I hesitated for a long time before posting about Sitestar(SYTE) yesterday. Now that I have, I am gratified by the response. I have been contacted by a number of Sitestar shareholders, representing a significant ownership % of the company. Every one of them shared my concerns. It would appear that the only shareholders who don’t agree are the CEO, Frank Erhartic, and his handpicked Board members.
My first attempt to communicate with Mr. Erhartic was on November 18, 2013. Mr. Moore had recently been appointed to the Board.
I first purchased the stock in April 2009, and have continued to acquire shares since, primarily over the last 18 months. I was attracted to Sitestar as a company which traded at a significant discount to its asset value and to its ability to generate cash flow. I was also impressed with the company’s capital allocation strategy.
That said, I have been disappointed of late at what appears to be a complete lack of progress in the company’s real estate division. I have found Mr. Moore’s public statements on the company compelling as well as the letter to the Board by Mr. Kiel. I am very pleased with Mr. Moore’s appointment to the Board, and, it appears based on recent movement in the stock price, so are other investors.
Mr. Moore’s appointment, while a good first step, is not enough to ensure that the company’s value is preserved and grows. I believe that the company should schedule an annual meeting of shareholders, as it is required to do, as soon as practical. The company’s financial reporting is opaque and should become more transparent.
In particular, the performance of the real estate division has been abysmal over the past 9 months. Though the company states that “Management believes that there is sustainable cash flow potential for the near future in real estate”, no property has been sold, and the rental income on the properties amounts to a ridiculously low percentage of the carried value. The filings provide no breakdown of property held for sale vs. property to be rented, of the conditions of the properties, or even of the number of properties. The filings continue to assert that “The current real estate market presents the unique opportunity to acquire properties at deep discounts from fair market value with the potential for substantial profits”, but the lack of new acquisitions tells a different story.
While I am pleased with the company’s ability to manage the decline in the internet business and preserve cash flow, I am unclear on the long term strategy for that business. The company seems to have abandoned its previous strategy of opportunistic acquisitions in the space, If this is due to uneconomic valuations, perhaps the company should be exploring the sale of this business to a larger competitor.
I am also confused about the need for the company to borrow money, and pay above-market interest to, a director, presumably Mr. Ehrartic. Given the company’s surplus capital and below-market returns, why is the company paying interest on this loan rather than repaying it in full? If the company requires capital, I would think that non-recourse debt secured against real estate would be a preferable alternative.
After much email prodding from me to both Mr. Erhartic and Mr. Moore, and multiple emails and texts from Mr. Moore to Mr. Erhartic, Mr. Erhartic finally responded a month later, on December 17, 2013, stating he would answer me the next day. Two days later, I finally received his answer, on December 19,2013.
Neal Shanske: That said, I have been disappointed of late at what appears to be a complete lack of progress in the company’s real estate division. I have found Mr. Moore’s public statements on the company compelling as well as the letter to the Board by Mr. Kiel. I am very pleased with Mr. Moore’s appointment to the Board, and, it appears based on recent movement in the stock price, so are other investors.
Frank Erhartic: We are disappointed also with the progress of the real estate division. Unfortunately, we purchased too many properties too quickly that were big projects and we didn’t have the reliable people that we do now to complete those jobs on a timely manner. We have been focusing on rental properties and should focus our efforts back on flips in the next couple of months.
I am glad you are pleased with Mr. Moore’s appointment.
Despite Mr. Erhartic’s disappointment and belief that the real estate business was back on track, the divisionhas continued to languish in the subsequent two years, with no progress in either rental properties or “flips”.
Neal Shanske: Mr. Moore’s appointment, while a good first step, is not enough to ensure that the company’s value is preserved and grows. I believe that the company should schedule an annual meeting of shareholders, as it is required to do, as soon as practical. The company’s financial reporting is opaque and should become more transparent.
Frank Erhartic: We will be holding a shareholder’s online chat tomorrow at 1:00pm EST. We are preparing for our next annual shareholder meeting for some time in April or May of next year.
The chat was, in fact, held over a week later. The technology used was straight out of 1996 and many participants had trouble participating. In a future post I will explore some of the discussion from the chat. No shareholder meeting was held in April or May of 2014 as promised, nor was any held in 2015. In fact, by April 2014, the incumbent Directors were no longer meeting with or communicating with Mr. Moore. Nor had they ever held a Board meeting prior to December 2014, according to Mr. Moore’s proxy statement. The settlement agreement with Mr. Moore’s group requires that an annual meeting be held prior to the end of June 2016. The company’s financial performance remains opaque.
Neal Shanske: In particular, the performance of the real estate division has been abysmal over the past 9 months. Though the company states that “Management believes that there is sustainable cash flow potential for the near future in real estate”, no property has been sold, and the rental income on the properties amounts to a ridiculously low percentage of the carried value. The filings provide no breakdown of property held for sale vs. property to be rented, of the conditions of the properties, or even of the number of properties. The filings continue to assert that “The current real estate market presents the unique opportunity to acquire properties at deep discounts from fair market value with the potential for substantial profits”, but the lack of new acquisitions tells a different story.
Frank Erhartic: We have purchased less properties this year than we have in previous years because we need to complete more of the projects we have started. Many of the projects we have are close to completion and we hope to knock out all of them in the coming months. Many of the properties we have purchased lately have been for rentals and have actually been rented out now. We should see a greater increase in rental income next year and the following years. As we fix and flip some of the houses we are going to sell, we will use some for flips and some for rental properties. We will try to address in the chat tomorrow more of the breakdown. I cannot give you specifics here due to insider trading rules.
Rental income has not increased as Frank predicted. Houses have not been flipped. The company did begin breaking out real estate held for sale and real estate held for investment in its financials. Frank claimed he couldn’t give me “specifics here due to insider trading rules”, but the specifics could certainly be released to all shareholders, either in an 8-K or a regular quarterly or annual report.
Neal Shanske: While I am pleased with the company’s ability to manage the decline in the internet business and preserve cash flow, I am unclear on the long term strategy for that business. The company seems to have abandoned its previous strategy of opportunistic acquisitions in the space, If this is due to uneconomic valuations, perhaps the company should be exploring the sale of this business to a larger competitor.
Frank Erhartic: We have stopped acquiring companies in the Internet business field due to us acquiring most of the bigger players. Most of what is left are small ISPs. We will be considering selling the ISP business in the future if it makes sense.
Frank would have us believe that Sitestar is the largest ISP out there. Either ISP business are valued well relative to cash flow in which case the company should sell, or they are valued poorly, in which case the company should buy. There is no indication that the company ever seriously looked at either buying more ISPs or selling the division any time in the last two years. Meanwhile the decline of this business has accelerated. Oddly, even in its most recent financial statement the company blames the decline, in part, on “lack of acquisitions of Internet access and web hosting customers of ISPs” though the company does not pursue acquisitions in the space and has not in several years.
I would add to this point that the company claims that “The Company’s Internet division markets and sells narrow-band (dial-up and ISDN) and broadband services (DSL, fiber-optic and wireless), and supports these products utilizing its own infrastructure and affiliations. Value-added services include web acceleration, spam and virus filtering, as well as, spyware protection. Additionally, the Company markets and sells web hosting and related services to consumers and businesses.” The company has never broken out these segments, making it impossible to model the decline. It is my belief that the vast majority in revenue is from basic dial up.
Neal Shanske: I am also confused about the need for the company to borrow money, and pay above-market interest to, a director, presumably Mr. Ehrartic. Given the company’s surplus capital and below-market returns, why is the company paying interest on this loan rather than repaying it in full? If the company requires capital, I would think that non-recourse debt secured against real estate would be a preferable alternative.
Frank Erhartic: Actually, the loan outstanding is not my loan. It is my mother’s loan to the company when we needed it for acquisitions of real estate. All debt in the past was collateralized by me personally and personally guaranteed. This was to do acquisitions of Internet customers. Since Sitestar didn’t have any real amount of tangible assets a bank could loan on, I had to put up my properties. I shouldn’t have to do that now since we now have real estate to back up any loans. We have had the cash mostly to do what we have been doing and at some point, we can use the equity of the rental properties to purchase more and bigger deals. We are working on building that up so we can do just that.
The following Note appeared in the company’s 10-Q for the 3rd Quarter of 2013
NOTE 11 – NOTES PAYABLE – STOCKHOLDERS
Notes payable – stockholders at September 30, 2013 and December 31, 2012 consist of the following:
2013 2012 Note payable to officer and stockholder on a line of credit of $750,000 at an annual interest rate of 10%. The accrued interest and principal are due on January 1, 2020. $ 280 $ 280 Note payable to stockholder for $50,000 at an annual interest rate of 8% interest. The accrued interest and principal are due on January 1, 2020. 50,000 50,000 Totals 50,280 50,280 Less current portion — — Long-term portion $ 50,280 $ 50,280
Presumably, the credit line was to Mr. Erhartic. The $50,000 note was, I learned to his mother. At the time the company was paying 8% on this $50,000 loan to Frank’s mother, it reported $120,852 in cash and $3,268,675 in real estate on its balance sheet. By the time the 10K was filed several months later, Mr. Erhartic’s loan had been paid off, but was reported to have had a due date of January 1, 2014, and his mother’s loan had ballooned to $59,826 from $50,000.
At the end of the first quarter, the note had increased again to $60,990, but was omitted, somehow, from NOTE 5 on Notes Payable. By the end of Q2, it increased again, to $63,547, still with no mention in the footnote on Notes Payable. Q3 had the note rise only slightly, to $63,867, and again lacked mention in the footnote.
Finally, in the 10K for 2014, the note is shown as having been paid off during the 4th quarter, and the footnote has returned, but the interest rate somehow became 10%.
The fact that the shareholder who held the loan was a related party was never disclosed in any filing that I could find. The magically changing balance and magically changing interest rate are not documented anywhere, and there is no indication that the arrangement was approved by independent directors.
The email exchange above as well as the undocumented related party transaction is typical of how Mr. Erhartic has run this company as his own fiefdom. The remaining shareholders, who collectively control two thirds of the company, deserve far better.
More to come…
Disclosure: The author owns a significant stake in Sitestar
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