About Me

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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.

Friday, September 30, 2016

A Brief Description of the Kinds of Stocks I'm Wary Of

Here's one type at least: The "heroic / satanic savior"

That's where "BNI's" (ie "brand name investors") with terrific financial backgrounds but no industry experience swoop-in heroically with the imprimatur of "financial stewardship" ... and destroy value.

I speak specifically in this case on $CDI, now trading near net / net valuation, but there are so many examples I've seen where this happens. 

In this case, some ex-Eddie Lampert / Sears / Lehman folks joined the company in Oct 2014, and since that time, shareholder equity is down 25% and total debt is up 10-fold.

I imagine their compensation reflects the skills required to achieve such a distinction. In fact the word "compensation" shows up a quite astounding 385 times in the most recent proxy statement, though you'd have to scroll to page 24 to see the actual discussion on executive compensation (by that point, they've already mentioned the term 107 times).

From there on, you'd see there a quite intense amount of description of a comp plan that focuses on "shareholder value," which is mentioned only eight times in the report. (Perhaps a new investment analysis is the ratio of "compensation" to "shareholder value" in the proxy statement).

As for what drives "shareholder value": The company believes "... that if CDI consistently attains or exceeds its target levels of operating profit and RONA, shareholder value will increase over the long term. Our targets are intended to be challenging, yet realistic and achievable at the time they are established."

Since RONA excludes goodwill, that comp plan essentially incentivizes management to lever up and make acquisitions in order to grow operating profit. You can imagine that's the plan. Scorpions gonna do what scorpions do.

But this is a business where the assets walk out the door every night and I can cite many more levered acquisitions in the people business that have not worked than those that have. (My experiences are in the investment banking world where it never works).

Still, the horse is out of the barn. They've already made their first purchase paying $35M cash for "EdgeRock Technologies" a company that supplies project managers for ERP rollouts. Plus, they have a new $100M credit facility to borrow for future transactions and given that they're under levered relative to other staffing firms, they have plenty of borrowing capacity available.

But if they can't maintain or grow the operations, it potentially leaves long term investors holding the proverbial bag.

Staffing is not a complicated business: manage your bill / pay spread, keep overhead as low as possible, and hire high energy, terrific salespeople. But it is also a brutal business characterized by:

- Cyclicality. Staffed employees are first in and first out.
- Low barriers to entry. All you need is an internet connection.
- Incredible competitiveness
- Disintermediated by technology

This is the second staffing company I've looked at recently trading at or near net / net valuation ($HSON is the other one) where some BNI's have come in to "turn it around" ... and they haven't.

The good news is, these are just two of the tens of thousands of companies that  trade everyday in the public market, with a bid on all of them.

If I wanted to own a services rollup, I'd be more keen on companies run by managers with a rabid dog mentality towards selling and collecting vs financial mgmt. I'm just not the type of deep value investor that can step in front of a business unless success is paved with operating excellence.

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Thursday, September 29, 2016

A Comparison b/t C&I loan growth and the ratio of multi family to single family housing permits

Been looking at a lighting company that gets half its revenues from multi-family residential new construction.

Though a different company than TAYD, both are exposed in some way to institutional or commercial construction.

This chart shows changes in C&I loan growth (commercial and industrial loans) - the blue area graph - via FRB layered on top of housing permit data, specifically, the ratio of multifamily permits (five or more units) to single family permits.

I think the takeaway is that multi family construction permits really ramp relative to single family later in a cycle, and that there was a period of under building of multi-family units during the housing bubble.

My sense is that business is passed the peak, at least for the current cycle (yes Virginia, there is a business cycle, no matter how skewed it may be by interest rate policy).

Or maybe slowing C&I loan growth is from uncertainty about future policy and rates, due to the election.

I'm not a macro-investor I just love comparing things.

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Thursday, September 22, 2016

Happy Birthday Vanguard (I got you a Spotify account as a gift!)

This morning, the Marketplace Morning Report  had a story on Vanguard's 40th birthday and a piece on revenue growth in music streaming. 

It dawned on me that Spotify and Vanguard shared similar dynamics - they are both disruptive innovations - and if that's the case, then it follows that stock pickers are the equivalent of hifi-enthusiasts in an ETF-dominated world; a shrinking community of music perfectionists that think they do it "better" than everyone else. 

Through the lens of convenience, "better" isn't about sound quality and imaging but about pervasiveness and availability. 

There are countless places we've accepted - for the sake of convenience - "lower quality experiences" in our lives. That's a key aspect of disruptive innovation that Vanguard brought to the investment world (the program starts at 3:40)

Vanguard's innovation? At a time when people were trying to beat the market with exceptional results, Vanguard offered a way to be ... unexceptional ... and now its S&P 500 mutual fund and Total Stock Markets Fund are the two largest funds in the country. 

What an incredible experience for the average person who doesn't follow the markets, who doesn't know how to tell a good investment from a bad investment - or even a good investment manager from a bad one - and who has no financial education to not have to make a decision and concurrently be freed from the bonds of snake oil salesmen with the ease and convenience of buying something that's simply good enough. 

What - if anything - are those people missing? And what can I learn from this as a startup RIA focused on small cap investing? 

I don't think people know what they're missing. Many treat their investment and retirement savings with little thought - and much hope - probably b/c they don't know how to think about it, or they've never entertained the notion of "I can invest." So they outsource it.

On the latter - what can I learn? - how do I reach people who don't know what they're missing? I guess I could start a fund and focus on the small market of other hifi enthusiasts who don't want to listen to a compressed version of Eine Alpensinfonie or won't watch "Lawrence of Arabia" on a cellphone. 

I'm passionate about trying to reach a wider audience to help them understand the choices they face, provide some education and service, and, potentially, deliver returns on capital that exceed the market, with less risk, less tumult, and also while avoiding companies whose missions are opposed by my clients. (When you own the S&P, you own companies that build guns, burns coal, promote addictions, etc. Why should someone opposed to those endeavors accept them in their investment portfolios?)

To anyone who thinks investing is hard, I tell them that picking stocks is just a concentrated form of the same decisions people make all the time: what shoes to wear, what fruit to buy, what to eat for dinner. Once you lay out the parameters, it's easier to make a decision. Not easy, but easier.

As an avid investor, I balance the difficulty of decision making with the alternative, and I can't fathom why someone would want to risk capital on an undifferentiated mass of companies whose value - on whole - tracks GDP growth +/- people's attitudes (ie multiples). Why would I want to outsource mine and my clients' capital to other people's attitudes when knowledge and experience can do better? Instead, I prefer to make decisions, and as few as possible. 

Finally, I firmly believe that we lose things when we accept unexceptional, in the investment world and in the real world. 

What we lose in the process of making undifferentiated investments, is, I think a key point in that Sanford Bernstein piece from awhile back, that if we're no longer allocating capital to its best and highest use but simply spreading it around, we disrupt price signals and outsource returns simply to a function of interest rates and money supply. 

And in the personal world, there maybe even worse consequences. Music, art, movies, conversations with people, travel, real adventures - not 3D replicas - these experiences create emotions. Video games create emotions too, that's why they're so much fun. But when we dial down the experiences to a virtual one, I think we limit our emotional selves. We can't possibly experience the same catharsis at a 160 kbps bit rate as we do in real life. 

In both the investment world and the world around us, when the effort at reproduction isn't towards replicating the best experience but only about convenience and accessibility - yeah, it's good enough - something is lost. We shrink the world to a bunch of correlated experiences, rather than expand it to a variety of global ones. 

-- END -- 


Wednesday, September 14, 2016

$EVI Acquisition: Brief Readthrough on WSD Deal + 8x ProForma Valuation

I first wrote about EVI here when I believed it to be the kind of well run company that I wanted to own forever; niche business that generates cash, functions in a kind of protected duopoly and doesn't dilute shareholders. I had behind me decades of financial statements as evidence that the business was a lock box for cash. It was a $16M mkt cap company.

Then, Henry Nahmad acquired a controlling interest in the company and he was pretty upfront that nothing / everything would change.

He'd keep the core business roughly the same but roll up the industry the way his uncle / father rolled up the HVAC industry ~40 years ago to create $WSO. Not a bad pedigree; WSO has returned +12,000% over the last 30 years.

And then nothing happened ...

... until the first week of Labor Day 2016 when the company announced its first deal to acquire Western State Design, a primarily West Coast distributor of industrial and coin/op laundry equipment, for $28M. WSD was privately held and owned by Dennis Mack and Tom Marks. With this first deal done, Nahmad can now be judged on his actions not his pedigree. 

This is a short summary of my reading on the deal.

Price / Structure / Value 

The deal has a headline $28M purchase price split between $18M in cash and $10M in stock. But there's more to the story than the headline ...

The $18M in cash comes from 1.29M shares sold to Nahmad's investment vehicle Symmetric LLC in a PIPE @ $4.65 / share (the close price before the deal closed) + $12M from a newly announced credit facility. The total size of the credit facility is $20M.

Of this cash, $15.2M is paid at the close and $2.8M will be escrowed until 18-mos after deal; this appears to be related to and contingent on collection of AR's at the time of the deal

The purchase price includes 2.04M shares of stock worth $10M based on the average closing price of the stock for the 10-days prior to the Asset Purchase Agreement. Mssrs Mack and Marks - the sellers - will own just south of 20% of the combined company after the deal.

+/- what appears to be standard working capital adjustments from the baseline $4.8M working capital at time of the deal.

Western State Design did $60M in sales last year vs $30M for the core EVI. The company, it should be noted, is tripling in size. Operationally, WSD appears to be more heavily weighted towards coin op than the commercial laundry equipment / boilers that EVI distributes. Also, there appears to be no overlap in regions as WSD is mostly out West and EVI in Florida / Caribbean / Central America.

WSD has more gov't contract / federal work than EVI and apparently has security clearances related to that work that will be transferred in the deal; (what kind of security clearance is required to do laundry?). Very little information is available though it at they are at least savvy enough to protest an award (FWIW).

Based on WSD's $60M sales figure and assuming roughly the same EBITDA margins as the core business, EVI is acquiring a company twice its size at 5x-6x EBITDA.

Before the deal EVI was trading at ~$4 / share or ~10x trailing EBITDA. Proforma it appears to be trading for ~8x proforma EBITDA.

The $12M in borrowings to fund the deal is part of a larger $20M credit facility with Wells Fargo, so they have access to an additional $8M in borrowings. Perhaps other deals are pending as well ... 

A bit about Western Design and its owners / sellers, Dennis Mack and Tom Marks

Mack and Marks are co-owners of the firm. Not much information available about them, strangely enough in this day and age of social media. Would like to learn more and probably will have a chance to meet them at the shareholder meeting in Nov, as they will both become execs of the company and at least one will serve on the board.

In the standard non-compete provision, there is a carve out for a business run by Dennis Mack: "The foregoing prohibition shall not apply to the involvement in any manner by Dennis Mack with respect to Associated Laundry Management, a commercial laundry  in Reno, Nevada." Maybe he has a lab underneath it.

Another irrelevent tidbit: EVI is not acquiring the facility of WSD's headquarters on Tripaldi Way in Hayward, CA, but rather signing a new lease with the existing landlord. That existing landlord is TylerTown LLC, an entity created in 2012 by the controller of WSD, Marianne Lenci, so like EVI itself, WSD pays rents to its CEO.

It's not an unusual situation - lots of companies do this - and its critical for investors who tend to dismiss such things as "inside dealing" to reflect and consider what's actually important information in making an investment decisions. I don't think this is.

Why am I scraping the Department of State filings to get information on this company? B/c I can't really find anything else material.

But as a sense of what kind of managers are Mssrs Marks and Mack, I found this interesting. In 2010 they had plans to develop on spec a "state-of-the-art commercial laundry for sale or lease to an operator, the company says. The building site encompasses 3.87 acres and includes a 14,000-square-foot enclosed service yard. It is strategically located for effective distribution throughout Northern California."

The risks for building on spec were somewhat offset by their ability to get funding from a state issued bond on the deal.

The point is, we know our new fellow shareholders and managers have a nose for opportunity. And they were willing to take 35% of their comp in stock. This reinforces that assumption and provides some affirmative bias that as with already existing shareholders, they see long term opportunity in the business.

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