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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.

Wednesday, December 21, 2016

ARIS: F1Q17 Results and the Most Absurd Proxy Battle Ever ($ARIS, $EBAY)

I've been a fan and stockholder of ARIS since it traded in the mid $3 range and I continue to like the company. I think the mgmt team is unusually strong in a sub $100M market cap company, I think the company still has room to grow in its variety of verticals and finally I think the business sells for a more than reasonable multiple such that a long term investment could benefit from the two attributes of growth and multiple expansion.

Despite these attributes, some impatient investor is challenging the company to sell itself. It is one of the most absurd proxy battles I've ever seen for a company so small. Absurd for so many reasons, but primarily in the waste of money and energy; there have been 15 DEF filings since the antagonist went after them in late October.

The information also directs investors in many cases to the wrong information - notably in this page of his presentation filing - which focuses on Net Income and not FCF. Because ARIS capitalizes its software development, Net Income includes significant depreciation. Back that out and there's quite material divergence b/t Income and Cash Flow. What do you think is more important?

(these are TTM figures)

I don't think the antagonist has a chance of winning the proxy battle - I certainly hope he doesn't, I want this to continue to compound indefinitely - so I think this is simply a drain on the company and shareholders like me who appreciate the value of compounding growth over the long term, and are not focused on the day to day changes in the stock price.

Its the compounding of growth and the benefit to returns that I aim to write briefly about here.

A week or two back, the company reported F1Q17 results. The company reported $12M in sales and $2M in EBITDA, reflecting a 17.6% EBITDA margin. By my account, these results reflect 29% ROE and 18% ROA.

(these are quarterly figures)

On a trailing 12-mos basis, the company has reported $48M in sales and $8.6M in EBITDA. With 18M shares out and $3M in net debt, this reflects a 12x multiple on trailing results. Everyone should decide for themselves what's cheap and what's not, but it seems an attractive valuation to me for a company consistently growing profits and FCF and reinvesting FCF at high returns such that topline and returns are growing consistently.

However, results do not reflect the Auction123 acquisition that closed a day after quarter end. According to the press release that accompanied the purchase, that acquisition adds ~$4M / year revenues.

And then these tidbits from the conference call:

On the $10.5M acquisition ... "From a multiple perspective, we paid 7.2 times the trailing 12-month EBITDA for Auction123 at closing. If the first two-year earn out is paid [$1.5M] and considered part of the transaction then we paid 8.2 times the trailing 12-month EBITDA." >> This implies ~$1.4M in trailing EBITDA, or about 35% EBITDA margins. Is it reasonable to think those margins are sustainable? It's in the same ball park as EBAY's margins so ... why not? 

On the balance sheet post the acquisition close: "... our transaction closed on November 1, 2016, we had about $16.8 million of total debt which is just under two times our trailing 12 months EBITDA, and cash and cash equivalents of approximately $3.3 million or a net debt of $13.5 million." >> On this basis, adding the acquired EBITDA and adjusting the net debt, this is now trading for 11x trailing EV / EBITDA. 

And finally thinking about year end, "... as we look ahead and consider our expected cash flow and debt payment schedule, we anticipate by our fiscal year end on July 31, 2017, our cash balance will be back above $5 million and our net debt will be below $10 million." >> this implies, assuming zero growth, that the company is trading at 10x FY17 EBITDA. 

On a comparable basis, the peer group multiple is about 15x. When it comes down to it, that discounted multiple is really what this whole proxy battle is about from the get go.

It feels a bit lonely talking about this company. I've not seen any evidence or read any information anywhere that this is a bad business. I'm not deterred by the debt as the mgmt team has been a terrific steward of it and is now operating in an environment where the pent up energy of millions of entrepreneurs is about to be unleashed (so much tongue in cheek, I just threw up a little).

I think the evidence suggests this is a good business trading for 10x next year's EBITDA, as good businesses sometimes do, and its generating cash and reinvesting it at high rates. The question is, do you sell now and lose the benefit of a quality mgmt team allocating capital wisely or allow the company to continue to generate cash and grow, and generate cash and grow, and generate cash and grow, etc.

To me, the opportunity for the patient investor is to buy more, and wait patiently.

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