I received an email from a young investor telling me he'd closed out of a common position we both held and had briefly shared research on over the last year.
He wrote to me, on why he sold: "I may be making a mistake down the road, but I could not get over the some of the risks surrounding broker/dealer requirements to keep the stock listed. This was a large position in my account, so the risks seemed magnified."
I am not one to judge. people sell for all kinds of reasons. he seemed like a nice kid who'd done some digging and we shared an interest in offbeat names. And I think he sent the email from a good place; he was sharing, and that's nice.
but i didn't know what to do with the information, and so i was bothered by the email. I still can't put my finger on it. i ended up quibbling with my wife, who'd texted me like 30 seconds later about dinner (that was assuredly not the right response).
a lot has changed with the company in the last year - it de-registered in April and hired a new, young (but experienced) CEO at year end - but nothing that initiates action now.
maybe if it were a reason i'd understood, it would have given me an opportunity to learn, think, review, or discover a new angle on the investment prism. instead, it felt like an affront. I don't know why? i know it wasn't intended that way. i think I didn't know what to do with the information.
i should have just deleted it, but i hastily penned him the response below. he politely and gracefully acknowledged it when he could've told me something else ... but when i reread it, i think it's pretty good advice for kids starting out as investors wall street, so i decided to post it here:
"A-
I appreciate that you told me you sold, though it was unnecessary and it has no impact on me.
But I'm writing here very much in reaction to something that's bugging me ...
you write on your SZ profile that you're fans of Mike Burry and Seth Klarman
And that you're a deep value investor
And that you read margin of safety
... And all I got to say is: "talk is cheap."
You've sold a stock you've held for maybe a year for a reason that makes absolutely no sense and based on this information - all the info I've got - you're not only failing on the long term deep value front but you're also not honestly reflecting on what you're doing and why. your reason for selling makes no sense to me.
lookit, I know nothing about you. maybe this is way off base. maybe i'm just a voice in the mist, but you might want to seriously take a long hard look at this experience, figure out for yourself with honest self critique what went wrong, what you can learn from it and how it might effect you going forward.
there's a lot of things we can do with our lives time beyond investing. whatever it is, if it comes from deep inside, from a place of passion and obsession and love, then you're in the right place. and I urge you b/c you're young, take your time and figure out what that is, and do not stop until you get there. it's worth the effort.
seth klarman and mike burry don't give a shit about you. Plus I bet there have been many days when they wish they were someone else. If you're putting them on a pedestal b/c they're rich and successful, then you're doing it for the wrong reason. [And] if they're your heroes b/c they did extra work to make sure they were right and stuck to their guns when everyone else said they were wrong, then you've just failed your test.
that's my best effort to be like "good luck, kid"
/ Avi"
... and I meant that, the good luck part, figuring it out and all that.
it takes a lot of practice learning to do anything and investing is no different. but learning means making mistakes. so beginners should start small and take time figuring out their tolerance for pain and risk and then use that as a guide to the questions they need to keep asking.
the way i see it, the more you know, the better you can establish an appropriate price for a stock, understand why it doesn't trade at your price and figure out what it will take to get there:
who are the customers?
why do they pay for it?
what would make them change their behavior?
how does the company make money on this?
etc
and then with more practice and observations, you might start to see patterns emerge where your research leads you places you didn't know, b/c you kept an open mind, and you asked more questions and dug for more research.
or it takes you to a place where you find other people investing in the same things and you are suddenly a victim of confirmation bias: "oh they're doing it, so i feel better." sometimes it's better to seek out people who disagree with you.
finally, there are so many angles to investing. but having a good post mortem is a great tool. keep a collection of your investment decisions (this is mine, here) and then reflect later on what went right and what went wrong. it can be very helpful in scaling the learning curve.
improvement is not automatic and no one is an expert in everything but if you love this, and carve out a place for yourself, and can maintain the intellectual honesty to reflect back on what's going right and wrong, then it just gets back to the theme that underlies this blog: patience.
it's tough - as someone just told me - when you commit capital to an idea that does nothing. capital is the air we breathe and our great passion requires a lot of it. start small, be patient, don't go bust and if investing it lights a fire for you, you'll find endless opportunities to learn.
- END -
THIS IS NOT A SOLICITATION FOR SERVICES OR ADVICE ON BUYING OR SELLING STOCKS. I DON'T KNOW KLARMAN OR BURRY OR THEIR FEELINGS ABOUT YOU. THEY MIGHT ACTUALLY GIVE A SHIT!
Friday, January 22, 2016
Monday, December 21, 2015
The patient investors' year end review (with add'l comments on $FRMO and $SEC.TO)
The end of the calendar year is upon us. A time to reflect on the prior year and ahead to the next with plans and "resolutions". I wanted to take a moment to do the same.
I wrote 34 posts in 2015, starting with a review of Betterment for my sister and an observation about the how Wall Street and the Philadelphia 76ers both sell "the wonderous future" while delivering sub par results.
The year included commentary on 14 separate stocks by my count in various levels of detail and analysis. I write about what I like most and know best, observing that I wrote most frequently about ARIS, ESWW, FHCO, FLTF & STRL.
When I find new ideas to write about, I will. I don't know how this blog will evolve in the future but it has more than a handful of readers that are not robots (unless of course we are all robots). I continue to enjoy writing it and most importantly it helps me organize my thoughts.
Beyond the blog, this was the year that my company, Long Cast Advisers, achieved registration as an investment adviser in New York state and started taking clients. I opened an investment account under the name of the LLC during the year to start to establish a "professional track record". That account initiated investing in June 2015 and is up 11% as of this writing vs. the SPX - 4%, the RYO (Russell 1000) -5% and the RTY (Russell 2000) -11%.
The time frame for these results is too short to be relevant but I think the inputs reflects the themes and processes that are critical to the long term success as an investor, which are patience, in depth research and portfolio concentration.
As of this writing this "professional" portfolio is comprised of six stocks: ARIS, FHCO, FRMO, FTLF, SEC.TO, and STRL. ARIS and STRL are the biggest contributors to gains and nothing has been a terrible detractor. In football parlance, turnovers kill drives and we've had no turnovers.
Two of these stocks - FRMO and SEC.TO - are very recent additions to the portfolio. I haven't written about them, because all they are are balance sheets and balance sheets are complicated in a boring sort of way. In this case, you just to read a bunch of filings. Both are investment managers, one trading at 2.5x book value the other at 0.6x.
The expensive one is managed by Murray Stahl and he needs no introduction. He writes on issues related to finance and trends in tradeable securities such as ETFs and the opportunities that arise when their algorithms are in phase. He also writes about specific stocks in a subscription newsletter I hear about. He thinks into the future and two specific investments on the balance sheet - exchanges, to be precise - attract me to the stock even at these multiples.
One is the Minneapolis Grain Exchange, which he started acquiring in 2014 and just had its highest volume month. He's also been buying seats on the Bermuda Exchange because he says it's the largest market for Insurance Linked Securities.
These assets - and a few others - are readily discussed in his shareholder letters and quarterly reports. I think of exchanges like payment platforms that generate cash on the backs of someone else's hard work (though when I think about it, what business isn't a payment platform, and if it isn't, why is it in business?) These particular exchanges may be wonderful cash machines if the volumes continue to grow. I imagine whoever has been the selling the stock lately has a shorter term focus than I do.
The 0.6x investment manager is Senvest Capital, managed by Richard Mashaal of an entity his father Victor Mashaal started.
The company is essentially the Mashaal family office fund, with ~50% of the stock owned by pere et fils. Returns are down down 12% this year but they grown equity from $284M in 2011 to $821M in 2014, or 43% CAGR vs ~18% for the S&P. Equity at 3Q15 remains is around those 2014 levels.
I doubt they are going to continue to grow SE by 43% CAGR but they take big long term bets on parts of the small cap market that I don't have the bandwidth to analyze deeply and I want to get a sliver of exposure to it at a discount to book value.
I think about the both of these companies like "investments in the minds of ..." stocks. Other stocks of this type that I've looked at include Biglari Holdings at 1.4x book, ALJJ at 2.9x and Greenlight Re at 0.8x where funds have returned -20% YTD. (I like on the GLRE website it says the "investment accounts are managed by DME Advisors LP" as if we don't know the manager is David Einhorn. I wonder if it says his name in up years?).
It's possible that SEC even at 0.6x is a terrible investment. It's on the radar simply b/c it hit a bunch of home runs in a few good years and this isn't really the picture of steady consistency. Also, they've been reorganizing their structure and adding a presence in NYC, ie expanding which most certainly means more G&A and potentially means they are confusing luck with intelligence. But if it's successful there's a lot of sizzle on the steak and you're not paying a lot for that option.
All of these companies in my portfolio I'm comfortable owning for the long term, though FHCO will require some changes in their consumer strategy, their capital allocation strategy or simply a change in management to work. That is something I want to figure out how to address.
And then there is long list of stocks on my radar for deeper analysis, etc. It hopefully never ends. When I get my teeth into an idea, time disappears. I am grateful that I get to do what I love.
Beyond stocks, I'm trying to figure out the fundraising aspects of the firm (from smiles to teeth gnashing). It is a quandry for every new business, but especially in the investment management world.
The difficulty is explaining what differentiates me from everyone else who says they're patient long term investors, and that's essentially ... everyone else. And then as well how to package my product without hype and deliver a message with integrity that resonates beyond just "growing capital" and "a solid foundation of wealth" and other white bread bullshit. It needs to pull together a lot of je ne sais quoi themes that resonate with me and hopefully with clients, like the "where are the clients yachts" concept, the dangerous stupidity of the biz-fo-tainment industry, the impact and attitude of thinking like an owner and not just a shareholder, etc. I'll figure it out at some point.
The goal of the service is investing client funds in a portfolio of small cap stocks that will outperform the market with lower risk. It sounds so easy on paper but as I've transitioned from doing it as an amateur personal investor with a diversified portfolio of hits and misses to a professional and concentrated portfolio with hopefully many more hits than misses, I can see that this endeavor - both the investing side, the marketing side and the business administration side - is one of the hardest things to do well and with enough consistency to prove that it's not blind luck. I hope to prove it over time.
I'll conclude by thanking allthe you readers - including the robots (01110100 01101000 01100001 01101110 01101011 01111001 01101111 01110101) - for their your participation and hope this blog has added value to them you, as an investment tool, or as a way to consider new ideas in the world of small cap equities, or simply even to pass the time.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. DO YOUR OWN WORK BEFORE INVESTING IN EQUITIES.
I wrote 34 posts in 2015, starting with a review of Betterment for my sister and an observation about the how Wall Street and the Philadelphia 76ers both sell "the wonderous future" while delivering sub par results.
The year included commentary on 14 separate stocks by my count in various levels of detail and analysis. I write about what I like most and know best, observing that I wrote most frequently about ARIS, ESWW, FHCO, FLTF & STRL.
When I find new ideas to write about, I will. I don't know how this blog will evolve in the future but it has more than a handful of readers that are not robots (unless of course we are all robots). I continue to enjoy writing it and most importantly it helps me organize my thoughts.
Beyond the blog, this was the year that my company, Long Cast Advisers, achieved registration as an investment adviser in New York state and started taking clients. I opened an investment account under the name of the LLC during the year to start to establish a "professional track record". That account initiated investing in June 2015 and is up 11% as of this writing vs. the SPX - 4%, the RYO (Russell 1000) -5% and the RTY (Russell 2000) -11%.
The time frame for these results is too short to be relevant but I think the inputs reflects the themes and processes that are critical to the long term success as an investor, which are patience, in depth research and portfolio concentration.
As of this writing this "professional" portfolio is comprised of six stocks: ARIS, FHCO, FRMO, FTLF, SEC.TO, and STRL. ARIS and STRL are the biggest contributors to gains and nothing has been a terrible detractor. In football parlance, turnovers kill drives and we've had no turnovers.
Two of these stocks - FRMO and SEC.TO - are very recent additions to the portfolio. I haven't written about them, because all they are are balance sheets and balance sheets are complicated in a boring sort of way. In this case, you just to read a bunch of filings. Both are investment managers, one trading at 2.5x book value the other at 0.6x.
The expensive one is managed by Murray Stahl and he needs no introduction. He writes on issues related to finance and trends in tradeable securities such as ETFs and the opportunities that arise when their algorithms are in phase. He also writes about specific stocks in a subscription newsletter I hear about. He thinks into the future and two specific investments on the balance sheet - exchanges, to be precise - attract me to the stock even at these multiples.
One is the Minneapolis Grain Exchange, which he started acquiring in 2014 and just had its highest volume month. He's also been buying seats on the Bermuda Exchange because he says it's the largest market for Insurance Linked Securities.
These assets - and a few others - are readily discussed in his shareholder letters and quarterly reports. I think of exchanges like payment platforms that generate cash on the backs of someone else's hard work (though when I think about it, what business isn't a payment platform, and if it isn't, why is it in business?) These particular exchanges may be wonderful cash machines if the volumes continue to grow. I imagine whoever has been the selling the stock lately has a shorter term focus than I do.
The 0.6x investment manager is Senvest Capital, managed by Richard Mashaal of an entity his father Victor Mashaal started.
The company is essentially the Mashaal family office fund, with ~50% of the stock owned by pere et fils. Returns are down down 12% this year but they grown equity from $284M in 2011 to $821M in 2014, or 43% CAGR vs ~18% for the S&P. Equity at 3Q15 remains is around those 2014 levels.
I doubt they are going to continue to grow SE by 43% CAGR but they take big long term bets on parts of the small cap market that I don't have the bandwidth to analyze deeply and I want to get a sliver of exposure to it at a discount to book value.
I think about the both of these companies like "investments in the minds of ..." stocks. Other stocks of this type that I've looked at include Biglari Holdings at 1.4x book, ALJJ at 2.9x and Greenlight Re at 0.8x where funds have returned -20% YTD. (I like on the GLRE website it says the "investment accounts are managed by DME Advisors LP" as if we don't know the manager is David Einhorn. I wonder if it says his name in up years?).
It's possible that SEC even at 0.6x is a terrible investment. It's on the radar simply b/c it hit a bunch of home runs in a few good years and this isn't really the picture of steady consistency. Also, they've been reorganizing their structure and adding a presence in NYC, ie expanding which most certainly means more G&A and potentially means they are confusing luck with intelligence. But if it's successful there's a lot of sizzle on the steak and you're not paying a lot for that option.
All of these companies in my portfolio I'm comfortable owning for the long term, though FHCO will require some changes in their consumer strategy, their capital allocation strategy or simply a change in management to work. That is something I want to figure out how to address.
And then there is long list of stocks on my radar for deeper analysis, etc. It hopefully never ends. When I get my teeth into an idea, time disappears. I am grateful that I get to do what I love.
Beyond stocks, I'm trying to figure out the fundraising aspects of the firm (from smiles to teeth gnashing). It is a quandry for every new business, but especially in the investment management world.
The difficulty is explaining what differentiates me from everyone else who says they're patient long term investors, and that's essentially ... everyone else. And then as well how to package my product without hype and deliver a message with integrity that resonates beyond just "growing capital" and "a solid foundation of wealth" and other white bread bullshit. It needs to pull together a lot of je ne sais quoi themes that resonate with me and hopefully with clients, like the "where are the clients yachts" concept, the dangerous stupidity of the biz-fo-tainment industry, the impact and attitude of thinking like an owner and not just a shareholder, etc. I'll figure it out at some point.
The goal of the service is investing client funds in a portfolio of small cap stocks that will outperform the market with lower risk. It sounds so easy on paper but as I've transitioned from doing it as an amateur personal investor with a diversified portfolio of hits and misses to a professional and concentrated portfolio with hopefully many more hits than misses, I can see that this endeavor - both the investing side, the marketing side and the business administration side - is one of the hardest things to do well and with enough consistency to prove that it's not blind luck. I hope to prove it over time.
I'll conclude by thanking all
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. DO YOUR OWN WORK BEFORE INVESTING IN EQUITIES.
Sunday, November 29, 2015
ARIS' annual report: Guides to 20% topline + margin expansion towards high teens
Last week, ARIS released its annual report. The shareholder letter highlighted very briefly (one page) the company's evolution from a two product / four vertical company with 70% of its revenues in the no growth / high cash flow e-catalogue business to a company with five products addressing lead generation and business management software, et al. and serving eight different verticals.
The letter also included a bit of forward looking guidance:
"As we look forward to FY16, we expect our current organic growth rate and the impact of the acquisitions we completed in FY15 to generate $47M to $49M in revenues. We also expect to see continued improvement in adjusted EBITDA and cash flows. We are on pace to achieve a $50M annualized revenue run rate in the back half of FY16 and a $10M adjusted EBITDA run rate shortly
thereafter."
IF they're right - and I always take guidance with a grain of salt b/c who knows the future? - it would imply 20% topline growth AND expanding EBITDA margins all within the structure of the company as it looks today.
If that means no more equity dilution, than conceivably EPS would grow faster than revenues and this would be the third straight year of substantial EPS growth.
I've been thinking a lot about EPS growth since meeting a PM friend of mine who uses sustainable EPS growth as one of the five metrics in his investment framework.
It resonated with me b/c I've never really weighted EPS that heavily, preferring instead to focus on cash flow or margins, but it's a great little metric that captures in one line and over time: operations, tax, capital management, acquisition strategy (b/c there's no GAAP EPS growth with goodwill writedowns) and or course equity dilution.
I've written in the past about the destructive nature of ARIS' share dilution but based on where the company is today, I think we are past the point of using expensive shares for acquisitions and moving towards inexpensive debt. (I say "expensive shares" b/c although the valuation of the shares were cheap when the deals were consummated, if the stock does what I anticipate it will, these purchases will seem very expensive in hindsight).
With a strong balance sheet, recurring revenues and solid cash flow, debt becomes a more palatable option for future growth, though even better would be organic growth. There is for example, the opportunity to grow their subscriber base with the new platform of projects as well as a high churn rate ~15% that should be converted into organic growth.
This will be the year where the company proves whether these acquisitions truly created a portfolio of services and solutions that resonates with customers. If it does, as my research indicates, then the stock remains very inexpensive.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY SHARES. DO YOUR OWN HOMEWORK. I MAY OWN THIS OR ANY OTHER COMPANY I WRITE ABOUT.
The letter also included a bit of forward looking guidance:
"As we look forward to FY16, we expect our current organic growth rate and the impact of the acquisitions we completed in FY15 to generate $47M to $49M in revenues. We also expect to see continued improvement in adjusted EBITDA and cash flows. We are on pace to achieve a $50M annualized revenue run rate in the back half of FY16 and a $10M adjusted EBITDA run rate shortly
thereafter."
IF they're right - and I always take guidance with a grain of salt b/c who knows the future? - it would imply 20% topline growth AND expanding EBITDA margins all within the structure of the company as it looks today.
If that means no more equity dilution, than conceivably EPS would grow faster than revenues and this would be the third straight year of substantial EPS growth.
I've been thinking a lot about EPS growth since meeting a PM friend of mine who uses sustainable EPS growth as one of the five metrics in his investment framework.
It resonated with me b/c I've never really weighted EPS that heavily, preferring instead to focus on cash flow or margins, but it's a great little metric that captures in one line and over time: operations, tax, capital management, acquisition strategy (b/c there's no GAAP EPS growth with goodwill writedowns) and or course equity dilution.
I've written in the past about the destructive nature of ARIS' share dilution but based on where the company is today, I think we are past the point of using expensive shares for acquisitions and moving towards inexpensive debt. (I say "expensive shares" b/c although the valuation of the shares were cheap when the deals were consummated, if the stock does what I anticipate it will, these purchases will seem very expensive in hindsight).
With a strong balance sheet, recurring revenues and solid cash flow, debt becomes a more palatable option for future growth, though even better would be organic growth. There is for example, the opportunity to grow their subscriber base with the new platform of projects as well as a high churn rate ~15% that should be converted into organic growth.
This will be the year where the company proves whether these acquisitions truly created a portfolio of services and solutions that resonates with customers. If it does, as my research indicates, then the stock remains very inexpensive.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY SHARES. DO YOUR OWN HOMEWORK. I MAY OWN THIS OR ANY OTHER COMPANY I WRITE ABOUT.
Wednesday, November 25, 2015
revisiting ESWW so I can sleep better at night
I've written a few short pieces in the past on ESWW, a tiny US manufacturer of diesel particulate filters, and just wanted to take a pre-holiday opportunity to revisit what's going on and as usual am happy to share what I find here.
The lede is that the stock has been a bit more active than usual and there's a new CEO. I like the former CEO a lot and he'll remain on as Chairman and apparently still work closely with the company and this is great news.
The new hire, Patrick Barge, has great experiences on paper and - who knows - he could be the person who lifts the company from the gritty turnaround that's achieved operational excellence and cash flow on a shoe string budget to an innovative company focused on R&D and new product manufacturing in the transportation diesel emissions after market. If the Volkswagon scandal tells us anything its how ubiquitous these systems are even though few end-customers know about them and they are little valued until the penalties of non-compliance become onerous. And I'll get to that aspect later.
The bigger picture as an investor is how deep into the weeds is it worth going for a company with just a few hundred thousand shares outstanding and a highly concentrated ownership structure (80% owned by one group) that concurrently holds the company's expensive convertible debt. Going into the investment, I thought "what could go wrong investing alongside a titan of finance" and although the business seem to be going in the right direction, the uncertainty around ownership will remain an issue until the debt converts or is paid off or the owners do something else. Whether or not the risk and concern of that "something else" is worth the massive valuation discount when I bought it is too soon to tell, but either way, it's a lesson I've paid to learn.
Barge according to his self reported resume is a mechanical engineer who rec'd a masters at this now defunct graduate school for the french textiles industry, many of whose graduates work in engineering, sales or quality control in various industrial or technology companies (BASF, Suez, Johnsons Controls and Thuasne). He appears to have "grown up" - so to speak - at Cummins where he worked in air and liquid filtration systems - including diesel emissions - with increasing levels of responsibility, most recently running the European geography of Cummins Emissions Solutions where he ran a P&L north of $300M.
Prior to that - and for a longer period - he was at Cummins corp HQ in Indiana doing R&D and new technologies where his budget was $150M with "700 employees in 6 technical centers located in 5 global locations".
This all sounds like good news, but it's still his first go around in the C-suite and there's no getting around that. And then there are questions ...
Why does someone go from +$300M budget and multi-national management to $25M peak revenues and two facilities? How much will they have to invest in new machinery to build out the operations this guy is used to? In what direction does the business go in the hands of an engineer with R&D experience sitting in an under utilized but high tech emissions testing facility an hour's drive from Trenton? Are they moving from a mesh metal weave to fabrics and if so is there a local supplier of polymers / fabrics who might have more insight into the market? What does he know about cash flow generation? Will he be able to thrive like his predecessor on a shoe string budget? etc. etc.
... in the absence of a conversation with him, I'm left to grasp at quotes from the press release on the hire ...
Old CEO: "We are thrilled to have Patrick join us as CEO at this critical phase of growth for ESW Group ... I look forward to working closely with him to drive growth within our rapidly evolving diesel aftertreatment and emissions market"
New CEO: "I am excited to leverage my relevant experience and seasoned leadership to help the ESW team achieve the next level of success within the aftermarket and OEM channels, as well as in the development of other potential markets"
So it sounds to me like the former CEO will remain a hands on Chairman (yay!) hopefully managing the financial / cash flow strategies as he's done so excellently in the past and the new CEO who is an expert in the niche industry, will have a lot of room to position the company more deeply into existing markets and also into new as yet unnamed markets. And the focus is growth.
In short, it looks good on paper.
I originally bought the company b/c Mark Yung was turning around a poorly run business that was thinly traded and valued at 1x-2x EBITDA, (the calculation of enterprise value being dependent on how one looked at the convertible option derivative liabilities).
The company's management prior to 2010 had a colorful history (ie a bunch of crooks), but in 2010 Yung took over in and hit the cover off the ball in a market with terrible crosswinds including changing regulatory deadlines, intense competition and highly reluctant customers. From 2010 to 2014, while acquiring one troubled competitor out of bankruptcy, he more than doubled revenues, grew EBITDA margins from -40% to +20% and FCF from - $2M to +$4M. The last we heard, ESWW had a banner 2014 year, with $25M in revenues, $6M in EBITDA and ~$57 in EPS.
Unfortunately, we don't know much about the financials anymore since the company "went dark" in April 2015, and there hasn't been any new financial information since.
We know however that theirs is a lumpy business and that two major drivers of performance in 2014 - a municipal contract in Chicago and CARB compliance deadlines in California - are unlikely to repeat. The former b/c the contract was due to complete and the latter b/c of lack of enforcement by the CARB of regulations that require legacy trucks to retrofit with expensive diesel particulate filters as well as resistance from truck drivers against installing retrofit DPF's, fires supposedly caused by DPF's and a lawsuit from the California Alliance for Business against the CARB (and other parties - case # 13CV01232 - in Glenn County Court, CA).
This is where we circle back to VW. When CARB starts to enforce the regulations with costs more onerous than the retrofit investment, then we'll see a change in adoption. But so far they haven't and California distributors of DPF filters and their suppliers are suffering.
It's hard to be sure whether or not the groups opposed to CARB are gadflies, wackadoodle freedom fighters or have a legitimate claim, but they fight with an unusual zealotry and with a good social media presence, so that can't be overlooked. We're also in an environment where the regulations seem to fall heaviest on the smaller independent businesses who tend to be a sympathetic group even if they are rolling coal.
But as crazy as this fight appears, I'd be surprised to see environmental regulations rolled back. And by the way, there are a lot of these DPF's on the road, in all kinds of diesel cars and trucks, so there's a wide opportunity around testing, cleaning, OEM supplies, aftermarket replacements, etc. This is a wide space they can play.
Now that the company seems to have someone who can anticipate and manage the market and not just a financial and operating guru who got the ship on an even keel, then it seems like the business could be set up for a bright future even if 2015 is a down year.
About 700 shares traded hands this week, a large amount relative to avg daily vol over the last three months of 40 shares. I don't know how one would assess the opportunity since they've gone dark except maybe using CDTi's "Heavy Duty Diesel Systems division" as a proxy though their product is a pos (I've been told) and their products have verification issues with CARB. Through 9-mos sales in that division are down 25% y/y weighed down by some of the similar issues facing ESWW. Except in my channel checks with distributors, they love the ESWW product and speak less highly of CDTi's.
Taking everything together, a still difficult environment, slow rollout of penalties to motivate compliance for older fleets and a lack of large contracts I still think even if 2015 is a down 25% year, with the new CEO steeped in this world paired with a Chairman who can focus on the financial aspects the potential for a brighter (and cleaner) future remains high. We will remain patient investors.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL STOCKS. DO YOUR OWN HOMEWORK. I OWN SHARES OF THIS COMPANY. IT IS THINLY TRADED AND NO LONGER DISCLOSES ITS FINANCIALS.
The lede is that the stock has been a bit more active than usual and there's a new CEO. I like the former CEO a lot and he'll remain on as Chairman and apparently still work closely with the company and this is great news.
The new hire, Patrick Barge, has great experiences on paper and - who knows - he could be the person who lifts the company from the gritty turnaround that's achieved operational excellence and cash flow on a shoe string budget to an innovative company focused on R&D and new product manufacturing in the transportation diesel emissions after market. If the Volkswagon scandal tells us anything its how ubiquitous these systems are even though few end-customers know about them and they are little valued until the penalties of non-compliance become onerous. And I'll get to that aspect later.
The bigger picture as an investor is how deep into the weeds is it worth going for a company with just a few hundred thousand shares outstanding and a highly concentrated ownership structure (80% owned by one group) that concurrently holds the company's expensive convertible debt. Going into the investment, I thought "what could go wrong investing alongside a titan of finance" and although the business seem to be going in the right direction, the uncertainty around ownership will remain an issue until the debt converts or is paid off or the owners do something else. Whether or not the risk and concern of that "something else" is worth the massive valuation discount when I bought it is too soon to tell, but either way, it's a lesson I've paid to learn.
Barge according to his self reported resume is a mechanical engineer who rec'd a masters at this now defunct graduate school for the french textiles industry, many of whose graduates work in engineering, sales or quality control in various industrial or technology companies (BASF, Suez, Johnsons Controls and Thuasne). He appears to have "grown up" - so to speak - at Cummins where he worked in air and liquid filtration systems - including diesel emissions - with increasing levels of responsibility, most recently running the European geography of Cummins Emissions Solutions where he ran a P&L north of $300M.
Prior to that - and for a longer period - he was at Cummins corp HQ in Indiana doing R&D and new technologies where his budget was $150M with "700 employees in 6 technical centers located in 5 global locations".
This all sounds like good news, but it's still his first go around in the C-suite and there's no getting around that. And then there are questions ...
Why does someone go from +$300M budget and multi-national management to $25M peak revenues and two facilities? How much will they have to invest in new machinery to build out the operations this guy is used to? In what direction does the business go in the hands of an engineer with R&D experience sitting in an under utilized but high tech emissions testing facility an hour's drive from Trenton? Are they moving from a mesh metal weave to fabrics and if so is there a local supplier of polymers / fabrics who might have more insight into the market? What does he know about cash flow generation? Will he be able to thrive like his predecessor on a shoe string budget? etc. etc.
Old CEO: "We are thrilled to have Patrick join us as CEO at this critical phase of growth for ESW Group ... I look forward to working closely with him to drive growth within our rapidly evolving diesel aftertreatment and emissions market"
New CEO: "I am excited to leverage my relevant experience and seasoned leadership to help the ESW team achieve the next level of success within the aftermarket and OEM channels, as well as in the development of other potential markets"
So it sounds to me like the former CEO will remain a hands on Chairman (yay!) hopefully managing the financial / cash flow strategies as he's done so excellently in the past and the new CEO who is an expert in the niche industry, will have a lot of room to position the company more deeply into existing markets and also into new as yet unnamed markets. And the focus is growth.
In short, it looks good on paper.
I originally bought the company b/c Mark Yung was turning around a poorly run business that was thinly traded and valued at 1x-2x EBITDA, (the calculation of enterprise value being dependent on how one looked at the convertible option derivative liabilities).
The company's management prior to 2010 had a colorful history (ie a bunch of crooks), but in 2010 Yung took over in and hit the cover off the ball in a market with terrible crosswinds including changing regulatory deadlines, intense competition and highly reluctant customers. From 2010 to 2014, while acquiring one troubled competitor out of bankruptcy, he more than doubled revenues, grew EBITDA margins from -40% to +20% and FCF from - $2M to +$4M. The last we heard, ESWW had a banner 2014 year, with $25M in revenues, $6M in EBITDA and ~$57 in EPS.
Unfortunately, we don't know much about the financials anymore since the company "went dark" in April 2015, and there hasn't been any new financial information since.
We know however that theirs is a lumpy business and that two major drivers of performance in 2014 - a municipal contract in Chicago and CARB compliance deadlines in California - are unlikely to repeat. The former b/c the contract was due to complete and the latter b/c of lack of enforcement by the CARB of regulations that require legacy trucks to retrofit with expensive diesel particulate filters as well as resistance from truck drivers against installing retrofit DPF's, fires supposedly caused by DPF's and a lawsuit from the California Alliance for Business against the CARB (and other parties - case # 13CV01232 - in Glenn County Court, CA).
This is where we circle back to VW. When CARB starts to enforce the regulations with costs more onerous than the retrofit investment, then we'll see a change in adoption. But so far they haven't and California distributors of DPF filters and their suppliers are suffering.
It's hard to be sure whether or not the groups opposed to CARB are gadflies, wackadoodle freedom fighters or have a legitimate claim, but they fight with an unusual zealotry and with a good social media presence, so that can't be overlooked. We're also in an environment where the regulations seem to fall heaviest on the smaller independent businesses who tend to be a sympathetic group even if they are rolling coal.
But as crazy as this fight appears, I'd be surprised to see environmental regulations rolled back. And by the way, there are a lot of these DPF's on the road, in all kinds of diesel cars and trucks, so there's a wide opportunity around testing, cleaning, OEM supplies, aftermarket replacements, etc. This is a wide space they can play.
Now that the company seems to have someone who can anticipate and manage the market and not just a financial and operating guru who got the ship on an even keel, then it seems like the business could be set up for a bright future even if 2015 is a down year.
About 700 shares traded hands this week, a large amount relative to avg daily vol over the last three months of 40 shares. I don't know how one would assess the opportunity since they've gone dark except maybe using CDTi's "Heavy Duty Diesel Systems division" as a proxy though their product is a pos (I've been told) and their products have verification issues with CARB. Through 9-mos sales in that division are down 25% y/y weighed down by some of the similar issues facing ESWW. Except in my channel checks with distributors, they love the ESWW product and speak less highly of CDTi's.
Taking everything together, a still difficult environment, slow rollout of penalties to motivate compliance for older fleets and a lack of large contracts I still think even if 2015 is a down 25% year, with the new CEO steeped in this world paired with a Chairman who can focus on the financial aspects the potential for a brighter (and cleaner) future remains high. We will remain patient investors.
-- END --
THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL STOCKS. DO YOUR OWN HOMEWORK. I OWN SHARES OF THIS COMPANY. IT IS THINLY TRADED AND NO LONGER DISCLOSES ITS FINANCIALS.
Tuesday, November 17, 2015
A few lovely surprises this earnings season (STRL, FTLF, EVI and ARIS)
There were a few lovely little surprises this earnings season but none brought a smile to my face more than hearing that STRL had hired Ron Ballschmiede as their CFO.
Ron was previously the CFO of CBI, including the six years that I was a sell side analyst covering the E&C industry, and he is great.
To be frank, he joined CBI when it was in a period of dire need after one of those ridiculous petite-scandals that corporate america engages in every so often. In this case, in 3Q 2005 the company delayed filing its 10Q b/c of alleged accounting issues and then in winter 2006, filed this statement paying an underling in the accounting office $1.7M in hush money. A few days later, the CEO and CFO were fired. Phil Asherman, a former FLR biz dev guy was elevated to CFO and Ron was hired six months later.
I recall, during his tenure as CFO, in no small detail and with plenty of professional regret on my part, when CBI was losing boatloads of money on an LNG regas project in Wales (a project he inherited mind you), when much that could go wrong did including a labor force protesting work conditions daily and in 2008 the rainiest summer in UK history, when the company's balance sheet was so stressed it had $88M in cash compared to $1B in deferred revenue (ie cash collected from customers ahead of work to be completed), when it seemed to me the company was close to running out of money and I had a conversation with him where he calmly reiterated that construction companies - contrary to popular opinion - don't need a lot of cash on hand as long as the customers are willing to patiently accommodate temporary problems.
He was right, I was wrong, and the shame on my part was downgrading the stock in 4Q08 when shareholder equity was ~$600M vs $2.9B today.
I learned a number of lessons in that experience, as an analyst and as an investor, and also gained an enormous amount of admiration for a guy who is now the CFO of our wee +$90M mkt cap company that is also in need of an accomplished CFO who can lay the foundation of a professional organization. It should bring a smile to all the faces of STRL investors b/c he knows the construction business, the processes, the accounting and the institutional investors well in excess of what should be expected in that role and for a small company such as ours. We are lucky to have him. (He's also the person who hilariously once counselled me, "If you sit down at the airport, you've arrived too early").
Second to that satisfaction is a little vanity on my part seeing the amended 10Q STRL just filed. Something about the initial Q struck me as weird when they reported a swing to losses in the the Myers JV. So after the earnings call I asked the interim CFO about it (he is wonderful in his own right and for many sound reasons has zero interest in being a full-time CFO) and I really liked his frankness: "those parenthesis you see, they don't belong there."
To avoid this mistake in the future, I offered to proofread their filings a few days before their release but I doubt that's something anyone will oblige.
Other good surprises for the quarter included ...
FTLF: Getting back on track with revenues up 14% y/y and now having lapped the worst of its channel disruption and with the IFIT acquisition under its belt on track for $30M revs and 10% EBITDA margins, still trading at just 6x proforma EV despite growth and profitability.
EVI: The quarter wasn't great b/c of a delayed equipment delivery but customer deposits were the highest ever at $5.8M and a special $0.20 dividend was declared. I also just attended my first shareholder meeting and got a firsthand account of plans / expectations for buy / build strategy and how they intend to consolidate their fragmented, regional and balkanized industry. While I fear equity dilution to fund future deals, the suggestion that they use rights offerings to raise money would allow investors to substantially maintain their ownership levels.
ARIS: Still flying under the radar despite top line growth, cash generation and margin expansion. Returns are expanding to low teen ROE and ROA and high S/D ROIC. With several acquisitions under its belt, and I believe a focus on customer retention and organic growth, I see a lot left in the tank for a company whose stock is trading at 11x EBITDA vs a peer group north of 15x.
... of my larger holdings sadly only STLY continues to underperform. My initial views on the company was that the furniture business sucks, that management destroys value, that there's no growth, no margin, no competitive advantage, and that it's not a business I want to own. Somehow I convinced myself that activist investors who own large chunks of it would push out the CEO and turn things around but in talking recently with a source in the business, as he put it: "there are always wall street folks who think they can turn it around. It has a great brand within the industry, but customers have no idea what it makes, their styles are out of fashion and the industry's distribution model is broken."
While STLY doesn't put a smile on my face, I was more right than wrong in the quarter and more importantly the lessons I learn today as I continue to grow in this business will, I believe, provide a framework for better decisions in the future.
-- END --
THIS IS NOT A SOLICITATION OR AN ENDORSEMENT OR A RECOMMENDATION TO BUY OR SELL SECURITIES. DO YOUR OWN HOMEWORK BEFORE INVESTING.
Ron was previously the CFO of CBI, including the six years that I was a sell side analyst covering the E&C industry, and he is great.
To be frank, he joined CBI when it was in a period of dire need after one of those ridiculous petite-scandals that corporate america engages in every so often. In this case, in 3Q 2005 the company delayed filing its 10Q b/c of alleged accounting issues and then in winter 2006, filed this statement paying an underling in the accounting office $1.7M in hush money. A few days later, the CEO and CFO were fired. Phil Asherman, a former FLR biz dev guy was elevated to CFO and Ron was hired six months later.
I recall, during his tenure as CFO, in no small detail and with plenty of professional regret on my part, when CBI was losing boatloads of money on an LNG regas project in Wales (a project he inherited mind you), when much that could go wrong did including a labor force protesting work conditions daily and in 2008 the rainiest summer in UK history, when the company's balance sheet was so stressed it had $88M in cash compared to $1B in deferred revenue (ie cash collected from customers ahead of work to be completed), when it seemed to me the company was close to running out of money and I had a conversation with him where he calmly reiterated that construction companies - contrary to popular opinion - don't need a lot of cash on hand as long as the customers are willing to patiently accommodate temporary problems.
He was right, I was wrong, and the shame on my part was downgrading the stock in 4Q08 when shareholder equity was ~$600M vs $2.9B today.
I learned a number of lessons in that experience, as an analyst and as an investor, and also gained an enormous amount of admiration for a guy who is now the CFO of our wee +$90M mkt cap company that is also in need of an accomplished CFO who can lay the foundation of a professional organization. It should bring a smile to all the faces of STRL investors b/c he knows the construction business, the processes, the accounting and the institutional investors well in excess of what should be expected in that role and for a small company such as ours. We are lucky to have him. (He's also the person who hilariously once counselled me, "If you sit down at the airport, you've arrived too early").
Second to that satisfaction is a little vanity on my part seeing the amended 10Q STRL just filed. Something about the initial Q struck me as weird when they reported a swing to losses in the the Myers JV. So after the earnings call I asked the interim CFO about it (he is wonderful in his own right and for many sound reasons has zero interest in being a full-time CFO) and I really liked his frankness: "those parenthesis you see, they don't belong there."
To avoid this mistake in the future, I offered to proofread their filings a few days before their release but I doubt that's something anyone will oblige.
Other good surprises for the quarter included ...
FTLF: Getting back on track with revenues up 14% y/y and now having lapped the worst of its channel disruption and with the IFIT acquisition under its belt on track for $30M revs and 10% EBITDA margins, still trading at just 6x proforma EV despite growth and profitability.
EVI: The quarter wasn't great b/c of a delayed equipment delivery but customer deposits were the highest ever at $5.8M and a special $0.20 dividend was declared. I also just attended my first shareholder meeting and got a firsthand account of plans / expectations for buy / build strategy and how they intend to consolidate their fragmented, regional and balkanized industry. While I fear equity dilution to fund future deals, the suggestion that they use rights offerings to raise money would allow investors to substantially maintain their ownership levels.
ARIS: Still flying under the radar despite top line growth, cash generation and margin expansion. Returns are expanding to low teen ROE and ROA and high S/D ROIC. With several acquisitions under its belt, and I believe a focus on customer retention and organic growth, I see a lot left in the tank for a company whose stock is trading at 11x EBITDA vs a peer group north of 15x.
... of my larger holdings sadly only STLY continues to underperform. My initial views on the company was that the furniture business sucks, that management destroys value, that there's no growth, no margin, no competitive advantage, and that it's not a business I want to own. Somehow I convinced myself that activist investors who own large chunks of it would push out the CEO and turn things around but in talking recently with a source in the business, as he put it: "there are always wall street folks who think they can turn it around. It has a great brand within the industry, but customers have no idea what it makes, their styles are out of fashion and the industry's distribution model is broken."
While STLY doesn't put a smile on my face, I was more right than wrong in the quarter and more importantly the lessons I learn today as I continue to grow in this business will, I believe, provide a framework for better decisions in the future.
-- END --
THIS IS NOT A SOLICITATION OR AN ENDORSEMENT OR A RECOMMENDATION TO BUY OR SELL SECURITIES. DO YOUR OWN HOMEWORK BEFORE INVESTING.
Thursday, October 22, 2015
One More Letter to $FHCO After they Blocked my Effort to Improve Exec Comp
A few weeks ago I sent a letter to the Chairman and Board of $FHCO asking for a proposal to be included in the proxy re: chg'd exec comp.
With a board that avgs 71 y/o and +13 years of svc I'm not surprised they responded with obstructions and not open arms. Since I am not a shareholder for the continuous year (thank goodness for my portfolio) they won't consider it.
But the thing is, the same people running the company are the same people who've been there since the product was approved by the FDA in 2009, and its still not on drugstore shelves, which means either the product sucks, they suck, or somewhere in between. I'm in the group that thinks its somewhere in between.
Yet, even if the product sucks (and I've been assured by some it does and others it doesn't) there are so many condoms on the shelves of every drugstore I've ever been to, at least one female condom can fit there as well, even if its just a novelty. If it ain't the FC2 it will be something else someday.
And thus this letter (see below). I cut the part where I pan their decisions to hire an ex-pharma exec and an ex-marketer of IUD's (who is also on the board), b/c it seemed appropriate to be nice. But I am dumbfounded, speechless, nonplussed in the true definition of the word, why they'd hire execs with those kinds of expertise for a product that's the anti-IUD and the anti-pharmaceutical. It's like hiring a vasectomy surgeon to sell condoms. They need brand strategy and consumer distribution expertise not ex-pharma folks.
In my view, at least if we can align comp structure, I know they won't be paid unless my capital is put to best use, which so far, it hasn't.
Here is the full letter going out to the board today and please remember this is not a solicitation to buy / sell / transact business just shared out loud thoughts and ideas.
-- END --
Dear OB:
I was disappointed by your response to my letter regarding my shareholder proposal for changing executive compensation. I had hoped you would welcome the proposal not put up roadblocks to cause its exclusion.
My goal in recommending an alternative comp structure is simple and threefold
• To find a system that is fair to executives
• To find a system that incentivizes good long term capital allocation not short term goals
• To find a system that aligns the interests of shareholders and management
The current compensation plan isn’t fair.
As your filings point out, you have no control over the timing of public sector purchasing patterns. Since the public sector remains your largest customer, one order, the timing of which you have no control over, can determine whether or not executives are compensated.
Last year, executives did not receive bonuses. This year, because of the Brazil tender, they likely will (including yourself). The key point is that your current executive compensation system doesn’t reward decisions from the FHCO C-suite, but rather decisions made in developing world health departments thousands of miles away.
Executives should be compensated for the decisions and efforts they make, not someone else’s.
The system doesn’t motivate long term planning or capital allocation.
Your current plan is based on one year sales and margins over which – as you’ve long established - executives have limited control. As a result, spending on marketing campaigns or strategies with long term payoffs negatively impacts the compensation for executives, disincentivizing long term planning.
Executives should not be compensated solely on short term results as your current policy now holds.
The system doesn’t align interests of shareholders and management.
Ending the dividend to invest in your business is an equivalent indication that you can allocate capital better than your shareholders can. The system I recommended in my proposal rewards good capital allocation and ensures that the capital you’ve taken from shareholders is put to the best and highest use, as your shareholders themselves likely would have done with their dividends.
A plan that promotes good capital allocation would incent better decisions and might improve outcomes.
I hope you and the board will address the shortcoming of your current executive compensation plan and consider implementing one – perhaps along the lines of the ones I recommended in my earlier letter - that is forward thinking and rewards good long term capital planning.
Above all, I want to see evidence of a management team that makes sound long-term high-return capital decisions while providing safe, low cost and accessible choices in women’s reproductive health. I imagine we stand on common ground with respect to that goal.
A few additional comments.
As you are aware, I previously recommended in prior communications with you and Ms. King two low cost ideas to help expand your product reach.
1. Explore a partnership with SHE Sustainable Health Enterprises.
SHE, as you know, has created a program to locally manufacture and distribute affordable menstrual pads in Africa (Saathi does a similar program in India). They have a partnership with J&J and their founder, Elizabeth Scharpf, is an advocate for expanded use of the female condom.
In fact, in an interview I read online, she is asked: “You’re going to a desert island, and you’re allowed one food, one drink and one feminist. What do you take?” and she answers: “Cherry pie, champagne and whoever invented the female condom.”
It is easy to imagine a wealth of opportunities available through a partnership with SHE to reach a shared customer base in Africa, your largest market. I previously recommended you reach out to her and I've emailed with her several times. In response to my suggestion, both you and Ms. King replied: “She didn’t return a phone call”. That is not leadership regarding a potential partnership with an influential advocate of your product.
2. Expand your creative / brand development.
I have also suggested that you hire a creative / brand team from one or two “innovator cities” (perhaps offering equity as a form of long term alignment) to test creative programs and get your product on shelves. This suggestion was simply ignored and I see no evidence to support your statements that you have already initiated a successful brand building strategy.
I think we both agree that bending the consumer sales curve will require smart long-term investments in sales, marketing and distribution today, with the benefits in years 2, 3 and beyond. I also think we both agree that getting the right consumer brand strategy is the key to fixing recent cash flow degradation, stagnant shareholder equity, rising competition, and risks associated with a being one-product company.
So please consider changing your incentives to align them towards the long term investments required to bend the sales curve. Doing so will help provide shareholders more faith and trust that decisions from management and the board are made with optimal long-term capital allocation in mind.
With a board that avgs 71 y/o and +13 years of svc I'm not surprised they responded with obstructions and not open arms. Since I am not a shareholder for the continuous year (thank goodness for my portfolio) they won't consider it.
But the thing is, the same people running the company are the same people who've been there since the product was approved by the FDA in 2009, and its still not on drugstore shelves, which means either the product sucks, they suck, or somewhere in between. I'm in the group that thinks its somewhere in between.
Yet, even if the product sucks (and I've been assured by some it does and others it doesn't) there are so many condoms on the shelves of every drugstore I've ever been to, at least one female condom can fit there as well, even if its just a novelty. If it ain't the FC2 it will be something else someday.
And thus this letter (see below). I cut the part where I pan their decisions to hire an ex-pharma exec and an ex-marketer of IUD's (who is also on the board), b/c it seemed appropriate to be nice. But I am dumbfounded, speechless, nonplussed in the true definition of the word, why they'd hire execs with those kinds of expertise for a product that's the anti-IUD and the anti-pharmaceutical. It's like hiring a vasectomy surgeon to sell condoms. They need brand strategy and consumer distribution expertise not ex-pharma folks.
In my view, at least if we can align comp structure, I know they won't be paid unless my capital is put to best use, which so far, it hasn't.
Here is the full letter going out to the board today and please remember this is not a solicitation to buy / sell / transact business just shared out loud thoughts and ideas.
-- END --
Dear OB:
I was disappointed by your response to my letter regarding my shareholder proposal for changing executive compensation. I had hoped you would welcome the proposal not put up roadblocks to cause its exclusion.
My goal in recommending an alternative comp structure is simple and threefold
• To find a system that is fair to executives
• To find a system that incentivizes good long term capital allocation not short term goals
• To find a system that aligns the interests of shareholders and management
The current compensation plan isn’t fair.
As your filings point out, you have no control over the timing of public sector purchasing patterns. Since the public sector remains your largest customer, one order, the timing of which you have no control over, can determine whether or not executives are compensated.
Last year, executives did not receive bonuses. This year, because of the Brazil tender, they likely will (including yourself). The key point is that your current executive compensation system doesn’t reward decisions from the FHCO C-suite, but rather decisions made in developing world health departments thousands of miles away.
Executives should be compensated for the decisions and efforts they make, not someone else’s.
The system doesn’t motivate long term planning or capital allocation.
Your current plan is based on one year sales and margins over which – as you’ve long established - executives have limited control. As a result, spending on marketing campaigns or strategies with long term payoffs negatively impacts the compensation for executives, disincentivizing long term planning.
Executives should not be compensated solely on short term results as your current policy now holds.
The system doesn’t align interests of shareholders and management.
Ending the dividend to invest in your business is an equivalent indication that you can allocate capital better than your shareholders can. The system I recommended in my proposal rewards good capital allocation and ensures that the capital you’ve taken from shareholders is put to the best and highest use, as your shareholders themselves likely would have done with their dividends.
A plan that promotes good capital allocation would incent better decisions and might improve outcomes.
I hope you and the board will address the shortcoming of your current executive compensation plan and consider implementing one – perhaps along the lines of the ones I recommended in my earlier letter - that is forward thinking and rewards good long term capital planning.
Above all, I want to see evidence of a management team that makes sound long-term high-return capital decisions while providing safe, low cost and accessible choices in women’s reproductive health. I imagine we stand on common ground with respect to that goal.
A few additional comments.
As you are aware, I previously recommended in prior communications with you and Ms. King two low cost ideas to help expand your product reach.
1. Explore a partnership with SHE Sustainable Health Enterprises.
SHE, as you know, has created a program to locally manufacture and distribute affordable menstrual pads in Africa (Saathi does a similar program in India). They have a partnership with J&J and their founder, Elizabeth Scharpf, is an advocate for expanded use of the female condom.
In fact, in an interview I read online, she is asked: “You’re going to a desert island, and you’re allowed one food, one drink and one feminist. What do you take?” and she answers: “Cherry pie, champagne and whoever invented the female condom.”
It is easy to imagine a wealth of opportunities available through a partnership with SHE to reach a shared customer base in Africa, your largest market. I previously recommended you reach out to her and I've emailed with her several times. In response to my suggestion, both you and Ms. King replied: “She didn’t return a phone call”. That is not leadership regarding a potential partnership with an influential advocate of your product.
2. Expand your creative / brand development.
I have also suggested that you hire a creative / brand team from one or two “innovator cities” (perhaps offering equity as a form of long term alignment) to test creative programs and get your product on shelves. This suggestion was simply ignored and I see no evidence to support your statements that you have already initiated a successful brand building strategy.
I think we both agree that bending the consumer sales curve will require smart long-term investments in sales, marketing and distribution today, with the benefits in years 2, 3 and beyond. I also think we both agree that getting the right consumer brand strategy is the key to fixing recent cash flow degradation, stagnant shareholder equity, rising competition, and risks associated with a being one-product company.
So please consider changing your incentives to align them towards the long term investments required to bend the sales curve. Doing so will help provide shareholders more faith and trust that decisions from management and the board are made with optimal long-term capital allocation in mind.
Tuesday, October 13, 2015
Another year, another attempt to improve exec comp at $FHCO
A few weeks ago, I submitted the following letter to the board of FHCO and its CEO / Chairman OB Parrish regarding executive compensation. Alas, I haven't been a shareholder for the last continuous 12-months, a good thing for my portfolio since the stock is down more than 50% y/y but a bad thing for myself as shareholder since comp is a strong way to align goals, and they are prejudiced against short-term shareholders.
My effort is to comp execs on ROIC. My reasoning is that once they stopped paying shareholders a dividend to invest in the business their capital allocation decisions should have become paramount.
They haven't, and shareholders suffer.
They SHOULD invest in their business no doubt. The industry has changed - the product is no longer a monopoly - and the company has spent considerable money and efforts to broaden its consumer appeal, but without articulating or explaining the strategy and with no improvement in the goals they seek to attain.
I believe they are going about it all wrong - old fashioned ex-pharma marketing - versus just getting it on shelves, and I've suggested low cost creative and strategic partnerships to no avail. I think they are afraid to make fun of themselves and therefore try something risky (the consumer product is risque).
Whatever ... since I can't effect how they are going to spend their money at least I can try to make sure they understand that cost of money and try to ensure compliance with a return.
So while the board has discretion to consider this proposal it is unlikely hey will oblige. With an average age of 71 years and an average length of service of 14 years this is not a group that invites new ideas.
Dear Mr. Secretary
Last year I wrote a letter to the Board regarding a proposal on executive compensation that I had hoped would be addressed at the annual meeting. However, the letter was sent too late for the deadline.
I am writing a similar letter with substantially the same proposal for inclusion in the proxy materials for the 2016 shareholder meeting (see below).
In the year since I wrote the initial letter, the stock has lost 65% of its value. Concurrently, year-to-date unit sales are up 44% and year-to-date revenues and operating income have grown 33%. So management is likely to receive its bonuses even after a year of shareholder suffering and negative cash flow generation. There is clearly a misalignment.
A compensation system that incentivizes principles of good capital allocation will re-align interests between owners and managers, ensure optimal investments in the business and re-instill confidence that management is making wise, capable and thoughtful decisions that will reward shareholders over the long term. I sincerely hope the Board allows shareholders to consider this proposal at its next meeting.
Sincerely
Long Cast Advisers, LLC
CC:
O.B. Parrish, CEO & Chairman
Brian Bares, Institutional Shareholder
A PROPOSAL TO CHANGE EXECUTIVE COMPENSATION
The current executive compensation system is based on unit sales and operating margin targets. It has as its greatest virtue, simplicity. It is not ideal but neither is it inappropriate for a single product company in an industry characterized as a monopoly.
However, recent issues have arisen that require exploration of a new executive compensation plan:
• The industry is no longer a monopoly.
• The company has cancelled its dividend.
• The company is seeking to use capital once reserved for shareholders in the form of dividends for internal growth and / or acquisitions.
• The company, once a great cash flow generator, is currently a cash flow user.
With these changes, especially the cancellation of the dividend and the recent cash “burn”, it is obvious that the role of management has expanded from one of maintaining market share to one of capital allocation.
I therefore propose that the board terminate the current compensation plan and adopt one based on capital allocation and cash flow. I suggest one of three options: Returns on Incremental Invested Capital (ROIIC) targets, Economic Value Add, or Cash EPS. Any of these would be better choices for a company that diverts capital from its shareholders to fund internal and acquired growth.
A compensation structure that rewards wise, capable and thoughtful capital allocation would be the best way to ensure that the owners of the company, who no longer have access to the company’s capital via dividends, are getting the greatest value for their shares.
My effort is to comp execs on ROIC. My reasoning is that once they stopped paying shareholders a dividend to invest in the business their capital allocation decisions should have become paramount.
They haven't, and shareholders suffer.
They SHOULD invest in their business no doubt. The industry has changed - the product is no longer a monopoly - and the company has spent considerable money and efforts to broaden its consumer appeal, but without articulating or explaining the strategy and with no improvement in the goals they seek to attain.
I believe they are going about it all wrong - old fashioned ex-pharma marketing - versus just getting it on shelves, and I've suggested low cost creative and strategic partnerships to no avail. I think they are afraid to make fun of themselves and therefore try something risky (the consumer product is risque).
Whatever ... since I can't effect how they are going to spend their money at least I can try to make sure they understand that cost of money and try to ensure compliance with a return.
So while the board has discretion to consider this proposal it is unlikely hey will oblige. With an average age of 71 years and an average length of service of 14 years this is not a group that invites new ideas.
Dear Mr. Secretary
Last year I wrote a letter to the Board regarding a proposal on executive compensation that I had hoped would be addressed at the annual meeting. However, the letter was sent too late for the deadline.
I am writing a similar letter with substantially the same proposal for inclusion in the proxy materials for the 2016 shareholder meeting (see below).
In the year since I wrote the initial letter, the stock has lost 65% of its value. Concurrently, year-to-date unit sales are up 44% and year-to-date revenues and operating income have grown 33%. So management is likely to receive its bonuses even after a year of shareholder suffering and negative cash flow generation. There is clearly a misalignment.
A compensation system that incentivizes principles of good capital allocation will re-align interests between owners and managers, ensure optimal investments in the business and re-instill confidence that management is making wise, capable and thoughtful decisions that will reward shareholders over the long term. I sincerely hope the Board allows shareholders to consider this proposal at its next meeting.
Sincerely
Long Cast Advisers, LLC
CC:
O.B. Parrish, CEO & Chairman
Brian Bares, Institutional Shareholder
A PROPOSAL TO CHANGE EXECUTIVE COMPENSATION
The current executive compensation system is based on unit sales and operating margin targets. It has as its greatest virtue, simplicity. It is not ideal but neither is it inappropriate for a single product company in an industry characterized as a monopoly.
However, recent issues have arisen that require exploration of a new executive compensation plan:
• The industry is no longer a monopoly.
• The company has cancelled its dividend.
• The company is seeking to use capital once reserved for shareholders in the form of dividends for internal growth and / or acquisitions.
• The company, once a great cash flow generator, is currently a cash flow user.
With these changes, especially the cancellation of the dividend and the recent cash “burn”, it is obvious that the role of management has expanded from one of maintaining market share to one of capital allocation.
I therefore propose that the board terminate the current compensation plan and adopt one based on capital allocation and cash flow. I suggest one of three options: Returns on Incremental Invested Capital (ROIIC) targets, Economic Value Add, or Cash EPS. Any of these would be better choices for a company that diverts capital from its shareholders to fund internal and acquired growth.
A compensation structure that rewards wise, capable and thoughtful capital allocation would be the best way to ensure that the owners of the company, who no longer have access to the company’s capital via dividends, are getting the greatest value for their shares.
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