About Me

My photo
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, November 2, 2022

On Tracking Tigers + LCA 3Q22 Letter

I recently attended a small retreat for fund managers where one of the guest speakers, via video presentation from a game reserve in S. Africa, was a lion tracker. He shared some point about tracking lions that had significant overlap with investing. I thought I'd share a few notes I jotted down ... 

Intuition drives the first step 

"Trackers sit in the tension of the unknown" 

"Trackers are energized buy the state of the unknown" 

Walking over the same areas multiple times offers opportunities to see new things more clearly 

Trackers develop narratives based on information but they need to be open to new information and open to re-calibrating those narratives. 

"We take in the macro (sounds, wind direction, weather) and integrate it into the micro."

When trackers lose a trail, they stop. Then reassess.  

... there were many more nuggets of information, and the guy was pretty inspiring, but I wondered how much more effective a tracker is vs simply hanging out at a watering hole and waiting. I suppose that would be the index investing analog to tracking a lion: Less fun, less interesting and though unlikely to have as high a success rate, zero effort utilized. Of course, if hanging out at the watering hole is just as good as the tracker, then maybe the tracker isn't so good? 

Our portfolio is having a pretty good YTD - here is a link to my 3Q22 letter - but whatever success I'm having rests heavily on lessons learned from 2020, which was a very hard year for me and our portfolio. It took me a long time to internalize the experience of significant losses and learn from it. I wrote about some of these lessons in my 3Q20 letter and these lessons very much inform my work as a portfolio manager today. I can summarize those lessons in three words: "IRR is everything."  

I started my business with significant experience as an analyst and zero experience as PM. I knew there was a lot to learn and seven years in, I've learned a few things beyond just the importance of IRR. It includes the importance of changing ones mind, limiting large losses, starting with smaller sized investments and growing them over time, buying on the way up or down, all in the effort to upgrade the lowest expected IRR company in the portfolio with companies with higher IRR's. Though I aspire to own stocks forever, the realities of managing a portfolio of SMA's is very different and occasionally prohibitive of that endeavor. 

I realize what I do is idiosyncratic and not for everyone. I'm still not earning what I would make if I were an employee, but it's all moving in the right direction, slowly and steadily. I love engaging my curiosity about the world through the lens investing and I believe I'm building something thoughtfully and step-by-step that I can do for decades longer. If I keep my head down and show consistency in finding companies that grow in value, the business will grow in value too, and create something of substance for me and my clients.  

-- END -- 


Wednesday, July 13, 2022

Richardson is Having an Interesting Product Cycle

This is a product-based thesis. The company, Richardson Electronics (RELL), long a “dog” stock with a lousy corporate governance structure, is having its day. It has a few new products that are finding eager audiences. These products include ultracapacitors to replace lead acid batteries in backup power systems (wind farms, telecom base stations, et al); lithium phosphate batteries to replace lead acid batteries in diesel engines; and magnitrons used to convert methane into diamonds (seriously).

“Why this? / Why now?” comes down partly to Maxwell’s demise under Tesla; partly due to ESG rethink of the use and pervasiveness of lead batteries; partly due to keen segment management by industry veteran Greg Peloquin, who returned to the company from Arrow in 2016; and partly due to the CEO’s willingness to fund odd and interesting projects.

The stock may be cheap for a number of reasons. Investors may assume growth is cyclical semi CAPEX related. The company’s long history of under-performance and poor corporate governance may lead to doubt and disbelief among otherwise knowledgeable investors. It is likely to fly under many investors radars and requires a bit of effort to understand. But the company seems to have locked up substantial supply of raw materials at reasonable prices and has a head start on competitors in what could be a large and durable niche in the uninterruptible power supply ecosystem and possibly beyond.

Introduction: Richardson Electronics (ticker: RELL), an electronics parts manufacturer and distributor, is a publicly traded family business. At the current price of $14 and with 14M diluted shares outstanding (Class A + Class B), RELL has a market valuation of ~$200M. Less ~$40M cash (no debt) yields an enterprise value of $160M. Given TTM EBITDA of ~$18M this yields an EV / EBITDA multiple of ~9x. It trades roughly in line with, if not at a slight premium, to its industry group but TTM sales growth of 30% is the highest among them and EBITDA has grown faster.

The electronics distribution business is operating in the midst of global inventory imbalances and a semiconductor CAPEX cycle. Knowledgeable but uninformed investors would wisely apply a low multiple to cyclically inflated sales for companies so exposed. However, the underlying thesis on RELL is only partially driven by current cyclical industry conditions.

This thesis is primarily driven by specific products the company offers. Broadly speaking, these products are supported by “a new age of electrification”. I realize it’s a weird thing to say 90 years after the death of Thomas Edison, but there is a shift happening on the margins resulting in changes in energy storage away from non-hydrocarbon sources and changes in generation from non-combustion sources. Wind and solar generation, hydrogen, lithium or various kinetic systems for storage, nuclear, etc.

How much of the total energy pie these alternative eventually provide isn’t known or even relevant; it is such a big pie that small changes are meaningful, especially to the component supply dynamics in the electronics industry, leading to changing demands for power management and power storage across the production chain. This is RELL’s wheelhouse.

Specifically, there are three product tailwinds of note:

1.   Ultracapacitors replacing lead acid batteries for remote backup power, et al. A lead industry website indicates that 86% of global lead production is for lead-acid batteries used in transportation, and also for zero emission and hybrid vehicles, back-up power (for example for computers and telephone systems), and energy storage in remote power applications. Global production of lead is about 12M tonnes and it is said that 90% of lead is recycled but this math doesn't seem to foot.  

How big is the lead market? I’ve seen (free) internet data that global lead sales is ~$20B and that global lead acid battery sales are ~$40B. How much of that is uninterruptible power supply? I am trying to find out, but don't think 10% is a conservative guess. A UPS system typically includes a lead acid battery as a starter. Given how we’ve "rethunk" lead in paint and gasoline it’s not a stretch that engineers would rethink its use in batteries, especially in an ESG dominated world. Ultracapacitors, which hold a charge longer than regular capacitors, offers an improved solution for UPS systems. 

These improvements are especially functional in wind turbines, which take a lot of effort to maintain. Each blade of a wind turbine has its own pitch control system so the blade no longer catches wind. Each pitch control modulator has its own backup power system. Vestas wind turbines control blade pitch hydraulically (in a fault, gravity does the work) but hydraulics are messy and prone to failure. Other manufacturers – including most GE wind turbines - use electronic systems with a lead acid battery as the backup power source.

The problem is that lead acid batteries require replacement every 3-5 years and degrade in extreme temperatures. There are opportunities to do better. Wind turbine owners are electing to swap out lead acid batteries for ultracapacitors, which last more than 10 years and operate consistently in wider temperature bands. An ultracapacitor need only store enough power to pitch a blade, which takes less than 30-seconds. Here's a short video from 2018 with a former regional sales manager at Maxwell (he's now at Licap). 

In May I attended the American Clean Power conference and talked to competitors, customers, OEM’s and installers all of whom affirmed this evolution. In the US based aftermarket wind turbine business alone, this is estimated to be a $300M opportunity (30,000 installed GE wind turbines x $10,000 / turbine). 

The opportunity to sell U/C’s into the wind farm world fell into RELL’s lap when Tesla acquired Maxwell for its dry capacitor business and shut down everything else. RELL (and many others) formerly sourced U/C’s from Maxwell. Forced to go elsewhere, it now has an exclusive supply agreement with Korean-based LS-Mtron for distributing U/C’s into the US “green energy” space. RELL is supposedly buying every U/C LS Mtron makes and at a significantly lower price than from its prior supplier. 

RELL US assembles the U/Cs into a form factor identical to the lead acid battery system and has a patent on this design. Former Maxwell folks have split into two separate companies (LICAP and UCAP, which acquired the old Maxwell business). They, along with Skeleton in Europe, are pursuing this market, all from behind RELL.

I think this market alone is enough to support continued growth and earnings from a low base. But taking a step back from wind turbines, when one considers how often a lead acid battery is integrated into a backup power system (at telecom base stations, to start a generator, etc) and that ultracapacitors last longer and need less maintenance than a lead acid battery, and that lead acid batteries are considered “dirty” in an ESG world, it isn’t a hard stretch to believe the ultracapacitor opportunity could be quite a bit larger than simply backup pitch control systems for GE wind turbines.

2.       Diesel electric engines replaced with lithium phosphorous engines. RELL has a supply distribution agreement with Chinese based Amolgreen to supply lithium phosphate batteries to Progress Rail – a division of Caterpillar – for integrating into rail cars. The sales value per car is in the six figures. RELL is one of the few US manufacturers with the capability to assemble these cells in the US, meeting “Made in America” purchasing requirements. The company believes that in-roads with CAT could bear fruit on additional machinery and implements.  

3.       RELL builds specially designed magnetrons that used to create synthetic diamonds from methane and for tire recycling. The specialty magnetron is an engineered solution where RELL has called out significant growth as per the 3Q22 earnings call (4/7/22): “For instance, on the magnetrons, in the normal year on the YJ1600, we build 800 a year. And we went from building 800 last year, we have orders for over 5,000 right now.”

In addition to these secular tailwinds, and as previously mentioned, there is concurrently a semiconductor CAPEX cycle, which is driven by both supply / demand dynamics (ie resolving “chipageddon”) and the effort to produce chips and components domestically. Chip making is a highly cyclical and high capital intensity business and development CAPEX will ebb and flow. The key is that I think most investors believe whatever is happening at the company today is mostly tied to the semi CAPEX cycle and missing the greater product related “secular” event.

History. RELL was founded by the father of current CEO Ed Richardson, who has worked there (according to his self-reported business biography) since 1961. Mr. Richardson owns 2.1M Class B shares, which convert 1:1 to common shares but has 10x voting rights. This situation gives him ~60% of the vote, a corporate governance red flag and therefore should be noted right off the bat.

Started in the 1940’s as an electronics overstock seller and distributor, the company moved into manufacturing through the 1981 purchase of National Electronics in La Fox IL – still the national headquarters - and it went public in 1983. Skip ahead to 2010: Over-levered, losing money and suffering from the transition from analog to digital TV, the company sold its core RFPD electronics distribution business – it’s largest segment - to Arrow Electronics for $210M, leaving behind a smaller company with two business lines: The “Electron Device Group”, focused on capacitors, vacuum tubes, and high voltage power supplies and an integrated display business (ie “Canvys”) focused on the healthcare space. (Expecting parents possibly saw the first glimpse of their issue on a Canvys display integrated into an ultrasound machine.)

In 2014, three years after the sale of Richardson RFPD to Arrow, the company rehired that segment’s leader, Greg Peloquin, who had been part of the sale, and put him back in charge of the EDG division, an effort akin to “getting the band back together.” The primary driver of this investment thesis is substantial growth and opportunity in this segment, now renamed “Power and Microwave Technologies” (PMT), and notably in ultracapacitors and magnitrons.

A homegrown third business line called “Healthcare” launched in 2016, manufacturing replacement tubes (“Alta 750”) for CT-scanners and MRI machines. This business has struggled due to OEM’s willingness to match replacement prices in order to protect long term service customers. This segment has been a drag on earnings and possibly as an acknowledgement of its poor market position, incentive compensation for the Canvys and PMT business leaders excludes performance at the Healthcare segment (ie 50% segment results, 50% corporate OpInc excluding Healthcare).

Status quo in Healthcare is not sustainable. Either of the two alternatives - success in pending product launches for Siemens machines or outright closure of the segment – would both be beneficial to earnings. I don’t anticipate any success here; any would be meaningful upside to what is already attractive.

Financials. The company’s fiscal year ends in May and it already preannounced FY22 sales of $225M, up 27% y/y, accelerating from 13% sales growth in FY21. Margins have expanded since 2H21 from the lower single digits to higher single digits. Backlog at year end was $200M, up 87% y/y, but this should be taken with a grain of salt, since the company has only recently started quantifying backlog. (Management says it was previously immaterial).

Management has indicated that backlog is driven primarily by volume, not price and not supply chain backup. The concurrent growth in sales AND backlog speaks to this trend. If these opportunities for ultracapacitors and magnitrons are as real as they seem to be and they are delivering on them as they seem to be, this will be worth substantially more.

FCF. It’s understandable for a company in the distribution space to use its working capital to fund growth by re-investing profits into inventory and receivables - that’s what distributors do – but RELL’s FCF conversion is lumpier than larger, well known and arguably better managed distributors. This probably speaks to the opportunity for better w/c management. Given the corporate governance structure, the CEO would need to find their own motivation to change. In the meantime, he’s buying as much inventory as he can b/c he thinks the market could be big

Valuation. The company is likely to do $20M in EBITDA this year, so the stock is trading at less than 8x FY22 results. Growth is largely driven by discrete products in the company’s portfolio and primarily tied to a secular “age of electrification”. If these trends continue and the company can indeed deliver, there’s an argument for this re-rate higher against higher forecasts. Given the importance of a few products on this thesis, and given the company’s long history of under-performance, I expect this asset will require a more than the usual monitoring.

Risks. There’s a tendency for investors to try to encapsulate risks as if they aren’t infinite. On the flip side, it’s not hard to worry unendingly about everything. Here are a few rational concerns at the top of my risk list:

As a family business, it is possibly not run to optimize for efficient manufacturing. A database search for “six sigma” or “lean manufacturing” within RELL documents showed zero hits.

Ultracapacitors don’t work / manufacturing is shoddy. This is kind of a new market and variuances out to be expected. Maybe turbines are the test bed, particularly b/c the maintenance is so onerous. But what if they don’t hold up? Also, RELL says its sole sourcing from a S Korean manufacturer that is new to the market and therefore reliant on a single supplier for a large market.

Limited history of value realization. For the many years the company has been around, results have been mixed. Over the last 20 years, you’d have seen growth in Tangible BVPS (see graph) only for the first 10, culminating in the RFPD sale. And the company has come across my radar over the over the years generally viewed as a “value trap” ie cheap without a catalyst. I think the poor corporate governance, the long history of under-performance, and the belief that growth here is all driven by a cyclical semiconductor CAPEX cycle phenomenon leads to the mispricing. However, underlying secular trends notably effecting the PMT group offer potential for a sustainable shift in earnings power that is not yet reflected in the price.

Corporate governance risk. For better or worse, the CEO does not make decisions 100% optimized for capital allocation and shareholder returns. The reality is, most CEO’s - and most people too - operate for the sake of ego gratification first and foremost and it’s the rare leader that puts the customer or shareholder first. My impression is that the RELL CEO cares deeply about customer and employee satisfaction but that has not translated into durable shareholder returns.

Changing tides on ESG. I don’t see anyone “standing up for lead” the way they do with coal or gas, especially given we’ve removed it from other products over the years due to its extreme toxicity, but anything is possible.

These risks can be ameliorated through portfolio management ie keeping the position size reasonable until pending deeper due diligence over time.

 -- END – 


Wednesday, June 8, 2022

capital losses is tuition in the school of portfolio management

So CTEK is selling itself for $1.25 / share. The company is in a “go shop” period until the end of June and still publishing contract announcements, so maybe there’s a higher price on the horizon but it's unlikely to exceed our cost basis. It will result in a permanent loss of capital. 

Owning this company (for this long) has been a terrible mistake. I say "has been" and not "was" b/c large portfolio losses have long tails, often why managers restart under new names after events like this. Not me. The only clients I've heard from are adding money, which is not a bad idea at the moment. War. Inflation. These are terrible times to invest, so valuations are attractive. 

Energy is an interesting environment. What seems different this time is that producers have financial flexibility to increase capacity based on higher, not lower prices, the scourge of past cycles. It is not an area we invest in, a view whose justification has been upheld by an argument lost many years ago to someone who isn't even a client, so possibly up for revisiting (as my son says: "money is money"). I'm in no rush to change but there was easy money in oil when it turned negative during COVID. 

Back to CTEK, I’ve written a letter to the Board reviewing mistakes - theirs and mine - and a public version of it is linked to here. (The private version was quite a bit harsher I'm afraid to say). 

A characteristic of SMA's run as if it's pooled capital is that purchases are allocated towards available cash, regardless of account. I make an effort to rebalance but - and i'm stating the obvious here - it is hard to know the "best and highest use of capital", ie choosing between A and B, at any time. That is of course portfolio management in a nutshell. It isn't easy. I generally think about upgrading the "worst" position in the portfolio: Which one has the highest risk of costing me money? Get rid of it. 

I've improved my portfolio management skills over the years, the tuition partially paid for by those CTEK losses. Given two paths for solving the complexity - either owning a little of everything or as few things as possible - I choose the "fewer" route and continue to endeavor to consolidate around best ideas, not b/c i understand them best but b/c I think their opportunity relative to their risk is highest. For accounts with constraints on cash, the CTEK sale frees up capital at less unattractive prices, to reallocate to higher return ideas. 

One new idea I am buying is in the electronics space; design, assembly and distribution. Component manufacturing is not historically a great business and it is possible that what I find attractive here is simply a semiconductor CAPEX cycle masquerading as a secular trend. But the hypothesis I am testing is whether the electronics space is experiencing "a new period of electrification" 91 years after  Thomas Edison died. 

I observe shifts happening in the way electricity is generated and stored. It might only be on the margin and the overall slice of the energy pie will likely remain overwhelmingly hydrocarbon and combustion based for the forseeable future. But energy is a big pie and small changes can be meaningful, especially when it bumps up against an industry that is historically static and commodity driven. I think we are still in early iterations of companies figuring out what works best. Wind turbines are improving. Solar farms are improving. The T&D grid has to improve. OEM's are building products that implement new ways of managing and storing energy. 

I think it's possible something big is happening with profound changes in valuation on the horizon for companies so disposed. I think the company we are presently allocating towards is benefitting from one such shift. Getting a read on an industry has to include looking at its biggest players so while I most enjoy burying my head in smaller more obscure companies, ARW's and AVT's are in the hopper. Will write more about this later. 

-- END -- 


Tuesday, March 22, 2022

An Observation on High ROE Companies and their Market Caps

Been awhile since I've written here. I've cooled on the blog to focus on my investment business, Long Cast Advisers, which continues to grow, slowly and thoughtfully. But the not-writing has left me with a hole of sorts. I like researching companies and sharing what I know with others who might be interested. Having been stuck at home with the fam basically the last two years, I can say confidently that folks around here are not interested. So I gotta put it "out there" instead. 

Figured I'd start with a quick review of hits and misses over the years, what's aged well and what hasn't, etc. I went back and briefly scrolled through old posts.  

What's working >> OTCM, CCRD (nee INS), QRHC and CCRN 
What's worked >> (all takeouts) IVTY, ARIS, SEV and CDI
What didn't >> FHCO, PSSR, ESWW and STLY 
What stings the most >> post on not buying OLED. (I generally regret most the things I don't do). 

FTLF gets a special call it. I sold it long ago but kudos to Dayton Judd, who recapitalized it and transitioned into a capital light and pure play brand now generating growth in profits and book value ahead of where it was before he took over. He understood the value of the brand and put the right investments behind it to make this all happen. 

Thinking about "the value of the brand and the right investments", I have stumbled on a chance to share a recent observation, which is a wide disparity in valuation multiples for small companies versus large companies that both have high ROE's. 

But let me take a brief step back ... With regards to finance, every few years there's some new / old idea and even occasionally new / new idea that takes the world by storm (CDO's and MBS, REITS and MLPS, SPACs, etc.) and promise juicy returns for investors. Often they do for some period of time, and certainly enrich the facilitators of these idea, but these rarely endure. 

But there's something foundational about active value investing where the less "new" the better. This is why timeless classics of investing are still relevant even if you've already heard them 1,000 times. I think adhering to the principles of value investing is what makes it so simple and pure, though one get lost at times looking at shiny new things. 

That's how I found myself flipping through Chris Mayer's "100-Baggers". There are always going to be stocks that go up 100x to great fanfare ... and then crash when no one is looking. This book is largely about the durable businesses that continue to operate to plan. It's not a ground breaking book, more of a tasting menu of other great books, and that's not a critique, it's just that the attributes of durable businesses that comprise 100-baggers haven't changed that much, so drawing on the "the Outsiders" and Joel Greenblatt and Michael Mauboussin, etc. is totally appropriate. 

For me it served as a simple reminder of the foundational principles of investing and one of those principles is looking for companies that have high ROEs. 

It's been awhile since I've done a simple "high ROE screen" but I got it in mind and fired up Sentieo's screening to look up companies with ROE between 25% and 45% and found something kind of crazy. Based on the data kicked out by Sentieo (which is sometimes quite wonky) on average, small companies with high ROE's trade at less than half the valuation multiples of large companies with high ROE's (and I included the median to account for outliers). 

This is just an observation. I don't think there's really enough data to draw firm conclusions as to why this might be the case and I don't want to fall into an anova excel-hole at the moment, though I'd be keen to explore how revenue growth might be a factor here. (Happy to share the data with anyone or collaborate on some deeper analysis). 

But my hypothesis is that larger companies whose brands are by nature better known enjoy the premium b/c investors believe the "moat" is wider and deeper, so easier to protect the R of ROE. One thing to note from this observation; investing in small companies with high ROE's might (might!) be a value trap unless there's a pathway to larger growth. 

Another thought is that from a high level, all business is "... a brand with the right investments behind it." That brand can be perceived or actual "better product quality, service, results, etc." Smaller companies are still developing those brands so there's more uncertainty to the brand value vs larger companies where the brand value is already established. 

And one final thought is the value available when a small company with an established brand that has endured years of poor investments gets taken over by someone who can put the right investments behind it. Like FTLF, or maybe that yellow pages company THRYV (which I don't know enough about). It was certainly part of the thesis behind the investment in CCRN and a few others over the years. 

- END - 


Thursday, May 20, 2021

on bugs and seeds (SANW)

We inhabit a world of bugs that has existed / will exist far longer than us and will feast on us when we are long gone. As a homeowner, I have my regular battles with the insect world. The termites get professional treatment; Chlorfenapyr indelicately pumped into the ground beneath my foundation every few years. But they always come back, b/c they smell wood and can't help it. 

On the ants, I use the NY State legal version of Fipronil, a nasty neurotoxin that workers bring back to their colony, feed to the larvae, and then the entire colony dies. It's brutal but they will have the last laugh. 

I bought the Fipronil direct from DIYpestcontrol, one of those sites that of course exists and of course has horrifying comments like "It's great!! I sprayed it all over my yard and now nothing moves!!" when the instructions call for sparing use in a few specific locations.  I think insects live a more deterministic life than we do but those comments beg the question: "Who in fact is the insect here, mindlessly consuming and destroying b/c they don't know any other way?" 

Both ants and termites trace back to the Crestaceous period, more than 100M years ago. They are born in dirt, feast on wood and other decaying cellulose (in the case of termites) or pretty much anything (in the case of ants), live as part of a colony and then they die. My house was built in their environment and I will fend them off, at least as long as I'm a homeowner. Thereafter, it'll be someone else's responsibility. 


I didn't set out here to write about insects so much as technical bugs, specifically one related to this blog. Feedburner is turning off email subscriptions, so if you subscribe, thank you, first and foremost, but be prepared that at some coming date, I think in July, new posts will no longer generate emails. 

I'm sure there is a workaround but I haven't bothered to figure it out yet. I'm now five years into running an investment management firm and my clients get most of my attention. If you're an accredited investor, I'd love to connect since I'm at a point in my business where I feel comfortable expanding my customer base, but anyone can sign up for quarterly letters through my website: www.longcastadvisers.com. 

In my last letter, I wrote about two companies and in this here penultimate blog post before the subscriptions get turned off, is what I wrote about S & W Seed. 


You likely notice we’ve been purchasing S & W Seed (SANW), a producer and manufacturer of agricultural seeds. At current price of $3.90 and with 34M diluted shares and $50M in debt, SANW has an enterprise value of ~$180M. Against trailing 12-month sales, this infers a 2x EV / sales multiple which is in the mid point of the 1x-3x range typically seen in the industry space. 

My interest in the company was piqued b/c I was looking for something that would work as a potential commodity hedge against inflation, and agriculture tends to do that. Digging in, I saw two broad attributes that make this company compelling. 

First, agriculture unfolds over a time frame that is utterly foreign to Wall Street – 6 to 8 year development cycles, limited by growing seasons – and that makes the company largely uninvestable to anybody but the most patient investor. It’s perfect for us! Second, the company is coming towards the end of a product development cycle with three new products to be released in the next 24 months. These will be the first new product launches since the company altered its strategy about six years ago. 

By way of backstory, back in 2015, SANW was pretty close to a pure play on alfalfa seeds and Saudi Arabia was its second largest market. Then, in the midst of a drought, the Saudi monarchy decided to no longer grow domestic alfalfa. 

The company had a large shareholder, noted small cap value investor Michael Price, who owned a ~10% stake in the company and he brought on the Board Mark Wong, an agriculture industry veteran who had previously built, grown and sold companies in the industry and in his retirement, ran his own ag business “for fun”. The company was already in the process of a slow pivot to diversifying its products and end markets when Price asked Wong to take over, which he did, in June 2017, with the understanding that the pivot would take several years and require a significant capital commitment from Price. 

We are now four years in. Price, through various stock offerings and capital raises, now owns ~50% of the company. The share count has nearly doubled to 34M diluted shares but revenues are roughly where they were in FY2017 and to the outside observer of financial statements it would seem like nothing has changed but the destruction of capital. 

What has in fact changed is a significant investment to diversify to “secondary crops” such as grain and forage sorghum, sunflower, pasture seed, stevia and alfalfa with key markets in the US and Australia. The diversification was enabled through various acquisitions including of two distressed businesses, Chromatin out of US bankruptcy, which delivered a sorghum portfolio, and Pasture Genetics, Australia’s third largest pasture seed company, while Australia was in the midst of a drought. Both were acquired at roughly 1x trailing sales. 

One further consequential change to the company was that it previously operated under a distribution agreement to sell its alfalfa seeds through the Pioneer brand, which is owned by Corteva. In 2019, Corteva wanted to bring this brand back in house and agreed to pay SANW $70M to exit the distribution agreement, essentially pulling forward the remaining term to one year. The implied valuation on the sale of this product was 3x revenues. Buying at 1x and selling at 3x might be a theme of the way CEO Wong runs his business. 

To date, there is little on the income statement to show for all this diversification. However, backing out Pioneer, the remaining “core” business grew revs 54% in FY20 (year end June 2020) and 27% YTD this year without even hitting the peak season (winter and spring in the northern hemisphere). The key is that most of the major investment is done. If the products find a market, there is significant room for rewards. 

The three products expected to commercialize in the next two years are all non-GMO by US standards (which to be fair has pretty weak GMO standards) and include a low lignin alfalfa that is easily digestible to dairy cows (and therefore potentially able to lower methane waste), an herbicide resistant sorghum and most compelling a dhurrin free sorghum using technology licensed from Purdue University. When one considers land use, water use and potential carbon offsets related specifically to forage crops, there is a lot of potential for this company to be where the puck is going, realizing that in this industry, the puck and the company move very slow. 

If any of these product launches work, this business becomes something completely different than what it appears to be today and what it has been in the past. Ultimately, the goal is to create a company that can dominate secondary crops the way the big four (BASF, Corteva, Monsanto and Syngenta) dominate the primary crops (corn, soy and cotton). Since it takes so long to develop a product, any success would be protected by a wide moat and would appeal to these larger companies for an acquisition. I’ll add below a comment made by the company in its most recent shareholder letter: 

Stocks in this space tend to trade at 1x-3x sales and we’re currently buying it at the midpoint of this range on a trailing basis and without the benefit of new product launches. If they’re successful – and this management team has a history of success – I think this easily fits into our threshold of three to five year doubles. In short, I see this as a small cheap bet on the potential for something becoming much bigger that would unfold over time. 

-- END -- 


Monday, December 7, 2020

A Brief Look at Nurse Staffing

For the tl/dr crowd >> Writing about Cross Country Healthcare, a nurse staffing company. At the recent price of $9 it has a market value of $325M. With $53M in net debt, an EV of $380M. Trailing revenues are $836M compared to $816M in FY18 and $822M in FY19. This isn't a growth story it's a mature business that's been under-managed for decades whose founder has returned after a +20 year hiatus, a time period that included several significant entrepreneurial successes for him, including in other biz services. His last mgmt role was a PE roll up sale to CCRN's largest competitor AMN. Already seen SG&A decline from $180M / year down to annualized $160M / year. COVID has helped speed this up + brand reductions (from more than 20 to 1) + new investments in technology. Mgmt target doubling EBITDA margins from 3% to 8%. Not an aggressive reach. Largest comp AMN is a 10-year 10x via levered acqs. Under new and experienced mgmt, this can too. 


There are many ways to think about a company and structure an investment narrative, for better or worse, and rightly or wrongly. Like plastic bags, narratives are easy to construct and hard to get rid of, and they drift around our minds long after they've outlived their purpose. An investment narrative that wraps too tightly and explains too much doesn't leave room for the reality of life and its inevitable surprises. One held too dearly exerts a gravity on perceptions and pulls objective data into an orbit of conspiracy. Investors need be cautious with their investment narratives as one is cautious with a box cutter;  inadvertently left open it can cause harm.  

I'm particularly cautious of narratives around heroic CEO's who turn companies around b/c the deux ex machina is a prop of theater not an investment thesis. But despite all this, here I am thinking about Cross Country Healthcare (CCRN), which strikes me as an opportunity given its new entrepreneurial CEO, who also happens to be the company's co-founder. 

In the mid-80's, Kevin Clark co-founded this specialty nurse staffing company with Joe Boshart and then left after it was acquired by WR Grace and subsequently passed into PE hands. Boshart, the other co-founder, took it public in 2001. William Grubbs, a staffing industry lifer, took over as CEO 2013 to 2019 (he's now Chairman at Volt). And now this +30 year old company is on its 3rd CEO who happens to be the co-founder.  

Clark's long interim history is worth noting. He was CEO of Poppe Tyson in 1997 and saw it through the merger with Modem Media in 1998, establishing himself as an executive in the early digital marketing world. His self reported business bio shows a string of other entrepreneurial leadership roles (I think he fell in with the PE crowd and was a go-to CEO for a variety of firms). 

Most recently he lead the roll up of Onward Health, a Welsh Carson backed firm that included nurse staffing, physician staffing and a SaaS vendor mgmt system, and was sold in 2015 to CCRN's largest competitor, AMN Healthcare, the only other publicly traded company in the medical staffing industry

What's most appealing is that the staffing industry - a low fixed cost "your assets leave everyday" kind business - especially favors entrepreneurial management and this is particularly important given Clark's history of success in the industry and related fields relevant to the industry. He brings that experience to a business that operates at scale - it is the 5th largest nurse and physician staffing firm in the US - but has never been managed aggressively.  

I covered both AMN and CCRN as an associate 2004-2006 and back then CCRN was always the smaller and not-quite-as-put-together as AMN. Until late last year, I hadn't looked at either in ages, but with COVID, I could see a need for helping hospitals staff emergency medicine, so I took a look. I saw that AMN has been a 10-bagger over the last 10-years and CCRN has done nothing except continue to exist at scale. And it had a recently appointed new / old CEO returning after a +20 year hiatus.  

Given the new CEO, there is little relevance to the company's long term history except that it's pretty consistently been a low margin business with little organic growth. The company is also poorly diversified with 90% of revs and 95% of OpInc from nurse & allied staffing (even pre-COVID) and nominal contribution from physician staffing and search. 

Recent history shows higher returns and improving TBV / share - a sign of value creation - but it's hard to pin that short term success on any one thing Clark has done, particularly given how skewed the market is from COVID. The point is, what he's done so far, very little shows up in the financial statements.  

When Clark joined the company in January 2019, it had over 20 brands and more than 60 branch locations, the results of unintegrated acquisitions and years of under-management. He's whittled the company down to one brand and ~15 branch locations (taking advantage of wfh to close branches and reduce the company's RE footprint). These are the kinds of things that a reasonable manager does. The resulting writedowns make recent financials somewhat "noisy" but have an expected impact of $20M in annual cost savings. Already on a quarterly basis SG&A has declined from ~$45M to ~$40M indicating some success with this endeavor. That shows up on the income statement but is masked by the headwinds of COVID.  

Then there are investments in new technology - even through COVID - at a pace, one gets the picture, that hasn't been done before at the company. The benefits of a new technology stack by someone who has experience doing such things, and with experience in the industry and with experience in turnarounds, offers a variety of ingredients to success. Again, none of this shows up on the income statement. 

COVID casts a pall over everything.  Charts below show volume and price metrics for nurse staffing (left) and physician staffing (right). Staffing is a bill / pay spread business and the impact of the pandemic sees declines in nurse volume offset by increases in price and no seasonal uptick in the physician side, probably b/c nobody is going away on vacation.

With little to observe about CCRN under the new CEO, let's take a look at its largest competitor, AMN. Over the 10-years where the stock price increased 10-fold, it added specialties and technologies to sell to hospitals, including the 2015 acquisition of Clark's last company and most recently an acquisition in the telehealth space. 

Looking at some summary data below, one's eyes no doubt, if they don't gloss over or go cross eyed, will eventually be drawn to growth in EBITDA margins and in returns punctuated by jumps in debt / equity and negative TBV / share. 

One would correctly draw the conclusion that this company engages in debt funded acquisitions of higher margin services, not a bad way to operate for a low fixed cost, services based, cash flow generating business with cheap access to capital. As a result of these acquisitions, AMN is much more diversified, perhaps why AMN is a darling of the two companies. But before it started its acquisition and expansion efforts, it looked a lot more like CCRN.  

CCRN shows no such evolution, yet. But what if it could? What if with the right technology platform and targeted acquisitions, the types of things the CEO has done before, CCRN, which is relatively underlevered, could acquire higher margin ancillary businesses? Why wouldn't it, in the right hands, be able to copy the AMN playbook, even at least partially? 

The downside is that this mature company remains consistently a no growth, low margin value trap. The upside however offers the opportunity for significant returns. With changes by the new CEO and more still to come, I think the patient investor could experience the benefits of these returns over time. 

-- END -- 


Saturday, July 11, 2020

on small adventures

Happy Post July 4th holiday, everyone. I prefer Constitution Day (9/17) over Independence Day as the Constitution contains the road map for governing a democratic society, versus the Declaration of Independence, which is more of a war document. But who would say no to BBQ and fireworks?

Worth noting here that within both these documents, the word "freedom" only shows up once, in the First Amendment: "Congress shall make no law ... abridging the freedom of speech, or of the press."

These two documents, built on compromise and sacrifice, shape and form our country's intangible assets of "life, liberty and pursuit of happiness" and the tangible assets of a democratically elected government with built in tensions on account of "balance" between three independent branches. They formed our country as a new experiment and provided a road map for other people's pursuit of self governance.

I've served on a few boards (coop, PTA, sports leagues) and just those small cases reveal how hard is self-governance but also how tension and conflict can lead to better decision making.

How each generation resolves those tensions is how we measure up or fall short from any guidepost of american exceptionalism. I see no better example of how far we are falling short than the hilarious / hideous video of wealthy white people screaming at and screaming past each other in a neighborhood aptly named "The Villages". It sums up what seems to be a zeitgeist of national schizophrenia.

I've learned a bit about that disease reading my friend Bob Kolker's book "Hidden Valley Road" (highly recommended). He writes early on: "Schizophrenia is not about multiple personalities. It is about walling oneself off from consciousness, first slowly and then all at once, until you are no longer accessing anything that others accept as real." It is a sad and debilitating disease.

I understand the Constitutional Convention of 1787 had quite a great deal of conflict itself, comprised of the same white and wealthy demographic as "The Villages" (sans women), but at least our forefathers had a loftier goal in mind. The goal now seems solely "politics as circus."

The modern day Village is a dark and dysfunctional place, lacking respect and full of contempt, egged on by those whose sole incentive is to fan their followers' emotions with little regard for long term resolution. All of this is a luxury we can ill afford at present and is certainly not a sustainable foundation for healthy governance.


Oh but those emails ...

I was never much favorable to Madame Secretary until a friend of ours and fan of hers asked in 2016 to have a conversation to re-assess my views. I will always welcome a conversation of self reflection, (especially about stocks), and I came away with a reformed view on how much gender bias shaped my perception.

Here was a woman from a fairly conservative family, raised in the 50's and early 60's, smart, precocious and ambitious at an early age, likely aware and reinforced that for a woman to get ahead, she simply can't show emotion. And so she didn't, not through all of the shit thrown at her, deservedly or not, over the last 30-years.

Rather, she was steely and tough. She hid from view or suppressed as best she could any vulnerability. I came to view her as a modern day Marlboro Man, the strong, silent mythological male (in modern times, that silence hides the dysfunction of someone who can't access their feelings). In her case, I think it created an incongruency in what we normally expect from a woman.

I don't know if she would have won if she were a man - her campaign had issues on its own - but I'm confident she would have been more accessible in conforming with people's expectations. Coincidentally, we ended up with male president who almost comically doesn't show vulnerability and has the dysfunction of someone unable to access their feelings. But hey, he puts on a good show, a recurring victory of style over substance.


I didn't intend to go off on this tangent so let me return to the matter at hand, the small adventure that is the market since March. I wrote early into this crisis in a letter to clients ...

The sun will set tonight and rise tomorrow and eventually calm will prevail again in the markets. For this reason I have been putting cash to work adding to existing holdings or buying other well positioned companies that fit our investment profile. In three years time, I think there will still be consumers and entrepreneurs; franchises seeking to recycle and compost waste; hospitals in need of outsourced IT services; there will still be credit card transactions; and airports and weather; etc. 

The old saying “you know who’s swimming naked when the tide goes out” comes to mind, as this decline may reveal which businesses and what funds are over leveraged, over margined and unsustainable. But skinny dipping is fun and I don't want to pick on it.

As we think about the beach, I'd rather remind bathers - beclothed and bare - how to survive a ripcurrent. I imagine getting pulled past the break might be terrifying but the worst thing to do is panic. Either swim parallel to shore, or tread water and float since the circular nature of the current may shortly return you to shore.

... and lo, for those who did nothing, the market brought us back close to where we started.

Painfully, this hasn't been the case to date for the small companies in our portfolio. "Ours" means mine and my clients, my wife's, our friends, my sister's retirement savings, the institutions and individuals who entrusted me with stewardship of their assets, all totalling roughly $5M in AUM at the beginning of the year that has diminished on paper by roughly 20% as of this writing. It's a hard feeling to underperform. Navigating the analytical vs emotional process is part of the parcel.

Our portfolio is skewed towards services companies, which are asset lite and have operating leverage. They solve important problems for their customers such as cyber-security planning, nurse staffing or managing waste streams. "Man hour labor" businesses tend to lead cycles; first in / first out. They have the capital to survive and while patience is trying at times, I am a long term investor in sound businesses at reasonable valuations. I expect they will endure and grow in time.

Through this adventure I've been thinking about one of my favorite stories of survival, that of John Aldridge, the local Long Island lobsterman swept off his boat in the middle of the night and 40 miles at sea.

As I re-read that, it got me thinking about stories of people getting lost, which is akin to the feeling I get trying to make sense of this market that is supported by QE^n and the never ending stimulus. I feel lost trying to reconcile market valuations with municipal budgets, declining GDP and missed mortgage payments, etc. (Here is a funny blogpost by Frank Martin who also trying to make sense of it all).

I read about Geraldine Largay who got lost and died in her tent not far from the trail and less than 200 miles from the end of the Appalachian Trail. I remembered reading about two teenagers who got lost and died when they were overcome by a fogbank while kayaking off the coast of Nantucket. It eventually inspired a book about navigation by Harvard physicist John Huth who was coincidentally lost in the same fogbank but survived. And the story of four tourists travelling in the US in 1996 that got lost in Death Valley National Monument and how their remains were eventually found.

There is a recurring tendency for people who are lost to panic, to seek action, to move. And then, either b/c one leg is shorter than the other or there they are not paying attention, they end up walking in circles.

The key is that when you're lost, you don't panic. The Boy Scouts teach "STOP" (Stay calm, Think, Observe, Plan). Why would someone need to be reminded to think? B/c gripped by panic, it's usually the first thing to go, and if you can't think, you won’t be able to find a reference point to re-orient or work your way out of the problem.

One way I've found to work my way out of the problem of the market adventure is to find new ideas. I'll spare the trouble of re-writing what others have done so well and suggest reading about $SMIT by @Deep Value Observer on twitter (I thought I was one of only people in the world watching that stock) or the MicroCapClub forum on $LSYN (I agree mgmt stinks but the podcast business continues to grow and activists are still engaged; what could this look like with a competent CEO?).

I also go on my own adventures and take day hikes up in and around nature. It is as accessible as the outdoors and with summer foliage even city parks offer lush vantages that hide the presence of man.

The Patient Investor's family recently took a day hike up in the Adirondacks. Walking through a wooded trail, climbing a summit, focused only on the surround sound of nature and the placement of the next footstep, it was easy to access a sense that we are all working for something bigger and grander than ourselves.

It's a universal feeling I think, but one too often tethered to a cause or belief. As comforting as certainty may feel, once we cling to it, we are anchored to an idea that can crowd out reason and create new biases. Uncertainty in contrast, a base principle of science and investing, is a bit harder to pin down. But learning to live with it and the knowledge that maybe we are all a little lost at times is itself a victory of substance over style. 

-- END --