Location: Itex headquarters, Bellevue, WA

Attendance: 12 or 13 people including the ITEX board and company operators.

A representative of the Polonitza Group was in attendance, to see who the Polonitza Group represents view this 13D filling. The Polonitza Group among others includes David Polonitza who according to this letter has been an ITEX holder since 2004. Most of the questions were asked by The Polonitza Group. Some specific questions that were asked:

What was the reason for removing from the company by laws the ability for shareholders to call a special meeting? Is there any plan to re-instate this in the future?

They essentially said that this was done as a result of the WEST situation and at the recommendation of the counsel that was helping them during that time period. They believe it is in the interest of shareholders because it prevents management from getting blindsided with issues that have to suddenly take them away from running the business. They also noted that there processes for shareholders to voice concerns and have items brought up at the annual meeting. In addition they noted that they are always available to communicate with shareholders.

It sounded like they have no plans of reinstating the provision to call a special meeting however they did solicit feedback.

Steve White thought the bylaws were amended two years ago, but the Polonitza Group noted that this happened in the past year or at least not publicly disclosed until the past year.

I have yet to go through and track down the filling where the bylaw change is mentioned.

The Polonitza group voiced concerns over the lack of perceived independence in the board and compensation committee. As a publicly company they do not feel ITEX is doing enough to maintain proper independence on the board. They would like to see someone on the board that does not have existing relationships with the board members and they would like that entity to be a shareholder who has a reasonable position in ITEX. The Polonitza group offered up any of its members to sit on the board with no compensation required. It should also be noted that while The Polonitza Group expressed concerns about the lack of independence on the compensation committee they did state that they feel Steve White is properly compensated if not undercompensated.

The board in general tried to emphasize that while they have working relationships they are not very close friends and maintain independent thoughts and ideas.

They wanted to express that felt the board is more independent than the Polonitza Group was implying. They mentioned that while they have known each other and worked with each other for quite some time, they do not frequent each other’s houses or family events.

The Polonitza Group expressed concerns about the track record of return on capital deployed recently by ITEX. They also noted that the having an independent board member with capital allocation experience could be beneficial.

Steve mentioned that ITEX expects to see future returns on capital they have deployed.

The Polonitza Group asked if they would comment on the performance of the “SuperTrader” exchange launched by Idearc Media which is powered by ITEX.

Steve said that they are not disclosing details on this at the moment. I believe he did note that they expect it could be around 10% of revenue.

The Polonitza Group asked if the Idearc Media’s bankruptcy has any effect on deal between Idearc and ITEX, and if they expect that Idearc would attempt to renegotiate or back out.

Steve said that Idearc has been a great partner, they have always paid invoices quickly and after entering bankruptcy they had a small outstanding balance which they have assured ITEX will be paid as soon as they emerge from the bankruptcy. There was no indication that Idearc plans to renegotiate or back out of the deal.

The Polonitza Group asked if the company has thought about paying a dividend in the future.

Steve asked the shareholders for their thoughts on this. I happen to be the first one asked and was caught a little off guard. My response was that I would not opposed to the idea of returning some of the cash back to share holders, however I want to the company to maintain a strong position and be able to take advantage of opportunities to reinvest earnings at decent rates of return should opportunities become available. Most of the shareholders agreed with my statement, The Polonitza Group specifically said they were not interested in dividends being paid, specifically they pointed out the double taxation that happens when you receive dividends in taxable account, meaning the company is taxed on earnings and then the shareholder is taxed as well on the portion of earnings that gets distributed in the form a dividend.

During the dividend discussion the Polonitza Group brought up capital allocation and stated that they believe ITEX would be a good candidate for a holding company structure where the business units return free cash flow up to the parent level and the parent level manages the deployment of capital.

One shareholder asked about a $500,000 bad debt expense recorded on the balance sheet.

This was attributed to unpaid accounts receivable, Steve mentioned that they have an extremely low percentage of monies that go uncollected. I believe the number was 2%. They also mentioned that no commission gets paid until money is received. He also mentioned that franchisees are empowered to collect this money from members which attributes to the high recovery rate.

The Polonitza Group asked the board to comment on the lack of insider purchases by the board during the market turmoil which left ITEX selling at extremely cheap prices.

The board gave some reasons for not buying, Eric Best said he was very tied up in his startup “Mercent”, and was not necessarily financially comfortable or able to deploy cash for stock purchases during these times. Steve commented that he already has a large position in ITEX and stock purchases generally don’t cross his mind. Another board member pointed out that no one on the board has sold any stock in years. The Polonitza Group pointed out that Eric was the last to sell, Steve pointed out that he bought the shares Eric sold.

The Polonitza Group said that they understand people have personal reasons for not buying stocks during this time period, but they noted that even some smaller purchase by the board would go a long way. I pointed out that when ITEX was selling at bargain basement prices and no insiders were buying this is generally interpreted in a negative light because people will often take this as a sign that management does not think the stock is a good deal.

The Polonitza Group expressed that they felt ITEX should have been buying back stock when the stock was cheap and said they felt stock buy backs would yield better returns then their acquisitions.

Steve mentioned that they have the ability to buy back stock without the need for seeking approval, I believe the number was up to 2 million but I can’t be certain. Steve mentioned that thought it might be better to leave stock in the market for investors who want to buy more ITEX instead of reducing the liquidity of the stock and making it less available.

One of the ITEX folks, not sure if he a board member or the CFO mentioned that he has tried to find compelling evidence that stock buy backs provide any benefit or value to shareholders and he said most reports he found say they do not work. Myself and the Polonitza group both commented on the fact that most companies buy back stock at a price that is too high to provide value to their shareholders. It should be a very simple exercise for them to determine at what prices they should consider buying back stock.

That’s all I can remember for now. If I think of anything else I will update it.

Disclosure:
I own ITEX stock at the time of this writing.

I was reading this Fat Pitch Financials post and saw mention of Bristol Myers (BMY) offering their remaining ownership of Mead Johnson (MJN) in exchange for BMY shares.

Bristol Myers did a public offering of MJN earlier this year and the stock has risen nicely since then. Mead Johnson was started in 1905 and aqquired by Bristol Myers in the 1960s.

Quick info about MJN

From their website:

We are Mead Johnson Nutrition — a global leader in infant and children’s nutrition.
We are best known for our Enfamil® and Enfalac® families of infant formulas as well as for our regional children’s nutritional products, including Enfagrow®, Enfapro®, Enfakid®, EnfaSchool®, and Sustagen® in Asia, and Choco Milk® and Cal-C-Tose® in Mexico and Latin America.

I like Mead Johnson because its a boring steady business. Infant formula, while it will probably change in the future is not going away and families are likely to stick with known recognized brands for their children. I think brand recognition in infant formula is a good competive advantage.

The flip side of this of course is that something as serious as infant formula requires the company does not tarnish is brand by producing bad products. It is likely that a recovering from a massive problem with its product could put the company in dire straits. As an investor you should realize the potential risk of things like this regardless of how likely or unlikely they are. There has been one instance of Melamine being found in MJN and others infant formula.

Info about the deal

Bristol Myers owns the majority of MJN (they sold some in a public offering this year). There is a tender offer being made in which BMY will provide up to 0.6313 shares of MJN for each share of BMY tendered. The actual ratio will be determined by an average price over a couple of trading days, in which they will provide $1.11 worth of MJN for each share of BMY (not to exceed to the 0.6313 number). The original tender was supposed to expire Dec. 14th 2009 at midnight. A recent SEC filling indicates they have extended the offer:

From the filling:

Bristol-Myers Squibb and Mead Johnson Announce Amendment and Extension of Exchange Offer
(NEW YORK, December 4, 2009) — Bristol-Myers Squibb Company (NYSE: BMY) and Mead Johnson Nutrition Company (NYSE: MJN) today announced that Bristol-Myers Squibb Company (“BMS”) has amended and extended its offer to exchange up to 170.0 million shares of common stock of Mead Johnson Nutrition Company (“MJN”) for outstanding shares of BMS common stock that are validly tendered and not validly withdrawn at an exchange ratio determined by a formula described in a registration statement filed by MJN on Form S-4 (Reg No. 333-163126).
BMS is amending the offer by:

•Increasing the upper limit on the exchange ratio to 0.6313 shares of MJN common stock per share of BMS common stock from 0.6027 shares of MJN common stock per share of BMS common stock; however, the final exchange ratio may be less than the upper limit;

•Extending the exchange offer’s expiration to 12:00 midnight, New York City time, on December 17, 2009, unless extended or terminated, from December 14, 2009; and

•Amending the current expected three-day period over which the final exchange ratio will be determined to December 11, 14 and 15, 2009 (which previously was expected to be December 8, 9 and 10, 2009).

The final exchange ratio will be announced by press release by 9:00 a.m., New York City time, on the trading day immediately preceding the expiration date. BMS and MJN currently expect to issue that press release by December 16, 2009, unless the exchange offer is extended or terminated.
As of December 3, 2009, approximately 1,055,000 shares of BMS common stock have been tendered.

Some Risks

Potential Kicker for BMY holders

Value?

A quick look at the DCF valuation using the OldSchoolValue.com spreadsheet prices it at about $20 fair value assuming 5% growth and 9% discount rate. It currently trades somewhere around $41 a share. One thing to keep in mind here is that due to the fact that MJN is only recently public there is very much historical data about the their growth. If I was really interested in this situation I might research Bristol Myers annual reports for more information. For sake of argument I picked %5 as a somewhat conservative growth rate.

Overall it seems like MJN is still a bit overpriced even if you take into account that you could get %10 discount via the tender offer, unless there is something that can indicate they will grow free cash flow at a high rate.

However if you look at this from an arbitrage perspective it is a potential 10% profit with a very short time frame. This assumes the market continues to value MJN at current levels or higher. If you want more information on this deal I would suggest following the link at the bottom of this post for the online webcast of the conference call.

What about BMY?

On the flip side BMY appears to be undervalued. I pulled it up on the spreadsheet and with %25 MOS (good moat), 9% discount and 0% growth it shows a 27.87 per share value and buy price of $21 to get a margin of safety of %25. If you bump the growth up to 3% the numbers start looking reasonable. The question is will they grow FCF? Well here are some things to keep in mind:

1. They are divesting themselves of all non-core units (hence the MJN spin off) so they will be more focused on their biopharma products. This has been a long standing plan that they have been following through on.

2. Shares that will be retired in the MJN tender will reduce their dividend payout. In the conference call BMY said that the dividend reduction will be larger than loss of dividends they currently get on their MJN shares.

3. Over the past 10 years FCF has been a bit of a roller coaster, but from 2006 to 2008 it has been growing which might mean that management has their act together more and their plan for focusing on biopharma is working.

Useful Links:

Bristol Myers Investor Relations

Listen the to MJN split off conference call

Most recent related SEC filling at the time writing

Summary

I think MJN is overpriced and BMY could warrant further investigation. That being said I might take a small position in MJN to go through the exchange process as a learning experience so I know what to expect in future opportunities.

Disclosure

This is not a recommendation to buy or sell securities or a replacement for your own investment research and due diligence. I have no positions in MJN or BMY at the time of this writing.

In his presentation he referenced some stats from a Blackstar Funds paper on the Russell 3000 index between years 1983-2006.

Russell 3000 stats 1983-2006

39% of stocks were unprofitable investments

18.5% of stocks lost at least 75% of their value

64% of stocks underperformed the Russell 3000

25% of stocks were responsible for all of the market’s gains

Well obviously an enterprising investor after reading this would be diligently researching looking for the %25. If you only invest in those companies you are sure to outperform the market. Well not always…

What a difference a day makes

The paper also gives us a sampling of some of the best performing stocks during that time period and their performance after the peak:

Thoughts

It would be interesting to see of the %25 that made up %100 of the gain in 1983-2006, how many companies would still be worth owning today. Looking at that list there are a couple. Of course there are some that would have resulted in a permanent loss of capital and some that are not permanent losses yet but for which the immediate future is not bright. Lets take a quick look at a couple…

GE

If you had bought GE on 01/03/83 at its closing price of 91.75, split adjusted (48:1) each share would be worth around $670 today. I figure thats about %8.3 compounded annual gain. If you had sold that share before the market drop you would have approximately 3x that amount somewhere around %12.5 compounded annually. Not including dividend payments. While GE is a mess today, its fair to say you could of done worse things than buying a share of GE in 1983.

MSFT

If you had bought MSFT when they went public on 03/13/86 at $28, split adjusted (288:1) each share would be worth around $8000 today. Around %29.3 compounded annually. Not including dividend payments.

Conclusion

This data reinforces a couple of points that I sometimes temporarily forget.

1. If you own a sub par company because it was undervalued when you bought it, sell it when it reaches intrinsic value and take your profit. There is no reason to hold it afterwards because it is likely to fall into the %64 that under perform the market. If you sell it and move on to the next value you will be on your way to out performing the market.

2. Paying a little bit of a premium for a a great business with a great moat and great management can pay off big time.

3. I think people should really call “buy and hold” “due diligence, buy and due diligence hold, rinse repeat”.

Lynch’s investment style varies quite a bit from the traditional super value investors. Lynch seems more likely to invest in public offerings or companies that have little operating history if he feels they have potential for serious growth. Lynch is willing to take a little risk on situations where there is some uncertainty so some people might call him a “growth” investor. That being said I try to ignore categorizing investors into buckets like “growth” and “value”. Instead I categorize them into two buckets “good” and “not so good”. Looking at his record Lynch falls in the “good” bucket. I can’t imagine how much work it must be to manage a fund with billions of dollars in assets, over 1000 positions and on top of it providing returns that outperform the market.

One point that Lynch makes again and again is that you should always use whatever edge you have over Wall Street. If you work in in a particular industry and have a finger on its heart beat, you have an edge over people sitting in front of a Bloomberg terminal all day who may invest or trade in that sector. In the book Lynch mentions examples of great companies that he identified before Wall Street simply by being a typical consumer. Lynch also mentions some of his follies, such as the sandwich shop he ate lunch at that made a public offering. He bought in because he felt he had an edge on predicting the success of their business. They found out the hard way that their sandwich shop format did not go over well in other cities as the expense of the shareholders who bought the stock offering.

I walked away from Lynch’s book thinking primarily about one thing. What unconventional research tools are available to investors? When I say unconventional I mean anything that gives you information a typical investor or money manager might not get from the annual reports or SEC filings. Here are a few examples of some unconventional and some more conventional but under utilized tools that might help give you an edge.

The Phone

This is not really unconventional, but I think underutilized. I personally have not exercised this option as much as I would like to but I think after reading Lynch’s book I probably will.

Email

Same the idea here. There was a risk arbitrage situation I was interested in and I was trying to get a little more information about when the company expected to complete the transaction. I emailed investor relations at the company supposedly making the purchase and my email to their investor relations address bounced because the person who answered that address was no longer with the company. While this doesn’t give me any information about the merger it could be an indication of how much or little effort they put into informing shareholders. On the flip side I have emailed investor relations at other companies and gotten immediate responses from an actual human being, sometimes with decent answers to my questions! That is always a good sign.

Web stats

In my previous post about IGOI I mentioned that I went to a local retailer to see what their in store marketing and placement looked like. Another bit of research I did was related to their online store. In their conference call from last quarter the CEO mentioned that they are engaging in a more direct to customer marketing campaign. They launched a new online store where customers can buy product directly from the company cutting out the middle man and resulting in higher margins for IGO. When I heard that I decided to go to Alexa and see what they said about traffic going to the IGO website.

Here is what they had to say:

The one thing this tells me is that traffic to their online store is not growing. For a company attempting to reach customers directly I don’t find this encouraging. Another thing I looked at is their online advertising. If I do a google search for IGO, I see an sponsored link for IGO’s website. They are paying to show advertisements for people who search for “igo” even though their site is the first organic (non advertisement) search result. Now if I do a search for “universal laptop power supply” I don’t see an ad for IGO. I refresh a couple of times, still no IGO ad. This makes me wonder if they have a handle on their online advertising campaign. Next I do a search for “netbook power supply” and first time I don’t see an IGO ad, I refresh and I start seeing their ads. At least they are going after netbook customers, but I still get the feeling that if they are really trying to reach more customers directly their online advertising strategy might need some refinement. Any one of these things on their own don’t provide a ton of data, but as you start to add them up you can start to draw a picture of how well the company is aligned with their mission. It is possible that they are just gearing up their online business, in which case now that I have this information I can monitor it accordingly and this can give me an edge on how the company is doing. We already know that they are loosing their biggest customer (Targus) and they need to make revenue up some where. If their Alexa stats start growing this might be an indication that they are on the right track.

Street View

In some cases Google Street View can be a good tool for checking out the company headquarters of smaller companies. Is it a fancy building? Is it a dump? Does it even exist? Unfortunately street view only works in major US cities and this information in a lot of cases could be of minimal use, but you never know what you may find.

Here is the Vaxgen (VXGN) office (I liquidation situation I had a position in):

View Larger Map

Here is a Berkshire Hathaway in Omaha, Nebraska:

View Larger Map

LinkedIn

LinkedIn is a professional social network. Facebook for corporate America. One of the ideas I had for LinkedIn was using it as a tool research company management. If a CEO or other executive is on LinkedIn there is a good chance his or her employment history is on their profile. Are their previous companies still around or did they run them into the ground? This could be a good starting point for finding out more about executives in small companies.

Obviously these tools on their own will not tell you what stocks to buy or sell. However they can potentially provide some value when used in conjunction with your normal investment research.

I initially learned about IGO from an excellent post on OldSchoolValue.com. At the time it was trading below its liquidation value making it a cigar butt with at least one good puff left as long as the management did not blow all the cash. The management has shown good signs of cost containment and even increased it cash position despite dwindling revenues.

I bought IGOI at $0.58 and while it has traded above my cost basis for the majority of the time I held it, it recently jumped up as high $1.30. Looking at almost %120 gain in 6 months I decided to reevaluate my position and see if I should continue to hold to this company now that it’s trading at a premium to what I believe to be its liquidation value.

I decided to evaluate the pros, cons and facts: