About Me

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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.

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. 

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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.

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 -- 

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.

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. 

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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.

Saturday, February 1, 2020

Thoughts on PESI from LCA Y/E Letter

Perma Fix (PESI) is one of the newer holdings in the Long Cast Advisers portfolio. I wrote about it in our year-end letter (link) and wanted to just focus on it here for interested followers. 

PESI operates in the nuclear waste remediation business through two segments.

The Treatment segment (62% of TTM revenue) is an asset heavy operator of low level and mixed low level radioactive waste facilities in Tennessee and Washington and a liquid waste facility in Florida. (Can go here and search by site ID for RCRA information or the links below for the company’s self reported information.)

Tennessee. Diversified Scientific Services (DSSI). Site ID: TND982109142
Washington. Perma Fix Northwest (PFNW). Site ID: WAR000010355
Florida. Perma Fix of Florida (PFF). Site ID: FLD980711071

Treatment is a capacity utilization business where volume growth offers operating leverage and non-linear margin expansion once fixed costs are scaled. 

Historical financials understate the true earnings power of this segment for two reasons: 1) TTM results are negatively impacted by closure costs for a facility ("M&EC") that is now closed. Excluding those costs, which are one time in nature, proforma margins are in the ~30% range. 2) PESI has never operated a strong Services component but now that one is growing, it can feed additional volume to treatment facilities, where incremental margins are +70%. In short, I think the earnings trajectory in Treatment may shift positively.




Concurrent with the closure of M&EC the company exchanged pf'd shares for common at $4.80, which served to simplify the capital structure. Furthermore, with the closure, the company received $5M from its insurer that had been held in collateral associated with insuring the facility, a benefit to the balance sheet and w/c. 

The Services segment (38% of TTM revenue) is a variable cost model. It’s essentially boots on the ground in Tyvek suits with picks and shovels plus engineering expertise, et al. This segment is benefiting from a turn-around under relatively new CEO Mark Duff, appointed in 2017, having replaced the founder who had run the company for decades. The growth in services has the multiplier effect of increasing waste volume to Treatment.




An interesting part of the Services turnaround in my mind is that the Mr Duff actually once ran and grew this exact business. A look at old filings and self reported biographies indicates that in the mid-2000’s until 2010 he was President of a company called “Safety and Ecology” where he grew revenues from $50M to $80M. He was running it when it was sold in 2008 to what appears a fairly schlocky public rollup called Homeland Security. He was gone however by 2011 when SEC was sold to PESI, which failed to sustain its growth (ie drove it into the ground).

After SEC, Duff was a project manager at the Paducah Gas Diffusion site, first for LATA-Kentucky and then for the Shaw Group / CBI JV that took over the site when that contract changed hands. Now he’s back at the original SEC and two years into a turnaround that is taking shape.

I'm writing a fairly abbreviated summary here. A lot of information is disclosed in the financials. One of the aspects that worried me during my d/d related to the growth in fixed price work on the Services side. Any company that goes into a new business under f/p terms is asking for trouble. However, as I understand it, this is not hard dollar / low bid / fixed price rather it's fixed unit price so there is limited risk of taking a loss on a services contract. 

And IMHO the pros > cons. The company has a lot of attributes I find attractive and various tailwinds to support growth. It is easy to understand and has a long operating history accessible for analysis. Its primary customers (DOE, DOD cleanup sites, et al) are spending money and re-letting contracts after a long lull, including potentially large contracts on which PESI is rumored to be a named sub-contractor.

Finally, large legacy contractors like Fluor and AECOM are selling / have sold their managed services businesses to private equity, who in turn I think are mostly attracted to the outsourced IT programs. This could create potential disruptions for themselves and opportunities for smaller companies like PESI, especially given its newly installed but experienced management team.

At current prices - after Friday's sell off - the company is valued at ~$90M EV. It trades at 1.5x TTM revenues, 6x TTM gross profit and 18x pro-forma EBITDA (after adding back one-time closure costs). This looks expensive, especially given AECOM sold their managed services division for 12x EBITDA. Some of the multiple is driven by rumours of the large contract I mentioned above. 

If we apply 12x EBITDA to just the Services segment, this implies the Treatment business trades for 1.5x sales and that’s hard to fathom. PESI’s Treatment business is one of three named contractors on DOE contracts to handle low level waste. The others are Energy Source and Waste Control. Those two tried to merge in 2015 a deal valued at 8x sales that deal was blocked on anti-trust grounds. I’m pretty sure 8x is not the right sales multiple for PESI’s treatment but in an environment like we have today, with increased volumes concurrent with high barriers to entry, it is likely worth more than the multiple inferred by comparative valuations on the Services business.

Regarding the sell off, I think the contract everyone is waiting for was supposed to be awarded by the end of January. It wasn't. Why not? There's a protest on a separate contract at the Hanford site, which is pushing out the schedule for other contracts. Overall, if they win the contract, it’s revolutionary but even if they don’t, the increased spending in general will lift all boats in the space. (But it would be better if they won). 

Historical figures are only good as a baseline and investors will make money on future results. What can this company look like in an environment where a large customer is spending again, there's some competitor dislocation and a relatively new management team that for the first time has Services experience? 

I think for the long term shareholder, it offers a wide success pathway and ample opportunity for returns even though current multiples don’t screen for value. But you should do your own homework. I'd be happy to hear what you find and I am always open to critique. 

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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.

Thursday, October 31, 2019

It all started with a song (LCA 3Q19 letter)

Five years ago Halloween I decided to start my business, and it all started with a song.

I was a month into a job at a hedge fund, a job I'd wanted for a very (very) long time but quickly realized wasn't going anywhere. And up on Spotify popped “When I Paint My Masterpiece” …

“Someday everything is gonna sound like a rhapsody,
When I paint my masterpiece

Someday, everything's gonna be different,
When I paint my masterpiece”

… and when I noticed that I was getting choked up, I realized I had already taken my first steps towards entrepreneurship. I was pretty terrified.

Two years earlier, I’d left behind a career as a sell side analyst, seeking a buyside role. While looking, I continued to invest on my own and gave voice to things I'd long thought about; consulting, public service, volunteering, parenting, etc. (Parenting is by far the hardest and the pay sucks but it's oddly rewarding for the rare moments your "bosses" offer gratitude).

Over that time, I'd met a handful of folks who’d started their own funds, some starting with $2M and growing it to +$25M (and beyond), others who had started with $2M and grew it to $1M (or less), everyone unanimously telling me it was the greatest experience they’d ever had. And everyone encouraged me to do it.

But I thought I needed experience first - took me a while to realize that was fear talking - so I got a job as an analyst, a job that lasted a month and a song.

That night I had dinner with a friend who'd started a few years earlier his own (incredible) architecture firm. He was like, “oh, yeah. It’s fucking terrifying. But go get your LLC and see where it goes.”

And that's what I did.

I had three primary tenets when I opened my business:

1. I want to solve a problem for my clients, not for myself. I wasn't doing this for validation, or to justify my existence. I needed to get a return on capital while offering something different and hopefully better than other available solutions.

2. I want to be available and accessible to traditional hedge fund investors as well as to people who don't normally have access to deeply researched, unique and unusual portfolios.

3. I decided back then (and I still say now), that if I saw signs of failure I’d stop and do something else. Failure doesn't just mean bad returns, which is inevitable from time to time, but failure to deal with stress, with OPM, with down periods and up periods, with the administrative rigmarole, with the professional aspect that you get up and do it even on the days you don't want to. Etc.

And now I'm four years in and I remain committed to those three tenets. There's still much to learn and my awareness is growing. I'm developing a deeper list of ideas, an important tool of portfolio managers, and continuing to keep my mistakes manageable. I've written about other thoughts in LCA's 3Q19 letter.

At the start, a lot of folks told me I'd fail. That's fine; failure is the baseline. Entrepreneurship is hard. I respect anyone of any stripe who starts their own business, including the oddly large cohort of folks around where I live with CBD infused pet food businesses.

Here's a sampling of things other entrepreneurs have said to me over the years ...

A friend who started a brewery: “my head is exploding every day.”
An old camp friend who is a serial entrepreneur and is one of the most upbeat humans I've ever met: “I look optimistic b/c I have to, but it’s so fucking hard”
A fellow fund manager whose daily mantra is "this shit is hard.”

... starting out takes a lot of support and persistence, some experience and undoubtedly some luck. If you're thinking about it, don't let fear hold you back.

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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.

Sunday, August 18, 2019

this shitty week in small caps, 2Q19 ($CTEK)

This might be a particularly urban experience, but do you ever order in from a restaurant where you've never actually eaten, then you drive by it and see a hole in the wall with dirty floors and it looks gross? I wonder how it changes the perspective of the food. If it's good, maybe you stick with it? Maybe it tastes worse next time? Or maybe nothing changes b/c it's good for what it does.

There's something about that perspective shift that resonates to me as an investing experience, especially after a tough week like this for so many small caps for myself and many of my peers also focused on this wee end of the market cap.

Cynergistek (CTEK) is a large holding of ours that debuted its new CEO, Caleb Barlow, on its recent 2Q19 earnings call.

When Mr Barlow's hiring was announced in July, the stock was at $4.80. Already declining going into the quarter on "rumors that a closing fund was liquidating" the stock fell out of bed during the earnings call when the retiring CEO Mac McMillan indicated that due to tough comps and delayed client contracts, sales in the back half would be down y/y.

The press release, filed the prior day, said nothing of this guidance as management chose instead to surprise investors ("surprise!") on the mid-day conf call. Now as of this writing it's at ~$3.05 trading for not much more than Book Value Less Goodwill & Intangibles.



Investors furthermore have no idea what last year's comps even look like. Earlier this year, in March, the company sold its large "Managed Print Services" division, a ~$60M sales per year business, leaving behind a smaller pure play IT svcs / cyber security consulting company with only $20M in sales. However, the company has still not filed pro-forma segment financials for this standalone pure play IT svcs company.

They've really thrown this new CEO into the fire! It's an unenviable environment I think brought on by amateur-hour preparation for the quarter and amateur hour thinking about capital markets messaging.

Or is this actually a gross restaurant? It's time to double down on research, (but it's also natural to rationalize).

CTEK has two lines of business ...

"Managed services" is a "relationship based" multi year services / consulting business to audit, manage and implement network or internet security procedures, mostly at healthcare institutions. This business has been slowly growing and is expected to continue to grow, sequentially and y/y. It is close to a recurring revenue and I think the company's primary focus.

According to the most recent 10Q this segment has $25M in backlog, up from $24M last year.


The second is "professional svcs" more simply a staffing company for IT security people, which is in a tight labor market. This is a lumpier business.

... the culprit for the quarter was the staffing business, which had a robust 2H18 that will not repeat in 2H19. Are customers taking their remediation work elsewhere? Has something changed with access to labor? Is it really just hard comps and management did a poor job messaging it? The contract business is growing.

I'm looking for answers - there's definitely a ton of competition in the space - but I believe a culprit is poor messaging during an interstitial handoff to the next CEO.

This is a sub $50M mkt cap company trading at 1.5x sales. It's on track to do ~$20M in sales this year. At ~40% gross profit margins equals $8M in annual opinc. The overhead is too large, with cash OpEx (S&M plus G&A) running at about $12M per. So they're losing close to $1M per quarter and have $10M in cash, no debt.

If they can grow and scale the cash OpEx, we win. They do this by delighting customers and offering hard to find employees interesting projects to work on.

If not, and they don't royally mess up, I think this could sell for $8 in a private transaction, assuming 15x multiple on $4M per year in EBITDA (after stripping out pubco costs and much of the G&A). But that assumes they're growing. I hear the new CEO is a "good guy" who knows how to solve problems.

But if they're really messing up, this cheap investment can always get cheaper still. And the thing is, the company has a long pattern of messing things up.

Going back five years, the company was named Auxilio and it was a standalone managed print services business to hospitals. Auxilio tried to expand into IT svcs with acquisitions in '14 and '15, spending about $5M in total. On both acquisitions, there was little realized growth and goodwill was written down within a year.

An activist Chairman got involved in 2016 to help it further and in January '17 it acquired Cynergistek, Mac McMillan's IT services / cyber security consulting firm, for ~$28M (1.2M shares of stock, a $9M seller's note and $15M cash funded by debt). A valuation of ~7x forward EBITDA of $5M, which never materialized.

The combined company changed its name to Cynergistek. The Auxilio CEO, who was expected to stay on, bolted to build a PE financed roll up in the managed print services space.

Mr McMillan, Cynergistek's founder who'd just sold his company and had eyes on retiring took over to run the company. In that process, he recognized that the two lines of business - MPS and IT security - brought together by the activist Chairman and touted as a winning pair, were actually way too much for this small levered company to manage.

In 2019, with urging at least from this shareholder, the company sold the MPS business back to its former CEO for $28M, enough to pay off the debt associated with the initial Cynergistek purchase.

... so in a way, Mr McMillan had his own private IPO sponsored by legacy Auxilio shareholders. Meanwhile, those legacy shareholders (if any have stuck around) own at roughly the same EV a smaller unprofitable IT services company instead of a larger low margin MPS business.

That history, I realize, offers ample reason to stay away. We all should want to avoid brain damage. But I also think knowing why people stay away is sometimes part of the reason to own it at the right price.

To be clear, some of that reason is that as a standalone they're not (even close) to as profitable as expected. This is doing 40% GP margins and still losing money on excess overhead. But at Book Value excluding Goodwill and Intangibles, for a company in a high demand space with low fixed costs, it could be a great price b/c IF they're getting the business right and satisfying customers, it can generate significant FCF.

It's still too soon to tell but I think the odds are favorable. In talking with folks who work in healthcare IT, I hear that demand is very high for the services they offer, though competition is also very tight.

As a small company investor, I buy when the ingredients are still in the kitchen and I think the chefs have know how, knowledge and time to bake the cake and still throw a good party somewhere down the line. That approach has to be based on due diligence to offer solid evidence of management capabilities. I've done some of this, it's always on going, and have heard independent positives about Mr Barlow. Not an empty suit at IBM. Understands the industry.

I've also worked in enough kitchens and prepped for enough parties to know that there are often points when you think "this is never coming together." And while the stock makes it look that way, certainly it makes it look like I've made an investment mistake, I think the mistake here is around transparency and disclosure, and I hope it's only made once. A lot of this could have been avoided if the company had just published the pro forma #'s calling out y/y comps offering more visibility rather than a surprise.

Beyond that, there were no surprises - little new information on the call - the core business remains too small relative to the overhead. They want to grow into big shoes. They have $10M in cash and so about two years to turn profitable. McMillan supposedly isn't selling his stock. If the operations are right and the new guy can grow, this is a steal.

Or this could be a terrible investment. The new CEO has zero pubco experience and running a tiny division at a large corporate is very different than running a tiny business. The activist Chairman is a poor look for a company that needs capital market and industry savvy. (This is the same person btw who once tried to open a business in California with someone who was barred from doing business in California, how's that for judgement). I can go on with the things that worry me about CTEK.

I'm reminded here momentarily - and apologize for closing on this tangent - of the time I thought it wise to write down all the things that worried me about my kids, just to get it out of my head. When I got to seven single space pages, I decided maybe it wasn't the best use of my time. The fact is, in life and in investing, there are always more ways by volume to go wrong than to go right.

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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.

Friday, August 2, 2019

"Mike Wallace is Here" + LCA 2Q19 Letter

I recently saw the documentary "Mike Wallace is Here" which was a rather impressive overview of his career and his impact on journalism. He started outside the field of journalism, as an actor and pitchman, but he found his calling in hard hitting 1:1 interviews, starting at Night Beat, and he developed his style at a time when most such interviews were fluff pieces.

Certain interviews were iconic, such as this one with General Westmoreland. Some were absurd enough to spawn spoofs like this one about fake novelty joke items on SNL

But two things mentioned in the course of documentary struck me as relevant today.

1. The idea that healthy independent journalism is a reflection of a healthy democracy.
2. The reflection of the interviewer as a surrogate for the viewer.

On this latter point, an un-aired clip from his mid-1980's conversation with Oprah Winfrey was particularly interesting. Despite their differences in styles and presentations, and there's a tangible iciness between them (typical, I think of Mike Wallace interview; Morley Safer interviewed him later in life and asked him "why are you such a prick?") both Wallace and Winfrey said they both felt like surrogates for their viewers.

I think this stuck out partially b/c it reinforces the reality that there are many (many) pathways to success - Winfrey and Wallace followed very different paths - but each one "got there" on the basis of their own identity, voice and style.

But it also reinforced part of what I see as my motivation for writing here: If it interests me, it might interest someone, and I want to promote that community of curious investors. It's partly also why I write letters to management (if I have questions, issues or concerns, so likely does someone else) though on those occasion I am much more tangibly a surrogate for my clients, to whom I act as a steward of their capital.

On that note of capital stewardship, I recently posted my 2Q19 letter on my firm's website, which includes a few comments on long time holdings QRHC, CTEK, DAIO, SIFY and INS.

I always welcome the (non-spam) feedback from this growing community.

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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.