Tagalongs

They're hard to resist. A classic combination: vanilla wafer paired with peanut butter all in a tidy chocolate shell. The crown jewel of Girl Scouts of America: the Tagalong cookie.

Industrious Brownies and Daisies and Juniors etc. take to the streets, knocking on front doors and attending the sliding entrances of each Walmart, Albertsons, Publix, or whatever other stores see heavy foot traffic to sell these and Thin Mints and Samoas and all the rest. Through its army of charming, uniform-clad, merciless sales kids, GSA drums up close to a billion dollars each year in cookie sales.

Then what?

Some of it goes to pay for the cookies, but what about the part that goes to the troops? Who owns that? Who gets to decide what to do with it?

The troops are clubs, after all, it's not like a company, where shareholders pay managers to maximize shareholder value.

This works OK for the troops. Everyone’s there by choice.  They can generally come to an agreement to spend the proceeds on trips, on crafts, on activities, on whatever else, but it would be a ridiculous way for a company to operate, right? …Right?

The feeling is mutual

Some companies, though, do operate this way. They exist through “mutual” ownership, just like a Girl Scout troop. Sometimes called “thrifts,” these outfits are almost exclusively small community banks. They exist for the benefit of the local community, not that different than a Scout troop. The bank’s depositors are the “mutuals” who own the bank. Each stake owned in proportion to the deposit. Any profits recycle back into the business for loans or other activities.

A key difference between thrifts and Girl Scout troops is that most Girl Scout troops are much better run.

Mutual banks are notoriously bad businesses. There's no real need to run them well. Management can't get paid in shares, like other businesses. Depositors really only care if they can access their money. There’s no one pounding the table to push for shareholder value. There are no shares.

This often works OK until it’s time for the managers to retire.

Since depositors own the bank, they're not traded. Managers don't want to sell the bank, since they’d get nothing but a pink slip.

So, how can managers conjure a payday for their years of dedicated service?

The move to make is to convert the whole venture to stock ownership — to become a “normal” company. The bank flips its ownership through an IPO with a few important nuances compared to a more traditional debut.

Only depositors and management can buy shares. The bank invites them to purchase shares for $10 per each — this is the price all thrifts have agreed to go public at. Depositors and management put in their share purchases. This gets added to whatever capital already exists in the bank, so investors end up holding shares worth more than $10 in book value.

Investors usually buy and sell real banks for 120% or more of book value. So, the owners, nee managers and depositors, are pretty pleased with this start.

Execs love purchasing shares in their own company for less than they're worth. Often, they’ll add to their stash – buying shares in the open market while they stay below book value.

The upshot is that any new investors put their money in right along with management. In a typical IPO, management might be inclined to stretch price as high as they can make it. In the case of a thrift conversion, when they're also buying shares, rather than cashing out, they want the price low, just like you.

This IPO isn't about raising capital though. It's about creating ownership. The payout comes later.

After a year, the troop can turn around and begin to use the IPO proceeds for this same buying effort. The bank can repurchase its own shares and retire them. Share count dips and the value for each remaining share rises. Three-years down the line, management can, finally, sell the company to another bank, enjoy a payday and ride off into the sunset.

I'll take two boxes, please.

Sometimes you'll come to a Girl Scout cookie booth at the end of its shift with only a few boxes of cookies left. Thrift conversions are like this too. Only a handful happen each year. They're small. They're quiet. They’re mostly in the northeast US. A few dedicated investing enthusiasts care about them, but not many others.

Here are two to snack on, though.

Last summer SR Bancorp (SRBK) converted from mutual ownership. Since then, execs have been busily buying shares. The company is coming up on its one-year anniversary of being public. When it does, if management is really looking to maximize the value of their new shares before they retire, the company ought to start repurchasing its own shares. If it happens, it will be a signpost that SRBK is on the right track.

SRBK still has a way to go before it would be able to sell itself. For a look at one further down the road, there's William Penn.

William Penn Bancorporation went public a few years before SRBK. It’s coming up on its three-year anniversary. That's when it can sell itself to another bank. It's trading close to book value but would likely be acquired for 20-40% more than that in a sale. Management has been buying shares the entire time. It's used its IPO proceeds since being public and other funds generated by the company to repurchase shares, sending all the signals that management's ready to sell.

Both are terrible businesses. SRBK earns about 3% on equity, less than putting your money in treasuries. William Penn doesn't do much better. Both would do better wrapped up in a larger operation that could better foot the bill for things like cyber security and offer a more convenient network. A sale is probably the endgame for both.

Just desserts

While those are two to keep an eye on, the playbook is similar across the space: management approaches retirement, they want a payday, they convert the bank to stock ownership, shares trade below book value, management buys shares, the company buys its own shares, in three-year's time the company sells itself.

There're reasons to stay away — these are small, thinly traded things. Banks can disappear in a blink, like Silicon Valley Bank last year. And these are mostly badly run efforts. But, by checking the ingredients for the ones that are fully baked, an investor can tagalong with management and uncover some satisfyingly sweet opportunities.

Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.