Daily Journal Corp (NASDAQ:DJCO) has until end of business today to respond to a series of letters calling for an 8-K filing regarding some alleged accounting irregularities and an internal investigation that have been uncovered at the company. Buxton Helmsley, an activist oriented hedge fund, has sent three private letters to the Daily Journal’s board of directors, followed by an initial open letter to Daily Journal shareholders on Friday.
Unlike most allegations of accounting irregularities, these potential mistakes could unlock significant value for shareholders — if corrected.
Value of software platform questioned
The Daily Journal acquired the Journal Technologies Platform in 2013. Alex Parker and Johnathan Flinkinger of activist investor Buxton Helmsley told Hedge Fund Alpha in an interview that that platform had some base technology that should have been ascribed some value on the company’s balance sheet — only it has not been reported as having any value.
The Daily Journal continued to develop the software and then sell it to courts, prosecutors and other target markets.
“Throughout that process, the money that they were investing into the software that should have been capitalized as an asset on the balance sheet, given it was going to derive so much in revenues going over the course of the future,” Parker explained. “Obviously, the revenues are supposed to fall in line with the expenses over the period of time of the useful life of the asset. So they've effectively just been expensing all of their asset value for years, even under Charlie Munger as well.”
Munger’s involvement in the Daily Journal
The late Charlie Munger served as chairman of the Daily Journal between 1977 and 2022 and remained a director until his passing in November 2023, also managing the company’s stock portfolio.
The legendary Munger was credited with investing the Daily Journal’s excess cash in stocks, including BYD, Bank of America and Wells Fargo, quietly building a $300 million stock portfolio from scratch at the company. Upon his passing, the Daily Journal warned that its returns would probably take a hit from the loss of Munger, who reportedly racked up $138 million in paper profits through September 2023.
Over the decades, Munger has espoused attributes like transparency and integrity at the companies he became involved in, so Parker finds it interesting that this situation was going on while Munger was involved in the Daily Journal.
Not intentional?
Parker does not believe the Daily Journal’s decision not to report any asset value for its software has been done with any nefarious intent, especially given that it doesn’t help the company in any way. When asked why they don’t assign any value to the software, management told Buxton Helmsley that they didn’t think they should be capitalizing the asset value. Parker said they can’t understand why, adding that the company said it’s not a complete product — even though it’s selling it.
Historically, Buxton Helmsley’s approach has focused on accounting and legal issues, and the Daily Journal came up on a screener in relation to reporting zero intangible assets and being a software company.
Like the other companies they’ve dealt with, Parker believes a lot of chief financial officers don’t understand accounting. In conversations, management attempted to justify their accounting approach using the word “conservative,” meaning charging off all value-adding R&D investments instead of retaining any part of those investments as asset value.
“It takes conservative accounting to an extreme, and we believe that's also a huge myth, as well as that conservative accounting is allowed when FASB obviously requires neutral accounting, to be neutral, in your opinion,” Parker added. “So even the explanations that they gave us… they just don't make any semblance of sense. I don't know how the CFO convinced herself with this one.”
What these issues mean for shareholders
For shareholders, Parker and Flickinger believe the biggest issue this accounting irregularity causes is a major depression in the Daily Journal’s valuation. Parker said the company has been reporting a materially untrue financial position.
“If you look at the company's valuations, you're looking at around, 2-3x book value,” he explained. “So if you look back through the amount that they were expensing over the past years, and if you look at the typical amortization periods for these assets, we believe a $50 million addition to the book value for equity is fair and maybe low as well. So if you look at a 2-3x book value, adding that $50 million back onto the balance sheet, you're looking at an additional $100 million to $150 million in equity for shareholders that currently does not exist.”
Parker also said the Daily Journal was not only expensing those assets improperly but also funneling all the expenses through general salary accounts or external contractor expenses. As a result, the company was allegedly putting those expenses in the wrong category.
According to Parker, those expenses should’ve come under R&D, if anything.
“Shareholders don't know what they've actually been investing in, the technology at all,” he added. “And so that's a whole separate violation under regulation S-X.”
Management issues
Parker said they’re very disappointed with the Daily Journal’s management response, which has been to not only try to justify their actions but also to attempt to investigate themselves.
“It's not a shock that this happened, either, frankly, because if you look at the audit committee, it's two people with a marketing background, and one guy who was a lawyer by trade, who is now in the financial industry,” Parker added. “But from our perspective, we don't see any real accounting expertise, and frankly, most people in finance don't understand accounting. And we've been told countless times by analysts, they don't understand what we're saying. They don't understand accounting, which is pretty jarring, but that's generally what we see.”
Initially, Buxton Helmsley said they would keep the current management team at the Daily Journal, but, given what Parker described as “the very improper reaction to the issues,” they now believe the current CEO and CFO should resign.
“It was just really appalling, even the way that the CEO had responded, effectively trying to frame it that we were threatening to turn them into the SEC, when we had very made clear that we had already turned them into the SEC,” he explained. “So we believe that just his response was very emotional, defensive. He responded without even reading the materials and understanding them, which we believe is not in line with what any public company CFO should be doing. It's just unprofessional to us.”
Next steps
While Buxton Helmsley is calling for the Daily Journal to put out an 8-K on the matter, Parker said they’ve also proposed putting two people on the board to help the company sort things out. He said they suggested a performance-based remediation plan linked to the value they create for shareholders. If they create no value, then they get nothing.
“By putting the two independent directors on the board, they would be on a special committee that would oversee independent experts resolving these issues,” Parker explained. “Obviously, to announce that they received notice from a whistleblower. As [related to] these issues, they called an emergency meeting on the 21st, and they have launched an internal probe over the matters. Obviously, those are, you know, very material events. We also believe that it was improper that they selectively disclosed the internal probe to us, obviously, just given the materiality and Reg FD prohibiting selective disclosure.”
After the 8-K, Parker said the next step would be the remediation, of course. However, he believes the board is essentially “paralyzed” when it comes to their fiduciary duties and given the conflicted nature of having overseen the alleged failures for some time and not detecting them. Parker also believes it’s a breach of the board’s duties not to accept the offer of help from a firm with a track record of finding such issues, especially when a performance-based remuneration plan is proposed.
Unlocking more value for shareholders
Beyond remediation, Parker believes there could be even more levers to unlock additional value at the Daily Journal. He thinks if there are already “glaring accounting issues of this magnitude,” there may be other problems.
“Phase one is really the remediation of the accounting issues,” Parker added. “We believe that phase two would be more strategic initiatives for unlocking value. That's really just shocking, because they don't do any quarterly conference calls for investors. They have no analyst coverage. They have no investor relations website. I mean, they're not even communicating their value to the markets at all, as though the markets are just supposed to know what the value of the company is.”
He noted that if shareholders are questioning the company’s value and not able to get answers consistently, it will undermine the valuation. Thus, Buxton Helmsley believes there’s a “massive value gap” at the Daily Journal. Parker also believes there’s a “severe lack of strategy on certain fronts.”
“All of this is preliminary, based on our external assessment, but I think as we start to peel back some of the layers here, there is going to be more that is uncovered, given the patterns that we've seen thus far,” Flickinger added. “… The way that I look at it is the plan that we actually proposed. It would have created around $150 million in equity for the market cap. Our proposal was to take the market cap from $550 million to over $700 million. And to me, I believe that we could do that based on the information we've seen externally. I think there's probably even more that we would be able to drive once we get inside the organization.”
Parker also noted their track record at companies like Fossil. Fossil stock is up more than 100% since the strategic initiatives Buxton Helmsley pushed through.
“We think that there's a there's a lot of confidence that could be instilled in investors, just through a more strategic approach to all of these businesses underneath,” Parker concluded. “And then also with regard to, obviously, they have this massive securities portfolio that we believe also could be much more strategically deployed as well. That securities portfolio is around $300 million to $400 million.”
