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This is written with serious investors in mind, though sometimes they're just drafts in progress. 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.

Saturday, August 29, 2015

$ARIS: Letter to the CEO & Board on the destructive impact of share dilution

I sent this August 11, 2015 to the CEO, CFO and the Board. There's a cautionary tale on the impact of dilution that isn't specific to micro caps caps but effects them greatly simply due to smaller shares outstanding. 

I wonder if capital allocation is something executives figure out and improve on over time? My general view is that people tend to not look constructively on their own behavior and therefore tend to not change their behavior, but I hope in this case they do. 

Dear Roy –

It’s an exciting time to be an ARIS shareholder.

I’m writing to you to commend you for the great work you’ve done since your elevation to CEO and President in 2008 and also to share three concerns that, if resolved, would translate your progress to date into more significant returns for shareholders.

Since taking over ARIS in 2008, you’ve done an impressive job leading and growing the company. Revenues, EBITDA and cash flow are up 12%, 15% and 18% CAGR, respectively and I believe sustainably. These results are driven by both organic growth and acquisitions that have expanded the company to new end-markets served and services offered.

Concurrently, the market value of the company is up ~25% CAGR as well, an impressive rate of growth that reflects the changes you’ve implemented.

And with the recent acquisition of DCi, you’ve added a tool in the automotive space that’s essential to your customers. DCi is a bit like the ARI business from 2008; a small no growth cash flow engine. And combined with TCS and TASCO you have the ingredients to create a sticky, recurring business that addresses the automotive end market with a product that's desired by customers and cannot be easily emulated elsewhere.

This letter however is not just about patting you on the back it is also about advising you and your board cc’d to really internalize the detrimental impact of the past seven years of share dilution and urge you to think more constructively and objectively about its impact going forward.

As the above table demonstrates, when we look at your financial performance on a per share basis – and as a part owner of your business, it is the only way for me to think about it - the results are largely unimpressive. Revenues and EBITDA flat. EPS down 11% CAGR.

I’d be remiss if I failed to point out one bright spot; the growth in book value per share. Though it comes off an extremely low base, it is the only remaining financial emblem of your value creation to date when viewed through the lens of share count dilution.

I can imagine back in 2008, a plan discussed and agreed to by the board to grow the company through acquisitions using a combination of debt and equity. This plan I imagine balanced benefits of increased liquidity, trading volume and a larger product offering against the disadvantages of shareholder dilution.

I would like to know if such a plan existed and if so, I should hope it is now complete. ARI’s portfolio of end markets and services has dramatically expanded and with 17M shares now outstanding, there’s plenty of stock to trade, particularly with an average daily volume of only 30,000 shares.

So I am writing to urge you and the board cc’d here to stop the share count dilution and suggest that on the next conference call you make it plain and clear that you pledge to stop the share count dilution and live only on your free cash flow and where necessary, low cost debt that is available to you.

Furthermore, as I’ve previously mentioned [in earlier conversations], I urge you to provide more disclosure around your subscriber numbers, whose growth is a major factor in organic growth (price being the other). This disclosure would provide valuable information to investors and a simple target around which to configure incentives.

And finally, there would be no better way for you, your executives and the board to indicate your trust and faith in the company that I share than buying its shares in the open market with your own money and not through stock grants and options.

In summary,

·        Stop the dilution
·        Disclose your subscribers
·        Buy the stock with your own money in the open market

Shares are not free money; they come with incredibly high costs in future value and their persistent use destroys everything you’re trying to build. It is simply impossible for any of us to earn a reasonable return on our investments with continued dilution of our capital.

With the business today more firmly ensconced in larger end markets and with additional services, I’m confident that sound and strategic management that generates organic growth will yield the cash flow necessary, over time and with patience, to grow the business while satisfying the required returns for its owners and executives.

Sincerely / 

Long Cast Advisers, LLC

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