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Author: michaelservet Big red star, 1000 posts Feste Award Nominee! Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 214649  
Subject: revisiting DJCO Date: 6/27/2011 12:43 PM
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Is DJCO Munger’s Japanese-style model for public ownership?

Current market capitalization for the Daily Journal is something like $99M. The company has cash and marketable securities of - as of the last 10Q - about $85M. That $85M is comprised of cash, treasuries, and– according to the filing – a portfolio of 5 equities, with unrealized gains of $39M. For what it’s worth, the company has reserved $15M for deferred taxes. We’ll get an update on the portfolio market value soon enough with the release of the current quarter's results.

The company also owns its 72.0sf of LA office space free and clear, with an original purchase+construction cost of about $12M (acquired a couple of decades ago, with the newer of the buildings, comprising half the sf, constructed in 2003. The Daily Journal is using about 55.0sf of the 72.0sf for offices and printing, with the rest reserved for future expansion. Hopefully someone has an idea of its value, but let’s say it’s between $12M and $20M. Someone can also provide an idea of what 55.0sf might cost to lease these days in Southern Cal, but let’s use $1.0M +/- as a place-holder for the moment.

The third component, the operating business itself, is generating $12M pre-tax. That’s exclusive of any portfolio income, realized or not. That core business has been generally flat-to-slowly-declining. The trailing twelve months’ performance has been flat. Included in the business is a small software company it acquired.

With this balance sheet and the company’s resulting standard-issue performance metrics, DJCO is obviously being managed more like a private company than a publicly traded one. In the public world, it’s more the Japanese model – a cash-generating, potentially high-ROE underlying business showing sub-optimal reporting metrics (ROE and PE) with its cash-rich balance sheet, and with little-to-no prospect of minority partners ever wresting those benefits from its controlling owner/managers. At least that’s what the market may be saying.

In much of the western business world, an activist shareholder might see opportunity here. Distribute the portfolio in as tax-efficient manner as possible; sell the real estate and distribute those proceeds, and instead lease suitable space. End up with just an operating business that, after leasing costs, might be throwing off $11 million pre-tax. What would the value of that remaining business be? More than zero?

If we were running DJCO – which clearly we wouldn’t be qualified to do – we might at least explore some alternative tax-efficient avenues. Maybe this is a pipe dream, but we could at least have a look.

Just one example, for those particularly into tax avoidance: we might find a capable business-law attorney someplace, and just for kicks see what it would take to set up an ESOP. First off, of course, we’d have to get the company out of C-corp status, if we could. Maybe a limited liability partnership. We’d have the attorney have a look at navigating compliance with the 3-year ownership time requirement. Keeping in mind that:
..(a) We’d still be running the company post-transfer (while ‘owners’, the employees have no say in actual management, they are just beneficiaries of the trust that we manage that owns the shares),
..(b) employees wouldn’t have to make any actual investment or take on any exposure- this would be a seller (us) funded LBO,
..(c) uniquely with ESOPs, both the purchase principal and interest payments to seller (again, us) are tax-deductible to the company, and those payments to the sellers (us) are tax-exempt for us - provided we reinvest the proceeds in a public company, eg Berkshire or whatever.
..(d) the hefty purchase price for this now-valuable company could be funded by the combination of the portfolio, the building - perhaps even through a sale-leaseback to the company - and the future cash flow of the remaining operating business – which will now be largely tax-free, due to the exemption of those hefty principal/interest payments to us, into the future.

And down the line – after we’re paid off - the employees are the eventual beneficiaries of the residual business – for which they have no cost or no personal financial exposure (other than their jobs – but that’s exposure they have anyway). They just have to keep it going.

[Does that cover everything? Of course not, which is why we need that attorney. But can we even improve on that structure? For example, better avoid otherwise taxable gains in the portfolio?].

Anyway, that’s just one tangential suggestion, for the particularly tax-phobic among us. Hopefully it's a hypothetical, and not a diversion to the underlying value consideration.

The main point here is that, if there were an indication that DJCO were Walmart-friendly, as compared to say, Costco-friendly (with Charlie on the board there, we can see some similarities), we might conclude that $99M is a quite decent price for DJCO. If we were into shareholder activism, and the current board were open to alternatives, it might be a bargain.
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