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June 1, 2007 5:14 pm
My investment firm focuses its research on two types of companies: those with wide economic moats, and those with hidden assets that are worth nearly as much as the value of the entire company.
The term “economic moat”, coined by Warren Buffett in the 1960s, describes a company with nearly unassailable competitive advantages within a healthy industry. This position allows it to generate high returns on capital for decades.
An example would be the Chicago Mercantile Exchange, which is the most liquid futures exchange and owns its own clearing operation, giving it the ability to raise prices regularly without threat of competition. Most wide-moat companies are large caps because the moat allows them to grow large over time.
We also spend time looking for hidden asset plays, which tend to be small-cap companies with illiquid shares. These are harder to find because you can’t screen for them; analysts often don’t cover them; and they usually aren’t very profitable (yet). They can be hard to value, so most investors don’t bother.
With these companies, we’re looking for a tangible asset or assets that could be liquidated at a price that would justify the market value of the entire company.
Examples of these “hidden assets” would be oil and gas leases that are not yet generating cash, real estate purchased in the 1950s and still listed at cost basis on the balance sheet, or a well-located salt mine allowing its owner to get its salt to port more cheaply than competitors.
When we find a company with an asset such as this ignored by the market, we try to take a large position because our downside is limited to the liquidation value of the asset.
Once in a very great while, we find a company with all three characteristics: A wide moat, a cheap price, and a hidden asset that provides downside protection. Premier Exhibitions (ticker PRXI) is one such company.
Premier was founded by Arnie Geller, now chairman, in 1993 and at its current price of $13.50 has a market cap of $450m. It has no debt and about $17m cash on the balance sheet. Insiders own about 15 per cent of the company. The economics of the business are good, resulting in high returns on capital and lots of cash flow.
In 1994, Premier was granted salvor-in-possession status by a federal court for the Titanic, which sunk in 1912 in 12,500 feet of water off the coast of Newfoundland.
Because of the court ruling, Premier has the exclusive right to recover artifacts, data, and images from the Titanic site. After several expensive dive expeditions over the years, Premier has amassed the largest collection of information and artifacts from the Titanic (in fact, it has pretty much the only legal collection of Titanic artifacts because no one else is allowed to explore the shipwreck site). The company tours the world with these artifacts, exhibiting them in museums.
This is the “hidden asset” part of the company. The market value of these artifacts is in the hundreds of millions of dollars (for example, the Titanic has 3m rivets and Premier has been offered $10,000 for just one rivet!) We feel that if Premier were to sell the artifacts, it would get a cash infusion equal to 25-50 per cent of its current market cap and still not lose much revenue because it could continue to exhibit some of the items under an exclusive licence agreement with the buyer.
Premier’s second business, a more recent addition, is the Bodies exhibits that are shown in museums worldwide. The company now has 11 collections of human body specimens that have been “plasticised” so they don’t deteriorate (compared with five a year ago). The exhibitions include whole bodies and individual body parts, and include exhibits such as side-by-side comparisons between the lungs of a non-smoker and a smoker, or the leg muscles of an athlete and a non-athlete.
These exhibitions have been a huge hit with tourists and schools who bring busloads of students to learn about anatomy, yet they are only now in a handful of museums worldwide. The potential for expansion is enormous.
There is only one main competitor (much smaller), and it’s difficult to imagine many more appearing because obtaining the plasticised body parts requires a large upfront investment and takes time. Further, Premier has developed good relationships with museums all over the world, giving them a percentage of the revenue from the exhibits, and these relationships would have to be supplanted by a potential competitor. While this is possible, it seems unlikely based on the research we have done. The real moat, then, is first-mover advantage with museums.
The museum relationships should allow Premier to roll out new concepts in coming years, and the company is planning several. While Mr Geller won’t disclose the details on any of these planned concepts yet, he has shown a real talent for coming up with exhibits that generate media interest and mass-market appeal.
Given its market cap, it’s likely that the company will be admitted to the Russell 2000 index in June. Our fair value for the shares, using a discounted cash flow model, is currently $20. We believe that will rise to between $35 and $50 over the next few years.
Mark Sellers is the founder and managing member of the Sellers Capital Fund, LLC, a long/short equity hedge fund. He was formerly chief equities strategist at Morningstar.
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