities of other public or private businesses.
Because Cash Box companies are inert, they are often forgotten over time and not promoted to the public. In weak resource markets, their share prices’ (ie. market capitalizations) tend to drift lower—sometimes to the extent that the business ends up being priced at substantially less than the value of the liquid assets the business owns (ie. cash, stock, receivables).
A company who’s market capitalization (price) drifts below Net Current Assets can be termed a ‘Net-Net’.
These corporate entities at some point may be dusted off and brought back to life through promotion. That typically occurs when an entrepreneurial group wishes to import assets into the cash box, or acquire it to form the basis of a new, larger company.
The above scenarios are coupled with regulatory filings by the involved companies of an imminent, friendly (most often) acquisition or merger – which may be conducted at a 25%-125% premium to the market price of the Cash Box.
This is precisely what occurred with Corona Gold Corp. in 2015. It took a few years of waiting, but those investors who bought at a price of “half of cash and securities” were rewarded for their patience.
The occurrence of companies selling at less than cash or current assets happens with enough regularity in markets that this form of observation (and subsequent buying of shares in said companies) represents, “A fruitful field for the technique of [security] analysis,” 1 notes Ben Graham, in the perennial classic, Security Analysis.
It forms the basis of a technique some call, “Net-Net” or “Net Working Capital” investment.
This style of approach is nothing new, and as Graham points out, has been practiced in stock markets for over 100 years.
So how often can one unlock the treasures of forgotten cash boxes? And what causes companies to sell for less than their worth?
Roughly every decade, many cyclical industries crash or undergo extended bear markets. While Cash Box companies can be found in any market, their pricing is often at its lowest risk during the depths of a depressed market.
Negative sentiment also contributes to attractive pricing.
2014-2015 marked the bottom (thus far) of an extreme bear market in natural resource equities. It brought about severe low share pricing relative to underlying assets, across the industry.
Compounding the severity of low pricing was extreme negative human sentiment.
My boss Mr. Rule often notes that, “People’s expectation of the future is set by their experience of the immediate past.” Indeed, the prevailing sentiment during the resource market of 2015 was the expectation of lower share pricing for the foreseeable future.
As a financial advisor I recall recommending certain resource stocks, and in the final months of 2015 in particular – I was most often rebuffed. Many people noted to me, “That stock is going lower—I’d rather wait until the market finds a bottom.”
In mid-2015, a colleague of mine ran a ‘Cash & Equivalent’ equity screen across the resource sector.
The search produced 30-40 companies, mostly explorers selling for less than cash held in their treasuries – with other assets (securities, properties, receivables, etc.) available for free, based on valuation.
In terms of human sentiment, I recall hearing feedback (in regards to those 30-40 companies) such as, “The management team will waste cash resources on general and administrative expenses (ie. salaries), plus, they are an exploration or development stage company so their treasury will be spent soon, anyways.”
However, as the resource market bottomed in early 2016 and recovered, those 30-40 Cash Box and ‘Net-Nets’ began disappearing – many moved higher in price, some were acquired at premiums and others were part of corporate ‘Roll Up’ activities – mergers between 3 or more entities, ‘rolling up’ assets into one corporate body.
Most of the 30-40 companies did quite well, in terms of share price.
In looking at today’s market, there are fewer remaining ‘Net-Nets,’ or Cash Boxes selling for less than their current assets. Those remaining are found in obscure parts of the early-stage resource exploration market, including Oil & Gas.
They also exist as tiny sub-$10 million (Canadian) market cap corporate shells, waiting to be shaken out of Sedar.Com archives.
Sedar.com by the way, is the Canadian security industry’s equivalent of Edgar.com – a searchable database of company regulatory filings, containing financial statements of many unknown listed resource companies.
While there are fewer Cash Boxes and ‘Net-Nets’ available in today’s market, the biggest opportunity may be in the future.
U.S. stock markets have advanced 9 years without a major correction. History shows market panics and crashes are normal events.
Ben Graham teaches that during the 1926-1929 U.S. general equity bull market, Cash Box and ‘Net-Net’ situations were, “[B]y no means rare.” 2
But it was after the major stock market crash of the Great Depression that, “[A] large proportion of issues…[sold] below their liquidating value,” 3 Graham explains.
“Our computations indicate[d],” Graham continued, “That over 40%…[of] industrial companies listed on the New York Stock Exchange were quoted…at less than their cash-asset value.” 4
While the Great Depression brought forth a ‘Once In A 100-Year Sale’, years later, a follow-on recession generated a stock market in which “[20.5% of] industrial companies listed on the New York Stock Exchange…[sold] at less than their net-current-asset value,” Graham further added. 5
This writer is not suggesting reoccurrence of Great Depression-era market conditions. But rather, broad-based sales, crashes, or extended multi-year bear markets are simply seasons that come and go…and may come again.
While reflecting on the 2014-2015 natural resource market (and the current U.S. general equity market) – one may understandably feel there are limited numbers of bargain opportunities.
By considering Cash Box and ‘Net-Net’ investing techniques now— before opportunities are widely available—one may be prepared to enjoy them, should they arrive.
But of course, it may take a while.
To learn more about Cash Box and ‘Net-Net’ style of investment, one can pick up a copy of Graham & Dodd’s Security Analysis and visit Chapter 43. Additionally, one can spend time sifting through financial statements on Sedar or Edgar.
One may also reach out to their financial advisor, and ask for any thoughts on the subject.
Tekoa Da Silva joined Sprott Global Resource Investments Ltd. in February 2014 after 10 years of focused study and investment in the resource sector. He currently serves the firm as an Investment Executive.
In his prior role as an investment publisher Tekoa conducted interviews with mining CEOs, fund managers, economists, and newsletter writers, serving an annual audience of many hundreds of thousands of readers. Notable published commentaries include opinion from Rick Rule, Eric Sprott, Marc Faber, European Central Bank President Mario Draghi and many others.