Alpha Pro Tech LTD (APT) is a Canadian micro-cap company offering products in three different operating segments: Protective Apparel, Building Supply, and Infection Control.

The stock is down almost 70% from a high of over $7 back in October 2009. APT saw significant increase in sales due to the outbreak and threat of the H1N1 flu virus, as it increased demand substantially for the company’s protective gear.

In 2010, comparable numbers are off significantly as the H1N1 threat has abated – the market has punished the stock despite a solid balance sheet and continuing profitability.

This is a great example of the market overreacting, providing an opportunity for savvy investors to pick up shares on the cheap.

Segment Breakdown

The company sells a variety of disposable protective items including shoecovers, caps, gowns, masks and eye shields, along with house wrap and synthetic roof underlayerments on the building materials side.

2009 was an incredible year for the company, with sales increasing 66.8% compared to 2008, driven by strong results in the Infection Control group. Infection Control sales almost tripled, as customers stocked up on protective gear to combat the H1N1 flu strain.

Despite the sharp drop in protective gear sales from the 2009 high-water mark, the company has managed to hold revenue numbers fairly steady in 2010, primarily due to growth in the Building Supply segment.

Building Supplies now make up over 41% of total revenues, almost double the segment average over the past five years.

Financial Information

Revenue has grown at 12.7% per year over the past five years on a solid gross margin of 46.4%. Both operating and net margins have remained stable as well, at 12.1% and 7.6% respectively.

Margins will fall as the company increases its focus on the lower margin Building Supply business, but the growth prospects should help to make up the difference.

5-yr CROIC (11.9%) and ROE (12.3%) are respectable although not outstanding.

On the balance sheet side, book value has increased at a steady rate of 16.6% per year and currently sits at $1.56/shr.

Last quarter, APT made significant inventory purchases across all product lines in order to strengthen marketplace position and ready for future sales. The company expects to generate and stockpile cash in the second half of the year as it works through inventory.

Loss of Key Distributor

In 2009, 28.7% of company sales were to VWR International, the company’s largest distributor. However, on March 29 2010, VWR decided to stop carrying Alpha Pro Tech’s product line and launch its own competitive line of products.

Although the company has slowly been transitioning away from VWR (the distributor made up 45.7% of sales in 2007), this will still have an adverse effect on financial performance as the company moves to a broader distributor network.

So far in 2010, Protective Apparel sales are off 26% – although the other business segments have picked up the slack, it remains to be seen whether the company will be able to stabilize sales through a broader distribution network.

Catalysts

Share Buybacks

In April 2009, the company announced a $2m stock repurchase program. The plan was expanded to another $2m in February 2010. While repurchases have slowed in 2010, the company has managed to retire over 6.1M in shares for an average price of $1.24 since the program was originally announced.

I’d imagine the company will begin repurchasing shares again once sales stabilize and the cash balance improves.

Business Supply Growth

Despite the troubles in housing and construction markets, APT’s Business Supply segment continues to churn out impressive results. The company has managed to operate the segment profitably, growing both top and bottom line results, and has hired additional sales staff to handle expected growth.

The company has also announced a new product offering in the third quarter which should increase market share as well.

Flu Season

In the U.S., flu season is usually marked by the October through May time period. While it is very difficult to predict the severity of the 2010-2011 season, there certainly remains the potential for another significant outbreak.

If so, APT’s products are well positioned to capitalize and provide protection where required.

The buildup in inventory will ensure the company can meet demand without costly production issues if an outbreak requires immediate supply.

Valuation

Assuming the company can deliver 2010 EPS of $0.12, the stock is currently trading at a forward P/E level of approx 13, compared to the stock’s long-term P/E average of 19.23.

Assigning the average multiple and the per-share value would be $2.31, right around my estimate.

The stock is currently trading at book value, despite a historical book value multiple closer to 2.5.

NCAV of $1.30 provides a measure of protection on the downside.

Conclusion

With Alpha Pro Tech, the market seems to be keying on the comparable YoY numbers between 2009 and 2010 rather than focusing on a business that has maintained profitability through the ups and downs in its business cycle.

The company’s Building Supply segments has shown exciting growth prospects, and while the loss of VWR’s business is detrimental to sales in the short-term, it might even offer an opportunity for APT to increase its sales network through broader distribution channels.

While $7 is too high for the stock based on current financial performance, conservative estimates peg APT’s value at north of $2.

I’m adding APT to Value Uncovered’s Model Portfolio at $1.58.

Disclosure

No positions in my personal portfolio at the time of this writing.

On the heels of the failed going private transaction in Emmis Communications, another recent special situations investment paid off in the last few weeks.

As I originally wrote back in June, American HomePatient, Inc. (AHOM) was going private in a transaction valued at $0.67.

Steps to Closure

On the surface, the transaction seemed to be complicated, as the company needed to go through multiple steps to close the transaction including reincorporation in a new state, the tender of more than 90% of votes, followed by a tender offer and debt restructuring.

On July 30, company shareholders voted to approve the reincorporation (an expected result, since Highland Capital, the acquirer, owned approx. 48% of shares outstanding).

The tender offer statement was officially filed on July 7, with an original end date of August 4.

On August 5, the company issued a revised offer statement and updated shareholder count – only 87% of shares had been validly tendered, slightly short of the required amount. The company extended the tender offer until Wednesday, August 25.

On the new closing date, the tender offer was extended again, with a key condition changed: the minimum tender condition would now be set at 80% vs the original 90% figure.

Since 87% of shares were still validly tendered, this modification allowed the transaction to proceed as planned.

On Sept 2, AHOM announced that 6,917,314 shares, or 87%, of the company’s outstanding stock were validly tendered at $0.67/shr.

I received the money in my account on Sept 3.

Return

Although the transaction took a month longer than I expected, it was a very profitable transaction on both an absolute and annualized return basis.

Conclusion

Looking back at these going private transactions, it is clear that investors must be conscious of the fact that tender offers do not always go as planned.

Although the deals were similar in many ways (i.e. each acquirer had a dominant ownership position in the company), there was one key difference:

the acquirer was not relying on outside financing for the transaction.

With no third party in the mix, Highland Capital was able to extend and modify the offer statement as required to complete the transaction without worrying about an outside investor pulling support at the last minute.

Disclosure

No current positions.

A good portion of special situation investing, or ‘workouts’, involve transactions with limited upside and tight spreads, yet significant downside risk if the transaction is called off.

The drawn out situation with the Emmis Communications (EMMS) going private transaction is a prime example of the risks with these transactions.

Last week, the deal fell apart after the company failed to negotiate a deal with a group of preferred lockout holders and the company’s original financier, Alden Global Capital.

Transaction Background

As I originally wrote back in back in June, the company’s CEO and Chairman, Jeff Smulyan, was trying to take EMMS private in a cash offer for $2.40/shr.

At the time, the deal was offering a spread of nearly 5%, with most conditions for the transaction all but guaranteed since Smulyan owned a controlling interest in the radio operator.

Preferred Shareholder Lockout

However, as I wrote several weeks later, the EMMS transaction was derailed when a group of preferred shareholders came together to collectively vote against the deal.

While the intentions were never disclosed, it is likely that lockout group was trying to get better terms as part of the transaction, as the company’s original offer priced the preferred shares at only 60% of face value.

After the lockout was announced on July 9, the parties engaged in a back and forth round of negotiations over the next two months.

Vote Delayed – Again and again and again…

EMMS’s stock varied widely during the time period, generally falling during periods of no news before leaping back up after another extension.

On August 4th, the company put out a positive press release, saying that the company was seeking an alternative structure for the transaction, only to extend the offer again.

On August 30th, another extension was announced, but with new and dire language:

“Emmis, JS Parent, JS Acquisition, Mr. Smulyan, Alden and the representatives of the group of holders of Preferred Stock negotiated and agreed in principle on revised economic terms for the contemplated transactions that each indicated it would support. Subsequently, Alden has informed Emmis, JS Parent, JS Acquisition and Mr. Smulyan that it would no longer support the negotiated terms. Accordingly, although discussions are continuing, JS Acquisition believes it is unlikely that an agreement will be reached with either Alden or the group of holders of Preferred Stock.”

In total, the shareholder vote was delayed a staggering 9 times, as it looked increasingly unlikely that the transaction would be completed.

Deal Falls Apart

On Sept 9th, EMMS’s going private transaction officially collapsed. According to the company’s COO,

“I think Jeff and the entire Emmis team are bitterly disappointed that the transaction didn’t conclude successfully,” Patrick M. Walsh, Emmis’ chief operating officer, said Thursday morning. “We thought we had a deal, and it’s unfortunate that Alden backed away from the deal.”

The stock market reacted swiftly, and the stock dropped more the 33% over the ensuing week.

Exiting my Position

I held onto my stock through most of the long ordeal, counting on the fact it would be very difficult for Smulyan to walk away from the deal again if there was any way possible to complete the transaction.

In addition to the negative press release on August 30th, strange trading in the preferred shares caught my eye as well. I’d been closely monitoring the preferred shares throughout the ordeal, figuring they would give a better picture about the odds of success.

On Thurs, Sep 2, the preferred shares (EMMSP) dropped more than 14%, with a large sale of 8.1k shares. This was by far the largest sale in the previous 2 months, and significantly below the original purchase price of many of the lockout holders.

Combined with an increase in the common price (the common & preferred had traded mostly in sync since the lockout), it appeared that someone ‘in-the-know’ had sold out.

I sold my shares on Friday, August 30, at $1.70, for a loss of 26%.

Lessons Learned

These special situations investments are designed to supplement an existing portfolio, with many ‘easy’ transactions for small but guaranteed profits.

With these investments, it is very easy to feel committed to a position, even though the circumstances surrounding the deal can change drastically.

In hindsight, I should have sold my shares for a small loss as soon as the lockout was announced (knowing I could probably buy back in if a deal was reached again.)

I’m sure a similar situation will occur in the future, and next time I’ll be disciplined enough to sell when the guarantee is no longer there.  No sense in being too risky while picking up nickels in front of a steamroller!

Disclosure

None