OM Group appeared on my radar as a potential value investment when I was looking for large companies selling below book value. OM Group currently sells at an appealing discount (P/B is .8) and has plenty of cash: $400M against debt of $120M and a market cap of roughly $1B. There’s a catch, though – too many off-balance sheet risks/balance sheet oddities and no chance that the cash will be returned to shareholders any time soon.
To me, the first red flag is that the company’s primary source of cobalt, a critical raw material, is located in the DRC and operated in a joint venture with Groupe George Forrest (25%) and Gécamines (20%), a state-owned entity of the DRC. The wikipedia entry is here, but suffice to say that the country’s overall history can safely be classified as “sad” and (key point) its stability is tenuous. Judging by
The other partner, GGF, was the beneficiary of a loan from OMG to refinance its capital contribution. Of the remaining $19.1M owed to OMG by Groupe George Forrest, $5.2M has already been written off, with the remainder guaranteed by the partner’s returns on the joint venture. First off, it’s a bad sign that there’s already a valuation allowance for 20% of the value of the loan. It also strikes me as somewhat paradoxical collateral: GGF primarily deals in metals, so if price changes of raw materials leave GGF strapped for cash then it’s possible that the joint venture might be experiencing similar price pressure, making it unable to cover the loan.
As an addendum to this risk, the company’s $68.1M “restricted cash” asset is actually money held in trust pending the outcome of a lawsuit against GTL, the joint venture company. The company (of course) assures shareholders that they expect everything to be fine and dandy. Since company’s rarely feel the need to draw attention to potentially crushing losses, I’d view their optimism with a bit of skepticism.
Regarding the balance sheet, there is also a disturbing jump of “Other Current Assets” from $32M in 2009 to $44M in 2010. Most of the increase – most of the account itself, actually – is not adequately accounted for anywhere in the 10-K. Derivatives, deferred income taxes, and the recent acquisition of EaglePicher Technologies account for perhaps 25% of that total and the rest remains a mystery. In “Financial Shenanigans” (great read, by the way) Howard Shcilit mentions that companies can inflate earnings by capitalizing costs and lumping them under the heading of “Other Current Assets” and a suspicious mind might question whether the same thing is occurring here.
OMG (I’m starting to feel silly typing that…) also has more customer concentration than I like to see. 50% of its battery sales go to three customers. That’s not quite ruinous concentration – they’ve got other business lines, after all – but it’s more than I like to see with all those other questions floating around.
Just to top it off, most of the cash (87%) is held overseas and will remain there for tax reasons. The company has explicitly stated that it will not pay dividends and it doesn’t seem particularly interested in buybacks either.
Other, more quantitative measures of value are more forgiving – low level of debt, decently low valuation relative to its free cash flow – but all of the concerns above suggest that the company’s financial integrity and asset quality are a lot more questionable than simple financial ratios and earnings multiples let on. I’ll pass.
Current Price: $34.13
Latest 10-K: http://www.secinfo.com/dsvr4.qHC1.htm