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This is written with serious investors in mind. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

Thursday, July 16, 2015

$ARIS: Thoughts on DCi acquisition and the essential nature of the catalog business ($MAMS, $TRAK, $CDK, $AZO, $AAP)

ARIS announced on July 14th the acquisition of Direct Communications, Incorporated (DCi) an online automotive parts catalog and while there was no financial info disclosed in the press release they also filed an 8K with add'l details indicating they are paying ...

$3.75M cash
$2M debt (promissary note to the owner's trust)
Plus issuing another 160k shares ~ $500k equity
= $6.25M for DCi, which has forward revenues of $4M = 1.6x revenue multiple

... why an online parts catalog like DCi is essential to dealers even in this day and age of "free information", why this deal makes perfect sense for ARIS, and how the company can bridge the deep valuation discount b/t itself and its peers are discussed below.

But first the numbers:

ARIS is a $54M mkt cap company with 17M shares out, $38M in sales through 9MOS of 2015 (y/e July 31), average annual EBITDA margins of 15%,  trading at ~11x EBITDA. The peer group trades in the mid-teens. Pulling that below comp multiple forward against the $8M EBITDA forecast gets to $4.70 / share or 50% upside. My thesis for owning the company is that the catalog business while undifferentiated on its own, can be an attractive entree and sticky engine for additional dealer related services like digital marketing, lead generation and point of sale use.

My ambition is that with a full suite of services, the company becomes a larger part of the network within transaction processing. The business generates cash and the valuation seems attractive. It is not without warts; They are overly dilutive of equity capital having grown from 7M to 17M shares outstanding since 2010, but I could see the attraction through their eyes of more liquidity and share volume (this isn't my most "patient investment") and while mgmt hasn't been the greatest capital allocators, there is cash generation and opportunity to improve incremental returns on capital.

Better disclosure around subscribers would also definitely improve visibility for investors.

FORECAST: Here's back of the envelope what I think the business looks like in 2015 and 2016 ...

... ARIS is on track do the 2015 revs and EBITDA numbers listed above.

For 2016 I'm assuming +$4M in acq revs as indicated in the press release + 10% organic growth. EBITDA margin expansion comes from this catalog business; when the company was primarily catalogs before the 50 Below acq they regularly did high teen / low 20% margins.

I've adjusted the share count for the 5/7/15 share offering + the new shares from this deal.

Net debt at end of last quarter was $10M. The share offering raised ~$5M. This deal cost $6M, getting us to $11M net debt PF for year end.

For 2016 I'm looking at lower net debt b/c of FCF. Here's a look at earnings and FCF history ...

... they have always generated cash. I think they can safely dial in $2M-$3M in FCF which leaves a lot leftover for owners, If management showed more discipline, they can do better. The business is a cash flow machine.

But as capital allocators - and this is no small "but" - it's impatient to sell stock low to buy other companies high and issue add'l shares to do that.

They could make up for it if they would SHOW information, so investors can see if they will GROW the business organically. What I mean to say is they should disclose more information about subscribers.

1, SHOW.  TRAK and CDK REPORT subscriber #'s. MAMS discloses it in the conf calls. ARIS buries a proxy for subscribers - avg rev / dealer - in their investor handout. The figure hasn't changed since 1Q15. The SHOW part is 100% within mgmt's control. Please give us subscriber numbers?

I think the limited visibility due to disclosure explains some of the multiple discount relative to the competition (according to Yahoo! key statistics MAMS trades at 22x trailing EBITDA).

2. GROW. Growth in rev per subscriber would provide evidence that the acquisitions of TCS and TASCO are in fact adding more services that are selling through existing channels.

To date, they appear to have done a good job growing rev / dealer but again they don't disclose enough information to be certain. We only see a static annual figure for # of dealers - most recently at 23,500 at end of 2014 - and based on that they've seem to grow ARPD 18% y/y through F3Q15. But this is a rough guesstimate. Competitors provide details. (and unfortunately grown share count faster than ARPD).

In short, mgmt and the board should please follow 3-steps, two of which are fully with it's control ...

STOP the share count dilution
regularly SHOW your historical and quarter end subscribers like your peers do
continue to patiently GROW subscribers organically and via acquisitions

... and this will yield above market returns to investors.

DCi AND WHY THE CATALOG BUSINESS IS ESSENTIAL AND SCALEABLE BUT UNDIFFERENTIATED: DCi is a parts catalog business in the automotive aftermarket sector and is right in CEO Roy Olivier's wheelhouse. He grew up in the catalog business, starting a company in his basement that was sold too soon, and later gobbled up by ProQuest and then SnapOn (I earlier wrote about the CEO's background in the parts catalog / library business http://goo.gl/2yKHlI)

Parts catalogs are funny things; you'd think they're irrelevant in this day and age of free information but access to them is essential for dealers that want to develop a web presence. Let's start with Advance Auto Parts ($AAP), one of the largest distributors of aftermarket auto parts ...


... looks like any shopping website. But there's a back end system that enables the company to provide parts information, photos, id numbers, etc. As a large dealer they likely have their own catalog or library relationship with manufacturers but maybe they outsource? I don't know (I put a call into IR). When you dig more deeply into their corporate site, there's information on their vendor reference center for the electronic parts catalog ...


... on that page you'll see that the PIES reference manual offers 33 pgs of technical specifications for contributing to their parts library and the top link, the AAIA imaging best practices document references the "best practices" of the automotive aftermarket working committee. Of the 30 names on the working committee, one is from DCi and another from ARI Partsmart.

None of this is at all material to the acquisition, valuation or financials, but it's relevant to the context of the business and establishes that DCi and ARIS are "players" in this market.

But it's definitely a crowded market. A quick search online found a free service to source a variety of parts through Timken ...


... which is actually powered by another company called Vertical Development Inc, which not only compares to what DCi does but the dude on the home page looks startlingly like ARIS' CEO ...


... there's one example of a competitor. There are many many others.

HOW DOES ARIS STAND OUT IN A COMPETITIVE FIELD? Consider all the dealer websites in the world and where these parts catalogs come into play. I think of them as small but essential back-end processes that - for small- to mid-sized dealers - are administrative choke points. 99.9% of the world will never really stop and think "wow, how'd those pictures get there and how do they connect to the actual inventory mgmt system?"

The good news about catalogs is it's scaleable, sticky and cash flow generating. The bad news is there's no lack of competition and as a standalone business it's really not that differentiated.

Here's where the imagination comes in.

The idea for ARIS is that with the bigger product suite of services - a point of sale system, inventory mgmt, marketing all via the company's core business + TCS + TASCO = there's a one stop shop for small- to mid-sized dealers.

And I'll take it a step further. Imagine if through the service ARI could create a customer community with information on what's selling and what's not and what's preferred, then there's an opportunity for a network effect, which is where a true SaaS company becomes a flywheel that throws off cash.

Now we're not talking about an 11x multiple company scratching for its next meal. If it never achieves that, I don't mind owning at 11x EBITDA a cash flow generating company growing 20% / year half organic half acquired IF THEY WOULD ONLY STOP THE SHARE DILUTIONS. That alone would be enough to reward patient investors.

-- END --

All rights reserved and copyrighted by Long Cast Advisers, LLC. This is not a solicitation for business or a recommendation to buy or sell securities. I own shares of ARIS.

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