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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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