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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Monday, September 17, 2018

CTEK: Letter to Management

Over the weekend, I mailed a letter to CTEK management asking them to please consider selling the MPS business so that they can focus on the high return IT Consulting / Cybersecurity business. The math on the two businesses just doesn't make sense for a company this small and undercapitalized and the MPS returns are too low to justify any incremental spend; they should spend all incremental capital growing their IT business.

Then a press release came to my attention that might indicate a willing buyer. If a sale could draw $25M, basically what the pure play MPS was worth a few years back, and the proceeds are allocated towards debt paydown, it would leave investors with a high margin, FCF generating pure play IT consulting / cybersecurity business trading for less than 6x EBITDA.

This is why I think CTEK increasingly looks like a “good co / bad co” situation, with the legacy MPS business hiding the value of the smaller- and faster-growth IT Cybersecurity business.

With a sale of the MPS business, management would have optionality, and the next best thing to $0.50 on the $1 is optionality. They can grow organically, by slow acquisition or via a reverse merger with a larger private company with pubco ready executives who want to roll up in this fragmented industry. I think the last option offers the best opportunity for investors, customers and employees, especially given the need to manage succession planning at CTEK as well.

I know I prefer investments where I can own the stock and never have to think about it again, but my attention gets focused when our holdings underperform their own expectations. When a reasonable and probable solution exists, I will always fight for mine and my clients' capital.

Here is the full text of the letter to the Chairman, JD Abouchar ...

Dear JD:

I am the owner, for myself and clients, of 100,000 shares of Cynergistek stock. I own these shares because I believe the market significantly undervalues the fast growing, high margin IT Security business that is over shadowed by its larger MPS cousin.

I write to urge the Board to maximize the valuation of the enterprise, and to ensure a strong, durable foundation for long term profitable growth, by selling the MPS business and expanding the pure play IT Security business through a reverse merger with a larger, highly regarded competitor.

I believe these steps would offer shareholders the potential for material value recognition, would provide customers the most focused service solutions and would ensure employees a more stable work environment within a fast growing high margin business.

I come to this conclusion upon the realization of three issues:

Despite the best intentions of holding both MPS and IT Security under one-roof, we are too small and under-capitalized to invest in both concurrently.

Every dollar we invest in IT returns substantially more than an investment in MPS so it makes no sense to allocate incremental capital into the low return, slower growth business.

Mac, our CEO, who built, grew and has already sold his business once, wants to retire. We need to find a dynamic pubco ready, lights out CEO to shepherd the business through its next leg of growth.

The good news is, we have assets and optionality, and immediate value could be realized by selling the MPS business. In 2015, as a standalone pureplay MPS, “Auxilio” had a $25M mkt cap on $60M revenues and $1.6M EBITDA. Today, that business, still around the same size but freed from public company expense, would be worth roughly the same to a strategic or a financial buyer.

Assuming a sale in that price range with the proceeds allocated to debt paydown, shareholders would be left with a fast growing, standalone IT Security / Consulting / Staffing business, with ~$5M in EBITDA, trading at less than 6x Enterprise Value, undoubtedly on the low end of the valuation range for a company with strong FCF potential.



From this foundation, I see three ways to grow our IT Cybersecurity / Consulting business into a larger pure play entity, providing broader solutions to more customers, potentially in allied verticals such as academia and government.

Via slow, patient and organic growth
Via a handful of “bolt on” acquisitions
Via a reverse merger with larger well-respected competitor with an existing management team intent on consolidating the mid-sized market and benefitting from capital markets exposure.

All scenarios require thorough due diligence and carry risk, but I believe the last offers the most expedient way to satisfy growth, durability and succession planning.

I don’t imagine I am telling you anything new. I came to these conclusions simply by contemplating the business and considering the best paths forward. I imagine the Board regularly does the same.

Whatever choice is made, I urge members of the Board to individually invest in the decided outcome with their own personal capital. We outside shareholders who endow our faith in Board decisions fairly deserve to see such mutual faith abided.

Sincerely ...

-- END --

ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.

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