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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.

Tuesday, July 21, 2015

Revisiting $FHCO

I have a draft post I've long been working on about investing mistakes I've made in the past year and $FHCO is atop the list. I'll summarize it here and note that the 34% I lost on the investment (MY OWN MONEY) from Oct '14 to Mar '15 wasn't "the mistake" but the outcome of the mistakes I list below. There were five of them, by my count, all of which lead to important lessons for me and I will bury my nose in these mistakes so I don't make them again ...

1. the need to be "doing something". when i bought the shares in Oct, I had just made the decision to form my business and I felt the need to be "doing something" to "be busy". I realized on reflection that what's worked for me in the past is the patience to invest only when the time and opportunity were right, not on some arbitrary calendar. Wearing a professional's hat can't change that.

2. i was attracted by what other people were doing instead of what seemed right to me. a friend in the small cap space brought the stock to my attention and other folks I knew swore by him. I've subsequently learned that he and I are very different investors - he buys a few shares of everything while I'm a concentrated investor - so we have different thresholds on what makes a good investment.

The lesson with this (along my experience working at a hedge fund around the same time) is that investing is a deeply personal experience.  I can't stress that enough. All the stuff they teach in business school about finance and valuation or what you read from "the experts", that might get you 99% of the way there, but that last 1% makes all the difference. What someone else sees as value, might not appear that way to another, and vice versa. That's a beautiful thing and a very important lesson.

3. i didn't talk to experts. As a former PI I pride myself on this aspect of my due diligence but I bought shares before I'd reached out to sources in public health who subsequently (and unanimously) told me that the product is a joke in the US. I've since learned that the largest consumer users in the US are gay men but since the product is FDA approved only for vaginal and not anal intercourse, they can't market to them.

4. i didn't talk to mgmt. I bought it at $4.40 before my impressions with mgmt were fully formed and sold it at $2.90 after they were fully formed.

5. didn't fully understand the market. i was attracted to the nifty, quirky and seemingly cheap story without fully understanding the market, the buyers, and most importantly the growing competition from Cupid in India.

... and so with these mistakes, I got involved and lost money - my own money, not client money - but I've come away with valuable albeit expensive lessons.

Yet, here we are with the stock at $1.40 and I'm revisiting this company. Maybe it's insane. The stock is cheap at 4x EBITDA but whose to say it won't get cheaper? There are few hard assets and just $0.50 in working capital / share and another $0.50 in deferred tax assets that would benefit an acquirer.

But the CEO who recently wrought massive destruction in shareholder value via a "strategic initiative" just resigned - on the one-year anniversary of the announcement of said strategy - and positive changes MIGHT be afoot now that the owner / operator / founder OB Parrish who owns 4% of the company is resuming control.

$FHCO is the Female Health Company. The company manufactures the Female Health Condom under the brand FC2. It's a $40M market cap company with $24M in sales on 43M units sold (2014). The company will exceed both these figures in 2015. Yet, the stock is trading below where it traded in '08/'09 when it was doing less sales and lower margins with roughly the same share count as it has today.

By way of background, the female condom was invented by a Dutch physician, who patented it and sold the rights to the predecessor company, Wisconsin Pharmacal Company. Then, through a series of dispositions, around 1995 / 1996 Pharmacal was split into two companies, with rights to the female condom put into one entity that was eventually renamed Female Health Company and run by OB Parrish. The other company, after changing hands several times, still exists today and is now run once again by OB's former partner John Wundrock ...


... so it looks like both these entrepreneurs are back where they started 20 years later.

The original product was the FC1 and an improved product, the FC2 was introduced in 2007 with production consolidated in Malaysia in 2009, where it can currently produce 100M units / year. (The FC1 was discontinued).

For the last few years, the company has consistently sold the products for ~$0.55 / unit and with EBITDA of roughly $0.15 / unit. (The apparent decline in rev / unit in 2015 reflects a change in the way a 5% discount was accounted for, previously in COGS now a reduction in sales).

In the early days, the company intended to sell the product directly to US consumers and in that effort supported local TV advertising where, as the story goes, a UN employee saw the ad and that opened the door for a more global and institutional business.

As a result of the global sales, the bulk of the business today is to developing-world ministries of health and / or institutions that provide public health reproductive services in the US and overseas sold via partnerships with local distributors in public tenders. US revenues account for just 5%-10% of revenues in any given year.

Given the nature of these tenders, sales and shipments are lumpy but the company has been profitable and cash flow positive, with the exception of this year, when cash flow has been negatively impacted - according to the company - by a large receivable to the Brazilian gov't ("120-day pmt terms"). I presume lack of focus on working capital contributed to the prior CEO's "resignation".

But competition is bringing structural changes to the market and this makes things different than they were 5 yrs ago. The global market has seen new entrants from China and India (I think Cupid is the most serious competitor) ...


... while in the US, a variety of new designs are pending via among other things, a Gates Foundation grant ...


... this competitive threat lead then CEO Karen King, to announce last year, July 2014: "... a series of strategic initiatives that we believe will ultimately generate greater value for our shareholders and other stakeholders.

In order to position the Company to pursue a growth strategy, the Board of Directors has elected to suspend the payment of quarterly dividends at the present time and devote cash flows towards these strategic initiatives that have the potential to accelerate the Company's long-term growth in revenue and earnings."


The initiative had two buckets ...

1. US consumer growth. First, they hired Susan Ostrowski - a sr. exec in pharma and chem sales and marketing - tasked with growing the US consumer market, and that they would spend more money on sales and marketing to do so.

2. Product diversification. They also announced "we will evaluate investments in new products, technologies and/or businesses that complement the core competencies and strengths of the Company ... we believe the risks associated with a single product offering, along with the significant volatility in purchasing patterns for FC2, can be mitigated by the presence of a more diversified portfolio of business activities."

... and here we are a year after cancelling the dividend and announcing the "strategy" and they

haven't acquired anything,
are no further along in articulating what they're going to acquire
are no further along in growing sales in the US market,
have a legacy sr pharma exec running a social media / marketing strategy
and that marketing strategy is costing incremental +$1M / year
meaning to break even on it, they'll need to sell an incremental 1-2M units to US consumers

A comment I heard on the lack of progress towards an acquisition was the fact that they're too small to field a dedicated M&A team to make an acquisition, which of course begs the question on why they went down the path to begin with.

And there are still a few other issues to mention  ...

the company has been operating at a cash flow deficit for the first time in my modeled history (going back to 2008) ... working capital has expanded ... DSO's are over 100 days ... and profitability / unit has shrunk b/c of the marketing spend to sell the product to a US consumer who won't buy.

... my guess is that along with the failed strategic change, the inability to manage cash flow lead to the CEO's resignation.

So here we are today and it's an awful mess. What was a $10 stock two years ago is now trading for $1.40 even though 2015 sales and units should approximate 2013 levels.

But in the convoluted world of investing, the bad news is an opportunity. With the stock hammered, trading at ~4x EBITDA (3x assuming a "normal" DSO), the CEO that lead the strategy now out, the company's founder OB Parrish is back in control.

Given the destruction in his net worth over the last year, I'm anticipating a finer pencil on the "strategic plan" implemented last year - may be a reversal or a change or an adjustment - so that the company can be run with a better eye on operations, leading to a resumption in cash flow generation and possibly a dividend and buybacks, or at the very least a better articulated strategy going forward with honest intellectual engagement on what's possible and probable.

In addition to Parrish the largest non-institutional shareholders Dearholt and Wenninger - and including the board members who are advising on next steps - have LONG been involved with the company ...


... I don't know what the future holds but the company will host its F3Q15 conf call on July 30th and more details should be discussed then. They say you can't cross the same river twice but I've recently initiated a small position ahead of the call anticipating positive changes.

-- 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 FHCO.

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