Thursday, October 11, 2007

Why I bought Citizens Financial Corporation

This morning, I bought less than 250 shares of Citizens Financial Corporation for $6.55 a share. It is a small Kentucky insurance company that announced a 1-for-250 reverse split with fractional shares cashed out at $7.25 a share. I've been burned in two straight going-private transactions, but I think this one will work out. Here are my reasons:

  • This is a reverse split with no corresponding forward split. That was how the BNS Holding transaction burned me because it only temporarily produced fractional shares. Since there is no forward split and no fractional shares will be issued, my broker will need to cash my shares out whether I'm a shareholder of record or not.
  • Over 60% of shares are owned by insiders, so the vote will go their way. Most likely, they will not back out of the transaction because the company will clearly benefit from savings from eliminating public-company costs.
  • Book value per share is about $7.90, which means even the $7.25 offer is a discount to the company's value. In fact, since many shares will be retired, the book value per share will actually increase. For an insurance company, book value is a better guess at intrinsic value than any measure based on earnings. That's because the rules for recognizing earning don't work well for the insurance business.
  • Given a 95% chance of success and the pre-announce price of $6.42 as a base, the Kelly Criterion suggests I'd be safe putting 92%+ of my portfolio into Citizens Financial. Even if the company is worth nothing, the percentage would be nearly 40%. The market currently prices the odds at 15.66%, which is far too low in my opinion.

I need to remind myself that though the results have been less than I expected recently, my process has been sound. It's easy to claim that failures are due to bad luck, but in this case I believe it to be true.

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