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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.

Tuesday, October 25, 2016

On the short term activist shaking the ARIS tree

It is an interesting observation that when one types the word "SEVEN" into google search function, it autofills "Seven Deadly Sins" a reflection I suppose on the frequency with which the people check for behavioral affirmations.

In a way, the stock market has a similar effect. Every tick in the market can be a behavioral affirmation of one kind or another that can heighten the tension between greed and charity, or diligence and sloth.

I write here however, of the tension between "wrath" (less formally known as "impatience") and its more virtuous partner "patience". I find the latter to be a stellar principle for sound investing but it can be so difficult in practice that even those who speak of "long-term value-oriented investments" find it hard to back up with actions.

This all comes to mind because of the impatience recently expressed by the investor filing a DFAN14A with the SEC on ARI Network Services (ARIS), indicating a desire to solicit the sale of the company, an action that strikes me less as the endeavor of an activist than an expression of impatience and idiocy.

What we know about ARIS need not be rehashed because I've written about it elsewhere, but I'll summarize in three bullets:
  • It is an $85M market cap company whose CEO Roy Oliver, since taking the reins in 2008, has grown shareholder equity 33% CAGR. 
  • In stewardship with his capable CFO Bill Nurthen, who joined the company in 2013, Oliver now runs a cash flow generating business that has reinvested in high return acquisitions, an attribute of a "compounding" company
  • By increasing the availability of and access to debt, the company should be able to continue to fund what has hitherto been a successful acquisition strategy into the future.
In my ~15 years in institutional finance, I've rarely seen such strong capabilities in companies above $10B market cap and here I am a shareholder of one that is still below $100M, and with a potentially long runway of growth ahead.

Taken all in, I believe the C-suite team is unusually strong and capable for a company so small (though they are not perfect). 

Yet, were the company to sell, we would lose our ownership rights to the company just as the going-got-good and we would lose the benefits of investing in a C-suite team that has performed so admirably. To break up the band, so to speak, seems premature; to nip such success in the bud seems stupid. 

Obviously, once a company has gone public it is in principle already sold; shareholders are the owners and the executives are the managers.

This missive is therefore addressed to my fellow owners who like me can see the long road ahead under present management, who don't want to pay taxes on their growth in capital to date and who know how hard it is to find well run companies that can compound growth over time, for what are well run companies but good mgmt teams allocating capital - labor, time and financial - wisely?

When we find them good companies well managed, we should hold onto them for long periods b/c they are few and far between.

I imagine all shareholders know as much as I do and see the same attributes as I see in ARIS,  but what do we know about the owner advocating for the sale? I aim here to briefly fill in that gap based on available information so we can judge for ourselves whether his suggestions reflect temperance or gluttony.

This appears to be the third activist endeavor for the owner ...

1. AdCare Health (ADK). Period of activism: 2013 until Present (he is now on the board).

Initial statement from April 2013 says he owns 750k shares at $4.01.

In July 2013 he's advocating they sell the real estate to generate $4 / share cash that they pay as a dividend to shareholders and that the remaining business would be worth $9 / share. In August 2013 he says they should split into a REIT and an operating company. July 2014, the company announces it will end operations and convert into a holding company that would make it attractive to be acquired by a REIT. In November 2015, the Vice Chair has fraud charges filed against him. (I can't keep up!).

ADK now sells for under $2 and is the subject of an activist campaign by Echo Lake Capital / Ephraim Fields. Value investors appear to like the opportunity from the NOL's and the property.

2. Resonant Inc (RESN).

Initial statement of ownership of 300,000 shares in Feb 2015 at $15.47.

Continued to buy through the spring of 2015 such that ownership stake reflects 700,000 shares and the stock is trading at $4.75. In February 2016 he's given a board seat with the stock at $1.80. As of 4/27/16 he owns 1.035M shares.

3. ARI Network Services (ARIS)

1M shares bought b/t October and December 2014 @ $3.67 / share. In December 2015 files letter that company should seek potential sale. In Oct 2016, files proxy that company should consider a sale and that he is nominating himself and some investment banker to the board.

... I dare not speak ill of other investors for it is undoubtedly a function of hubris to think that one is smarter than another.

We all see in companies values - the more divergent the value the greater the opportunity - and I hope the value this investor sees in the shares he owns can be realized. I know nothing about two of them. However, I have experienced two things in life that I can say with certainty:

1. People tend to repeat their patterns of behaviors. Conclusion: Someone who has a prior history of buying small cap companies, getting on the board and overseeing value destruction is likely to do that again. We should aim to keep those with a frequency of such behaviors from coming to near to managing the capital that investors, company employees and managers have worked so hard to produce.

2. When my children ask for things they've done nothing to deserve, I say "no". Conclusion: When your unsolicited proxy arrives, shareholders should do the same here.

-- END --


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