$EVI Acquisition: Brief Readthrough on WSD Deal + 8x ProForma Valuation

I first wrote about EVI here when I believed it to be the kind of well run company that I wanted to own forever; niche business that generates cash, functions in a kind of protected duopoly and doesn't dilute shareholders. I had behind me decades of financial statements as evidence that the business was a lock box for cash. It was a $16M mkt cap company.

Then, Henry Nahmad acquired a controlling interest in the company and he was pretty upfront that nothing / everything would change.

He'd keep the core business roughly the same but roll up the industry the way his uncle / father rolled up the HVAC industry ~40 years ago to create $WSO. Not a bad pedigree; WSO has returned +12,000% over the last 30 years.

And then nothing happened ...

... until the first week of Labor Day 2016 when the company announced its first deal to acquire Western State Design, a primarily West Coast distributor of industrial and coin/op laundry equipment, for $28M. WSD was privately held and owned by Dennis Mack and Tom Marks. With this first deal done, Nahmad can now be judged on his actions not his pedigree. 

This is a short summary of my reading on the deal.

Price / Structure / Value 

The deal has a headline $28M purchase price split between $18M in cash and $10M in stock. But there's more to the story than the headline ...

The $18M in cash comes from 1.29M shares sold to Nahmad's investment vehicle Symmetric LLC in a PIPE @ $4.65 / share (the close price before the deal closed) + $12M from a newly announced credit facility. The total size of the credit facility is $20M.

Of this cash, $15.2M is paid at the close and $2.8M will be escrowed until 18-mos after deal; this appears to be related to and contingent on collection of AR's at the time of the deal

The purchase price includes 2.04M shares of stock worth $10M based on the average closing price of the stock for the 10-days prior to the Asset Purchase Agreement. Mssrs Mack and Marks - the sellers - will own just south of 20% of the combined company after the deal.

+/- what appears to be standard working capital adjustments from the baseline $4.8M working capital at time of the deal.

Western State Design did $60M in sales last year vs $30M for the core EVI. The company, it should be noted, is tripling in size. Operationally, WSD appears to be more heavily weighted towards coin op than the commercial laundry equipment / boilers that EVI distributes. Also, there appears to be no overlap in regions as WSD is mostly out West and EVI in Florida / Caribbean / Central America.

WSD has more gov't contract / federal work than EVI and apparently has security clearances related to that work that will be transferred in the deal; (what kind of security clearance is required to do laundry?). Very little information is available though it at they are at least savvy enough to protest an award (FWIW).

Based on WSD's $60M sales figure and assuming roughly the same EBITDA margins as the core business, EVI is acquiring a company twice its size at 5x-6x EBITDA.

Before the deal EVI was trading at ~$4 / share or ~10x trailing EBITDA. Proforma it appears to be trading for ~8x proforma EBITDA.

The $12M in borrowings to fund the deal is part of a larger $20M credit facility with Wells Fargo, so they have access to an additional $8M in borrowings. Perhaps other deals are pending as well ... 

A bit about Western Design and its owners / sellers, Dennis Mack and Tom Marks

Mack and Marks are co-owners of the firm. Not much information available about them, strangely enough in this day and age of social media. Would like to learn more and probably will have a chance to meet them at the shareholder meeting in Nov, as they will both become execs of the company and at least one will serve on the board.

In the standard non-compete provision, there is a carve out for a business run by Dennis Mack: "The foregoing prohibition shall not apply to the involvement in any manner by Dennis Mack with respect to Associated Laundry Management, a commercial laundry  in Reno, Nevada." Maybe he has a lab underneath it.

Another irrelevent tidbit: EVI is not acquiring the facility of WSD's headquarters on Tripaldi Way in Hayward, CA, but rather signing a new lease with the existing landlord. That existing landlord is TylerTown LLC, an entity created in 2012 by the controller of WSD, Marianne Lenci, so like EVI itself, WSD pays rents to its CEO.

It's not an unusual situation - lots of companies do this - and its critical for investors who tend to dismiss such things as "inside dealing" to reflect and consider what's actually important information in making an investment decisions. I don't think this is.

Why am I scraping the Department of State filings to get information on this company? B/c I can't really find anything else material.

But as a sense of what kind of managers are Mssrs Marks and Mack, I found this interesting. In 2010 they had plans to develop on spec a "state-of-the-art commercial laundry for sale or lease to an operator, the company says. The building site encompasses 3.87 acres and includes a 14,000-square-foot enclosed service yard. It is strategically located for effective distribution throughout Northern California."

The risks for building on spec were somewhat offset by their ability to get funding from a state issued bond on the deal.

The point is, we know our new fellow shareholders and managers have a nose for opportunity. And they were willing to take 35% of their comp in stock. This reinforces that assumption and provides some affirmative bias that as with already existing shareholders, they see long term opportunity in the business.

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THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. FOR EDUCATIONAL PURPOSES ONLY. THIS INFORMATION IS BASED ON MY READING OF PUBLIC FILINGS AND MIGHT BE INCOMPLETE OR JUST PLAIN WRONG.

The Bias of Other Shareholders

When the esteemed fashion / style photographer Bill Cunningham died, the WSJ's Ralph Gardner Jr (a colleague from my first job out of college) wrote a piece with a hed / subhed ...

"Bill Cunningham Leaves a Social Void
The late photographer’s presence at an event told you it was worth attending"

... which struck me as a great analog to an activity popular among many investors, which is to look at what other are doing as a way to confirm that the event they're attending stock they're buying is worth owning.

If you're like me, you probably like to know who the fellow owners are and what other good investors are doing. But even while I peek at owners, I remind myself that a company's ownership composition has absolutely no bearing - zero - on its future cash flows, which is the ultimate arbiter of value.

Yet every quarter there's a flurry of time and effort analyzing 13F filings. It is the 3rd biggest waste of time for a practice "generally accepted" among investors. (The 2nd biggest is reading most sell side notes and the 1st is watching business channels).

At least this tweet, which compiles recent 13F filings has the self awareness that yes, it is probably useless. And yet, like a car accident, it's hard not to peak.

Investing is a most personal enterprise, and in some cases a most lonely one. Stop caring what everyone else is doing! Its fine to find comfort in fellow owners and to know what others are doing, but chasing stocks that other's own is a perversion of what makes investing so interesting.

A far better use of time for investors is finding people who disagree with you, a structural advantage for investors who are married.

Remember that the strike zone isn't the same for all hitters. Figure out an investment style that makes most sense to you, find businesses that fit that style, and be okay not giving a hoot what others are doing. You should be good to go.

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THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY / SELL SECURITIES. BEING MARRIED MAY NOT ACTUALLY MAKE YOU A BETTER INVESTOR.

How to not chase a stock ($TAYD)

While doing work on my last post, I came across Taylor Devices $TAYD on a screen for companies that - similar to $ARIS - have been generating cash and reinvesting it at high rates.

$TAYD is a $61M mkt cap / $55M EV company that makes products that solves problems caused by recoil, sway and / or vibration. These are generally called "dampers" or "shock absorbers" or "snubbers" and they make all kinds of them for two general types of applications: Construction and Aerospace / Defense.

In the construction side of the business, which is now about 60% of revenues, their dampers - including fluid viscous dampers - offset the sway of buildings, bridges and other structures where wind and / or earthquakes effect such things. One of the most recent / high profile applications is in the 432 Park Ave residential tower that blights rises over the NYC skyline like an oligarch's middle finger a tall reed of grass in the center of Manhattan.

On the aerospace / defense side the company sells components of military equipment to stabilize or isolate weapons and radars, personnel or equipment, like on the seats of naval craft or in the hold of the space shuttle.

An interesting tidbit around the history of the company is that it has deep roots providing fluid viscous dampers for the military (ie in the housing of MX missile silos so they would survive a nuclear blast) and then transitioned into the construction side after the end of the cold war, as per this short quote from an article in the January 2008 issue of the Journal of Structural Engineering:

"A major reason for the relatively rapid pace of implementation of viscous fluid dampers is their long history of successful application in the military. Shortly after the Cold War ended in 1990, the technology behind the type of fluid damper that is most commonly used today (i.e., dampers with fluidic control orifices) was declassified and made available for civilian use ( Lee and Taylor 2001). Applying the well-developed fluid damping technology to civil structures was relatively straightforward to the extent that, within a short time after the first research projects were completed on the application of fluid dampers to a steelframed building (Constantinou and Symans 1993a) and an isolated bridge structure ( Tsopelas et al. 1994), such dampers were specified for a civilian project; the base-isolated Arrowhead Regional Medical Center in Colton, Calif. Asher et al. 1996."

In short, this is a business with a long history making a high value product in an unusual niche; just the kind I like to invest in.

Through FY2015 ending May 31, 2015, the company sold $31M worth of these products generating profit of $2.2M, reflecting a net profit margin of 7.1%, impressive.

Even more impressive is that through the first 9-mos of fiscal 2016, the company generated $27M in sales - nearly matching the prior year with a quarter to spare - with net income margins above 10% for 1Q and 2Q and ~14% for 3Q. (The FY16 year end has closed but company won't report until August).

And most impressive of all is that 10-years ago, this company was levered 3x EBITDA, had $86K in the bank and did 1/2 the revenues as they do today, with 92 employees ($130k / emp). Today, they have $7M in net cash, twice the revenues and a stock trading at 3x backlog, with only 112 employees ($275k sales / emp).

How the company turned around its business was a function - like all success stories - of many things happening at once but a few things stand out:
1. wider acceptance and regulatory approval of fluid viscous dampers in earthquake prone areas
2. expanded production facilities with better equipment that improved turn times
3. larger production facilities to accommodate larger products
4. better tax management, (ie lower tax rate), which means IMHO that mgmt is actively working hard to generate higher returns.

Some of the improvement is structural but some benefits from a cyclical real estate / infrastructure tailwind. Such is the nature of all industrial businesses.

And it is the nature of the stock market - especially in smaller niches of the market - to occasionally be imperfect on valuing stocks. To mine eyes, after digging into the company's business and financials, the valuation appears to reflect a mistake by the market, erring towards a rather common mistake of a stock responding to earnings growth rather than the order book.

In short, the stock appears to be violating the old adage regarding investing in industrial long-cycle businesses to "buy in the order cycle / sell into the delivery cycle".

It does not take long for an investor to observe that backlog is declining, avg project sizes are declining, and that book to bill ratio is 0.5x, meaning the company is burning backlog at twice the rate they are bringing in new business.

For those more inclined to visual displays of data, here is a graph of TAYD's backlog activity layered on top of sales activity. It is quite easy to see how the two generally move in the same direction sales lagged one period.

Here is a graph of TAYD's sales and net income. Again, quite easy to infer a relationship between the two, except in the most recent period.

Why would it be that Net Income would suddenly diverge from declining sales? I'd hazard a guess that on large fixed price projects the company can harvest awards on completion, as is the case with many construction related businesses.  And with backlog coming down, one can infer that several large projects have recently completed.

Here is a graph of TAYD's Net Income layered over "price to backlog" a valuation methodology typically used for companies that generate income off of backlog. You can see how investors reward the company with a higher multiple during periods of strong earnings. 

And finally, here's a chart of the median quarterly price of the stock layered on backlog.

It is certainly possible that the market knows about some orders on the horizon that will boost backlog or potentially future opportunities for sustained margin expansion.

It is possible that the company has been "re-rated higher" b/c of its prior capacity expansion, with another capacity expansion currently under way, that will enable the company to build even larger product and capture more share of the market.

But it is not possible for the company to generate strong results without strong orders, and the orders of late have been lagging.

At $60M market cap, this remains, to the wider market, an "undiscovered gem" and perhaps even a good idea for a long term investment. I don't yet understand enough the competitive landscape to make that decision. But I do know that if the pull of orders tugs earnings down, and momentum buyers flee, there will likely be another bite at this apple at lower prices for patient investors.

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ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. DO YOUR OWN ANALYSIS OR CONSULT WITH AN EXPERT BEFORE MAKING INVESTMENT DECISIONS.

$ARIS: Generating FCF and reinvesting it at high rates ...

This post is a look at the financials of ARIS, a company I've written about before and have followed for awhile. It's been throwing out tremendous amounts of cash and reinvesting it at high rates, a characteristic typical of a kind of investment known as "compounders".

The last 1.5 years - and most notably the last half - have shown quite spectacular results, with FCF returns on equity of +17% and FCF margins of 16%.

Using a screen, we compare the company's recent results to other stocks listed on the major US exchanges both with limited mkt caps (under $1B) and unlimited and find it to be in rare company.

Whether or not those results can be sustained is obviously most important. At $70M mkt cap it's still not in "orbit" so to speak. Over the next 2-4 quarters perhaps, investments in the business to meet growing demand, reduce churn and lower turn time will likley negatively impact margins so that's a near term headwind to sustaining current rates of return.

But if those investments ultimately return what the current business is doing - or more - it's possible to consider that this company is doing something unusual and special as it appears that it might be.

In my effort to learn more, I am seeking out knowledgeable folks with experience in small dealer markets (1-10 doors) or dealer services markets in the areas that ARIS serves: powersports, RV's, medical equipment, marine and wheel / tire. Please ping me if you or someone you know fits that bill so we can be connected for a brief chat.

***

I like it where ideas converge as recently happened here in the last two weeks ...

First I reconnected with an old friend who runs Greenlea Lane Capital and shared some ideas with him. I know few investors as focused, disciplined and patient as he and I treasure his time and counsel. Were he older, I'd perhaps call him wise but that's a sobriquet for the old and an epithet for the young, and he is young and his success to date hopefully precedes a long career ahead.

He solely seeks out compounders and while I own companies for a handful of reasons I shared with him one that I've previously written about here - $ARIS - that seemed like it fit that bill, meaning that it generates cash and reinvests it at high rates of return.

ARIS is a small software / technology company that serves the dealer markets, primarily for powersports (motorcycles and ATV's), RVs, wheel / tire and home medical equipment.

While many dealer services companies serve the back office, ARIS goes to the consumer facing side, developing websites (~50% of sales) and offering eCatalogues (~35% of sales) so that dealers with 1-10 doors can be online, showing, selling and managing product. At $4.15 it sports a $74M mkt cap / $80M EV trading at 14x TTM EBITDA, neither terribly cheap nor terribly expensive, but a discount to peers.

That idea turned the conversation towards another more mature and well known compounder - $CSU.TO - which is also a software company serving vertical markets, and got me revisiting Mark Leonard's brilliant shareholder letters, notably the most recent one about high performing conglomerates.

Independent of all this, but around the same time, someone directed me to Base Hit Investing's post on ROIIC, another great read by John Huber. The nut of that piece is how to calculate and - more importantly, internalize and understand the meaning of - returns on invested capital.

Between those concurrent events, I decided to dive more deeply into $ARIS to see how it stacks up financially against more well known compounders and to get a sense if maybe it has an opportunity to be something special.

I am a shareholder - and I don't know the future - but their recent cash flow generation has been lights out and maybe that bears out the possibility that this company could be something special. I definitely see something in the results and quality of mgmt that is unusual in a company so small.

I'll start with most recent results ...

... The 17% topline growth is ~5% organic with the rest from three acquisitions last year that enabled the company to more deeply enter the wheel / tire services space ...

TCS Technologies (Sept 2014). A dealer services company in the wheel / tire vertical that not only does websites but has an integrated point of sale / integrated inventory management piece.

TASCO Software (April 2015). Also in the wheel / tire vertical with more business mgmt / back office related offerings.

DCi (July 2015). eCatalogue in the wheel / tire / auto after market space.

... if all this sounds boring and uninteresting ("websites?"), when you look online at products for sale, you are likely looking at a picture / price / sku sourced from some kind of catalogue. In short, eCatalogues are an essential part of the infrastructure of internet commerce.

Small dealers who don't own entire catalogues essentially rent them from a company like ARIS. It is a competitive business for sure - there is no end to small companies doing it - but it is scalable, low touch, high return and - with enough subscriptions - a cash flow engine.

For ARIS, this cash flow engine has generated low dd / mid-teen FCF margins for the last 1.5 years. 

Prior to 2015, the company was working its way through an acquisition of a distressed company (50below) that created a short term blip but enabled them to substantially grow their websites business. In that case, the acquired subscribers had already paid the target company, which squandered the cash, meaning ARIS essentially acquired the liability of having to provide a service to the subscriber, but not the cash. But that is all in the past.

What is in the future?

Even as the catalogue business churns out cash the websites business is like the yin to the catalogue yan; high touch - it takes time to get a dealer website set up - and high churn - they lose about 15% of sales / year when customers jump ship to competitors or close their doors.

Just to reiterate, 15% organic growth every year is churned away. That means every basis point reduction in churn is an increase in organic growth. Reducing churn is therefore something the company is focused on though some churn is structural to the business, a factor investors should consider quite carefully.

On the most recent conf call, mgmt indicated a number of investments to speed website turnaround, reduce churn and meet growing demand. Having too much work is what I call a "high class problem" but its a problem nonetheless and the investments will be headwinds to margins.

About these investments, in their words ...

1. General investments in the business:

"As we look ahead to Q4, I want to make a few points. First, we had another quarter of strong sales bookings. This means we will continue to apply resources into translating those bookings into revenue as quickly as possible. And as such, I suspect that will continue to impact the gross margin in a way similar to what we experienced in Q3 [ie down to the high 70% / low 80% range]. 

"The flipside of that is that we are aiming to maintain organic growth rates in Q4 similar to what we experienced in Q3. Second, as I noted previously, our profit performance in the first nine months of the year has exceeded our expectations. We anticipated that there would be some investments in Q3 that would prevent us from improving upon our Q2 performance. 

"While we did make some of those investments and still improved upon our performance, some of those investments did not hit in Q3 from a timing perspective and as a result will likely materialize in Q4. These investments include, among other things, our ongoing investment in our India office, consulting fees to upgrade and optimize our data centers and the rollout and go live of our enterprise wide CRM system."

2. Platform upgrades to websites and eCatalogue:

"We have several active projects including extending and improving our core website lead gen and e-commerce platform, developing a new next-generation version of that product, and developing the next generation of our core eCatalog technology. 

"The first item extending and improving our [existing] platform is pretty obvious and has resulted in a substantial increase, in some cases a triple digit increase in leads to our dealers. These improvements have resulted in strong new bookings this year and improved churn. We remain committed to building and delivering the best platform for lead generation and e-commerce in the markets we serve. [The existing platform is internally called "endeavor" and has been around for +10 years]

"The second item is a total rewrite of that platform ... The re-write is internally code named Domino, and Domino is a product that will openly replace Endeavor. It'll be our platform for the future. It is written to be a responsive design platform. It will be much, much faster. It actually will drive much more leads. It has a tremendous amount of flexibility to be able to appeal the different vertical markets as we continue to import medical data and the entire data and other types of data. And it also is going to have significant impact on our cost structure to deliver and maintain new customers.

"... We will start porting dealers over August or September, so we will begin porting dealers over to Domino and that process will take a minimum of 12 months, it might take a little bit longer than that, but that migration effort is not going to be incremental to our cost structure today. We've had a plan to do that for a long time, and we will be porting those guys over to Domino and eventually we will retire and cut down Endeavor and all the data center that goes along with it."

"In terms of eCatalog, we have spent the last year developing the next generation publishing tools that we expect to dramatically reduce the amount of time it takes our OEM customers and our internal teams to create new content and update older content. What previously took days or weeks will now take seconds or minutes with this new platform. We developed this as a global solution from day one and designed it for use in the markets we serve as well as any other market where the equipment is complex and requires repair."

3. Opening an office in New Delhi

"We continue to build out capacity in the US and India to lower our backlog and cost structure. While our overall numbers for the quarter were quite good, our revenues would have been even higher had we been able to deliver all customers in under 30 days which is our target.

"As we discussed in the last call, one of those initiatives resulted in opening an office in New Delhi, India. Almost a year ago we assigned a senior operation resource to investigate building additional capacity in India, we conducted a comprehensive review of the options and hired a VP General Manager in November and have continued to add staff. We now have an operations team up and running in India, the leader of that team was trained in our Duluth office for three weeks and one of our senior US resources is in New Delhi now completing that team’s training. We expect this team to start working on our backlog in the next few weeks.

The nut of these investments means on the plus side, they are investing in their business to upgrade their platform and reduce churn ...

... but on the negative side, near term margin impact and with the distraction of platform upgrades and ERP / CRM systems rollouts, I'm sure we've all seen how that can get off the rails pretty quickly. Again, things investors need to consider.

How the company manages the transition will be critical to the next years results and that's really the most important thing, despite prior year results that have been exceptionally impressive. I have been focusing on how to gain insight and comfort with these changes and if anyone has networks into dealer services software that I could chat with for 15 minutes, that would be most helpful. 

Back to recent results, here is a summary of TTM figures ...

... growth, margin expansion and FCF generation.

Putting it all together with some balance sheet data gives a sense of returns on capital ...

... 17% FCF return on equity and 12% return on total cap seem impressive to me.

As BHI discussed in his post, some use in the return denominator Total Capital less Goodwill & Intang (53% on TTM FCF) and others just use Tang Capital (89% return on TTM FCF). I don't think it's appropriate to exclude goodwill / intang for acquisitive companies b/c it is an essential element of deployed capital, even as it just sits there.

I've seen a table recently that showed how an index of "compounders" generates FCF return on equity in the 19% range vs the MSCI index in the 14% range, so ARIS is somewhere between the two.

Are these exceptional results?

I try not to get bogged down in parsing return numbers so finely. What matters to me is consistent and long term growth in BVPS and cash flow generation as proof that mgmt is adding value.

In ARIS case, a lot of the growth is through acquisition and in the past they've definitely overused stock for acqs, but at 17M shares outstanding it hasn't been inappropriate given the need to expand liquidity and especially when at one point there were paying as high as 14% interest on debt. Based on a prior correspondence with the company, I believe they will be much more parsimonious with using stock for future acqs.

As for how they compare to other companies, I created a screen to see who else might fit the bill. (I think I shared a version of it on screener.co called "Companites that look like ARIS"). I used the following parameters that shared the same recent dynamics as ARIS ...

TTM Rev Growth > 20% 
( total revenue(i) + total revenue(i-1) + total revenue(i-2) + total revenue(i-3) ) / ( total revenue(i-4) + total revenue(i-5) + total revenue(i-6) + total revenue(i-7) ) > 1.2

TTM EBITDA / Total Cap > 15% / 14% / 13% for last three quarters
( ebitda(i) + ebitda(i-1) + ebitda(i-2) + ebitda(i-3) ) / ( Total Debt(I) + Total Stockholder Equity(I) ) > 0.15

( ebitda(i-4) + ebitda(i-1) + ebitda(i-2) + ebitda(i-3) ) / ( Total Debt(I-1) + Total Stockholder Equity(I-1) ) > 0.14

( ebitda(i-4) + ebitda(i-5) + ebitda(i-2) + ebitda(i-3) ) / ( Total Debt(I-2) + Total Stockholder Equity(I-2) ) > 0.13

EV / LTM EBITDA < 14
built in parameter

FCF margin > 20% / 10% for last two quarters
( Total Operating Cash Flow(I) - Capital Expenditures(I) ) / total revenue(i) > 0.16

( Total Operating Cash Flow(I-1) - Capital Expenditures(I-1) ) / total revenue(i-1) > 0.1

** note that in my model, I appropriately calculate free cash flow net of capitalized software development, but screener doesn't have that parameter, so the comp margins are higher ** 

... and there are 13 US-listed companies not based in China with $1M > mkt caps > $1B. If you look at the screen you won't see ARIS there - strangely enough - and when I looked at the raw financial data noticed it didn't match the Q. This of course begs a whole host of other questions ... but that age old complain "until I can afford to get FactSet, its all I got to work with here".

Casting a wider net, when I lower the rev growth rate hurdle to 10%, raise the valuation hurdle to 20x and expand the market cap to $500B (also a shared screen "All cap blog screen"), the list grows to ~125 companies with a list of compounders that will be much more familiar to investors, topped by GOOG:, GILD, RAI, PYPL and ORLY to name a few.

That is good company to keep.

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THIS IS NOT A SOLICITATION FOR BUSINESS OR A RECOMMENDATION TO BUY OR SELL SECURITIES. I OWN ARIS FOR MYSELF AND CLIENTS. DO YOUR OWN HOMEWORK OR CONSULT WITH AN ADVISER BEFORE MAKING INVESTMENT DECISIONS AND DO TRY TO IDENTIFY AND STAY WITHIN YOUR CIRCLE OF COMPETENCE. TRY TO EXPAND IT INCREMENTALLY AND OVER TIME.

The robot selling investments; brief thoughts on a trend

Summary bullet points:

• No one likes being sold to. Poor selling - especially of financial products - feels condescending and judgmental. 

• And in an environment where a generic Financial Adviser at a generic bank charges 1% to do essentially the same thing as a robot, it makes sense to choose the lower priced, self directed option. 

• Robo-investing painlessly resolves the conflict a lot of people feel about investing, that they should know more about the market but they've never found that foothold on which to engage it. The various online robo-options provide non-judgmental, non-condescending ways of allowing people to engage the markets. 

• But is it the best option? An undifferentiated approach to investing is now the most popular but it is not necessarily right for everyone. It reflects a misreading of academic studies as well as the lazy (and greedy) aspects of the mutual fund industry, which has become good at aggregating AUM yet can't possibly allocate it efficiently in an active style. This "race to the bottom" of AUM aggregation - not robo-investing - is hurting the industry. 

• The underperformance by funds is not only "The Paradox of Success" (raising too much money) but it reflects a lack of creativity in allocating asset. Everyone is crowding into the same trades. 

• Selling differentiated aspects of active investing without compromising integrity or returns on capital seems the best and most attractive option to me as I try to grow a nascent asset management business. 

I recently attended an event where a lobbyist spoke for three minutes of prolonged insincere, smarmy-ness, and towards the tail end - concluding with an awkward introduction to the event's organizer - I had this revelation: No one likes being sold to.

It got me reflecting on the generational shift in attitudes around selling and how much the avoidance of salespeople and "being sold to" might factor into shopping online.

Personally, I still enjoy the occasional face to face shopping experiences and the guided journey towards a better product. But online shopping is such a better alternative.

Ironically, the entire online experience is made possible by constant shuk-like efforts to sell me stuff I just bought. Despite the ubiquity of those efforts (not on this blog, mind you), the intrusiveness is algorithmic and therefore feels impersonal and "just sort of there", like billboards in the city.

I imagine the current batch of 20-somethings - the first generation to grow up exclusively with online shopping - is super experienced with the self-driven, yelp driven, review driven process whose independence makes the dopamine rush at its completion that much more of an accomplishment.

Concurrently, I think every generation has their enlightenment, and if my experience in my 20's is any guide, it involves some recognition that whatever we've learned up until that point is propaganda and hypocrisy, and there's ample room for improvement to make things a bit better, more honest and real.

With that frame of reference, I'm conflicted about the trend in "robo-investing", the simple, self guided, asset allocation method of online investing targeting today's 20-somethings.

On one hand, of course they're investing online. The only people surprised by this are traditional financial advisers.

On the other hand, I have a hard time understanding why the same person who might spend 20-minutes trying to find the right restaurant, glasses or sweater, might spend less time buying the least differentiated product with likely larger sums of money and more limited information.

I struggle with this "dichotomy" (whatever that means).

I have this nascent business - an investment management firm - focused on well-researched, patient ownership of terrific small businesses trading for discounts to my sense of what they're worth, and with enough integrity to avoid companies that despoil the environment and drop bombs on people's heads, (ie the roughly 30% of the S&P tied to energy, commodities, dirty power, and aerospace / defense).

And I'm trying to come up with a good questionnaire to help clients better establish an awareness of how they think about money and investing so they can better understand themselves (what's more important than that?) and also so I can better understand if it makes sense for us to work together.

So here I am exploring various ways of framing surveys to engage people in their attitudes about investing, when a friend suggested I was overthinking this and perhaps I should check out how a robo-investor establishes suitability.

On Wealthfront I was asked TWO questions, quoted directly below ...

1. When deciding how to invest your money, which do you care about more?
Maximing gains
Minimizing losses
Both equally

2. The global stock market is often volatile. If your entire investment portfolio lost 10% of its value in a month during a market decline, what would you do?
Sell all
Sell some
Keep all
Buy more

... and based on those two questions I was given a portfolio of Vanguard ETF's.

In an environment where a generic Financial Adviser at a generic bank charges 1% to do essentially the same thing, I can see how it makes sense to use the robo-adviser. Undifferentiated AUM aggregation is a race to the bottom.

And in an environment where a shady salesperson might ask only one question for appropriateness: "Do you want to invest? Perfect, I have the right product for you" the robot is certainly a better option (and the client won't feel dirty).

And somewhere in the middle is the traditional FA who might unconsciously talk down to clients: "I know it's hard to understand, let me do this for you."

In all of these worlds, I can also see how the robo-option painlessly resolves the conflict a lot of people feel about investing, that they should know more about the market - they hear about it everywhere - but they've never found that foothold on which to engage it. These robots - like online ads - provide a non-judgmental, non-condescending way of selling.

But I also think: "Wow, Wall Street has gotten really good at separating people from their money."

Because on one hand, if you want an undifferentiated approach, of course you should just take the cheapest alternative. But on the other hand, why should anyone accept an undifferentiated approach?

We've taken these academic studies about how a long held passive index fund will outperform the "average active investor after fees" and turned it into an undisciplined mantra, as if its a solution to everyone's needs. Average the shady salesperson racing for AUM against an honest investor with sound judgment, and after fees you'll probably return below the market. 

But find someone knowledgeable, trustworthy and good at this, and you might, for not much more money, become a shareholder in terrific business that you're proud to own, and some might turn out to be great returns on capital. 

I'm framing this from my own bias as an active investor, where index ETFs seem like the investment analogy of a glory hole; it gets the job done at the lowest cost possible, just don't ask what's on the other side. (For the super-rich, secretive hedge funds fill the same void and at much higher costs, because the rich person's burden is the need to pay more).

If you do ask what's on the other side, you'll find that it's a mass of businesses, and businesses within businesses, some too big to fail, others too big to succeed, which overall should grow at or near GDP, and whose value depends largely on interest rates and the comparative value of alternatives.

This is "the market" - mentioned every 15 minutes on the radio, etc. in the form of "The Dow" or "The S&P" - and the huge propaganda machine that says we should invest in it absorbs people into doing things they wouldn't normally do, like wagering their retirement and savings on it, day in and day out.

I think due to misinterpreted studies, people think the markets are less risky than individual businesses so they throw their retirement savings and 401k's and money at them. I can't wrap my head around that. Would you rather own a handful of things you know, want and like, or bags full of random things, including those that aren't necessarily good for you, that pollute, that despoil, that kill?

I'd prefer to invest in actual businesses I (and my clients) won't feel dirty owning and that can provide meaningful returns on capital over time, no matter what "the market" does.

There are lots of people out there investing this way. Like some of them, I aim to be an open book, a guided journey through investments and analysis, providing clients with exposure to individual businesses that generally aren't in the indexes, that are well managed, generate cash, seem inexpensive and over time could grow materially faster than GDP so that perhaps at some point - if things work out and the value is realized - ownership in these businesses can compound capital faster than the market. 

And I do this without exposure to companies that drop bombs on people's heads or despoil the environment b/c my clients capital should have as much integrity as they do.

It makes so much more sense to me than the undifferentiated approach. Maybe I just need to find the right robot to sell it?

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THIS IS NOT A SOLICITATION FOR BUSINESS. THIS IS NOT A RECOMMENDATION TO BUY OR SELL SECURITIES. INVESTING IS A RISKY ENDEAVOR. ALL RIGHTS RESERVED

$WELX: An investment in Beatles history and nostalgia

As readers of this blog know, owning stock makes you a part owner of a business. This is why owning shares in tiny $7.8M market cap pink sheet listed company Winland Electronics (WELX) makes shareholders part owner of Beatles history and nostalgia.

I'll explain ...  

WELX has a day job selling remote sensing equipment used to monitor (track, log and alert) temperature, humidity, water leaks and power changes within buildings. Their products include the WaterBug, TempAlert, PowerAlert and top of the line, EnviroAlert800-ip, which has inputs for up to 12 sensors and requires a subscription to a cloud based monitoring service, their entry into IoT.

Here's the product catalog. 

I've seen these products in the closets / mechanical rooms of rental buildings, but they are also in commercial refrigerators, food or pharma plants and other industrial processing that requires certain environmental monitoring. They are not fancy like the Nest but work out of the box. 

There's a lot to like about that tiny little business though its not for every investor; revenues are highly concentrated and at 4x book, etc. it's trading at nosebleed valuations.

The valuation reflects (obviously) a desire by some to own the stock for among other reasons that the company has transitioned from a manufacturer, to an asset light model, and some expect even possibly to an investment vehicle for its two Co-Chairmen: Thomas Braziel and Matthew Houk.

You've probably not heard of them but they've had some success investing, Thomas through his firm BE Capital and Matthew through his work at Horizon Asset Management.

Houk, one would presume, is good at what he does since his boss at Horizon, Murray Stahl, acquired 15% of WELX in late 2014, which is another reason for the valuation, given Stahl's fame as a "guru" in the investment world.

In short, this is really about putting money on two young jockeys (so to speak), and alongside Stahl.

A lesson I learned a long time ago is that if you have a chance to meet a CEO or Chairman and you find them to be terrific capital allocators with high integrity and great ideas on long term shareholder value, sometimes its best to just make an investment in them and let them do their thing, even if "that thing" is not totally known ahead of time.

Some might say this is investing with your eyes closed, misunderstanding everything you see, b/c another lesson I learned even longer ago is not to blindly follow what you read online or promises you hear from someone with an angle. Saying "no" a lot - A LOT - and the ability to separate the "A" ideas from the rest is the hallmark of the best investors.

But unless you're building something yourself, investing is ultimately about entrusting your capital with the best capital allocators you can find, whether its a coffeeshop owner (entrusting them to build the right space that attracts customers), an industrial company (entrusting mgmt to anticipate the right product mix), etc., and at a price and with the right concentration so that the inevitable blips and bumps don't hurt you.

The problem of course is how to find good capital allocators. I think my brief experience as a PI helps with that, though I might be overstating its benefits.

In any case, the "investing in a jockey" theme isn't some new ground breaking idea. I doubt most people understand at all what's going on at Berkshire but a few own BRK b/c Mssrs Buffett and Munger are "terrific capital allocators with high integrity and great ideas on long term shareholder value." It is why I own WELX.

The aspect of being a part owner of Beatles history came later and is just the sugar in my coffee. 

***

Many museums don't have budgets to put on one-off special shows so companies like Exhibits Development Group (EDG) create shows, sell them as a turnkey solution and - if the shows are successful and desirable - keep selling it over and over, presumably collecting some % of ticket sales.

Its an easy model to comprehend; build the exhibit and resell it over and over. The incremental cost after the first show is ostensibly zero, the rent in theory is zero since the museums host, the material is probably part of someone else's collection, insurance might even be carried by the museum. The point is, in theory its a tremendous business that requires little capital and if things go well, generates cash.

One new show that EDG is putting on is a collection of Beatles memorabilia titled "The Magical History Tour", whose world premiere was at the Pacific National Exhibition, in Vancouver, BC in August 2015 and just opened at the Ford Museum in Dearborn, MI to good reviews. Other venues to host the exhibit include the Chicago History Museum, Chicago, IL; Putnam Museum of History & Science, Quad Cities, IA; and Minnesota History Center, St. Paul, MN.

To put on this show, created an entity called EDG-PMA LLC, reflecting the partnership between EDG and Peter Miniaci & Associates, the group of four Beatles collectors who supplied items for the show.

WELX, through an investment vehicle I'll explain below, currently owns 14% of an investment in this LLC but it won't be long 'til more belongs to them b/c - if everything works out - that investment will eventually convert into a 25% stake.

Here's how the investment was put together: Two investment groups - WELX and FRMO Corp an unnamed third party* - created an investment vehicle called Northumberland with initial investments of $200K and $1M, respectively and owned proportionally. Thus, WELX owns 17% of Northumberland and an unnamed third party owns the rest. [* i'd previously thought FRMO was this unnamed third party but can't find my source for this info, so i've edited that out as of August 2018. it's not financially material but transparency has value for its own sake]. 

Northumberland invested this $1.2M to EDG-PMA LLC. It looks like a loan but acts like a convertible preferred equity. In return for the loan investment, EDG will pay interest at an irregular dividend of 10% and once the loan  the investment is repaid - this is key - Northumberland will own 30% of the LLC putting on the show.

Furthermore, when the investment converts to equity, WELX will end up owning 83.33% of Northumberland meaning it will own 25% of the LLC. (30% * 83.33% = 25%). I reckon its set up this way to utilize WELX's NOL's, so the profit they take might equal the profit they make without sharing it with the taxman (rim shot).

The Beatles I hear, are pretty popular and if this ownership continues indefinitely and the show can continue, it should generate solid cash flow for as long as the LLC has access to the pieces in the show.

Obviously, all investment carries risk as does this one, and of course, if you really want to own Paul McCartney's pick or George Harrison's notebook, eBay or other venues might be most appropriate. The value of Beatles memorabilia might even be enhanced as a result of the new show, which I hear is worth a visit if you're passing through Dearborn.

Full text of the investment language follows.

"On Friday, July 10, 2015, the Company completed an investment of $200,000 in Northumberland IX LLC (“Northumberland”), an entity formed with another third party to invest a total of $1.2 million in EDG-PMA, LLC (“EDG-PMA”), itself an entity formed in cooperation with Exhibits Development Group, LLC (“EDG”) to develop, design, construct, market, place, own, and operate a traveling museum exhibition presently known as The Magical History Tour: A Beatles Memorabilia Exhibition. 

"Northumberland’s investment in EDG-PMA is effectively structured as convertible preferred equity. 

"The convertible preferred equity pays an irregular preferred dividend at a rate of 10 percent per annum on any outstanding principal balance and is immediately convertible into 30 percent of EDG-PMA common equity upon repayment of Northumberland’s $1.2 million principal amount, the timing of such repayment being dependent on the distributable cash flow of EDG-PMA." 

"Until repayment of Northumberland’s $1.2 million principal amount, the convertible preferred equity is entitled to the entirety of EDG-PMA distributable cash flow. Prior to the repayment of principal, the Company’s interest in Northumberland is proportionate to its $200,000 investment. Following the repayment of principal, the Company’s interest in Northumberland shall be 83.33 percent." 

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This is not a solicitation for business or a recommendation to buy the stock just something unusual about a stock that I thought readers would appreciate. It is based on public filings but I can't vouch for the accuracy of those filings or of this blog post.. This "safe harbor" statement is meant to cover my ass and to remind readers they are responsible for their own research and investment decisions. At the time of this writing, I own some of the stock. All investing carries risk particularly small cap equities and that risk includes the potential for a total loss of capital.

Kicking around a new idea: $PSSR Inexpensive and Independent Airspace Technology Company

Summary bullet points:

• $PSSR is a micro-cap with long operating history in aerospace technology and improving balance sheet.

• Book of business is growing with recurring revenue subscriptions and the tailwind of long term industry trends.

• Trading at inexpensive 5x EBITDA despite visibility into continued revenue growth.

In a recent article in the WSJ about a successful test using blockchains (ie bitcoin technology) to record transactions in the credit default swap market, I read the following quote ...

"Some may be reluctant to make changes that threaten their own market share or introduce new complexity to current systems that have been tested and refined over the years."

... and it struck me as something that could have been written about any industry, at any point in time in history.

This post is about technological change in the aerospace industry, NextGEN, and a tiny company called PASSUR Aerospace (PSSR) that until 15 years ago had a niche in "old technology" but is evolving with the "new technology" and could have an opportunity - given its established space in the industry, its slate of solutions that support NextGEN and recent hires - to grow revenues, maintain margins and thereby expand ROE and ROA back towards double digits.

The "old technology" is locating airplanes on a map, once essential, soon to be ubiquitous. The "new technology" is helping their customers - airlines, airports and ATC's - analyze, understand and make sense of enormous amounts of information to make better, faster and more efficient decisions around airspace and airport operations; scheduling, on the ground asset management, and routing.

Many larger companies are focused on using algorithms to provide better information for these customers. PSSR says its competitive advantage is +20 years of data analysis tracking its own and other information for more accurate predictive software.

I see another advantage as the stickiness of real estate in the enterprise, in the airport and ATC - the company has been there for more than 30 years - combined with finding solutions for airline customers that actually improves efficiency (a member of the board Kurt Ekert says he was formerly a sr employee at Continental Airlines when he found the company as a customer and fell in love with the product).

If ...the industry continues to modernize and evolve, if ... the product continues to improve and if ... the company continues to focus on meeting needs of existing customers, the stock could be attractive - revenues have grown recently and deferred revenues (a measure of subscriptions) imply continued growth - while the current valuation of of 5x trailing EBITDA seems to discount much in the way of a positive outcome.

I don't make price targets or predictions but I can imagine a future where continued and consistent steady growth and cash flow justify a higher valuation off of a larger pool of profit, while the balance sheet continues to delever, implying the potential perhaps for material growth to shareholders. Or not?  I am still trying to learn more; continued study and patience will be key.

PASSUR was founded in 1967 and has been publicly traded for more than three decades.

For most of this time, it operated under the awful / awesome name “Megadata” until 2008, when it changed its name eponymously to the pronunciation of the acronym of its heritage product, “Passive Secondary Surveillance Radar”.

Underlying PSSR – the acronym – are fixed radar sites – currently 185 in all - the largest passive commercial radar network in the world - at or near airports mostly in the US but also in Europe and Asia - that provide faster and more accurate position updates to airline operations control and ATC's. (These are the spinning radars that are used as establishing shots in movies, typically followed by skidding wheels on the runway).

The company once sold the machines, then sold the information from the machines as a subscription service. This fixed asset - and the service from it - gave PASSUR its name in the industry for solving the problem of locating an airplane and putting it on a map. As an example of this legacy, after the 1996 crash of TWA Flight 800, its radar network helped establish the precise location of the airplane at the moment it exploded and also the locations of other airplanes in the vicinity that might have witnessed it.

For several decades that legacy business was niche, yet essential and unique in busy airspaces. But new technology - notably ADS-B - is disrupting that position. By 2020 all airplanes flying in US airspace are required to have ADS-B - whether or not this actually happens is unknown - but it would make passive secondary surveillance radar a redundancy.

However PSSR is evolving ... and this brings us to NextGEN 

If you read the newspapers you've heard of NextGEN, perhaps as a bloated and expensive, FAA program; a failure; a plodding success; an over-promised and under-delivered program to - depending on your viewpoint - upgrade airspace technology to improve efficiency and safety in US airspace; or to simply force all the air traffic controllers out of work.

But NextGEN's over riding ambition is to modernize the US aviation system "... to improve the operational performance of the national airspace system."

Because of the collaborative nature of the US airspace, the benefits of any modernization at one airport or in one airplane isn't effective unless surrounding regional airports and airplanes using those airports also upgrade.

In the simplest least complicated explanation of NextGen, it is an effort by the FAA to "quarterback" the collaboration required between the primary agents in the industry ...

Airlines (ie operators)
Airports
Air Traffic Control Towers

... in order to modernize the US airspace.

The whole plan unfolds in a tough politicized environment where there is reluctance to change "... or introduce new complexity to current systems that have been tested and refined over the years" as per the introductory quote.

Big contracts. Government agencies. Modernization. It's all very complicated, long term and likely to benefit the large industry players, right?

The RTCA (Radio Technical Commission for Aeronautics) is an industry advisory committee used by the FAA as a "Public-Private Partnership venue for developing consensus among diverse, competing interests on critical aviation modernization issues in an increasingly global enterprise."

And here - among many places - is where PASSUR plays a part; despite their small size they are trusted, independent and known in the industry, so they have a seat at the table helping to develop, implement and track NextGEN priorities as well as participate in opportunities to improve operating efficiencies in the industry.

Furthermore, their "last generation" technology isn't so last generation; they continue to roll out new SSR systems at airports, as backups and redundancies.

And finally, they have been generating meaningful - and it seems recurring - revenue growth helping airlines and airports use the enormous quantities of data available to airlines from a variety of sources to solve one of three general problems that occur primarily when weather disrupts flights ...

• Better ETA’s and ETD’s to airlines improve on time performance and better prepare for arrivals and departures.

• Better on-the-ground airport information (ie “surface management”) to improve – among other things - turnaround times and on-ground performance.

• Better air-traffic management to safely accommodate increased overall capacity in the airspace and airports.

... in predictable environments these things on their own are not terribly complex but throw in diversions associated (most frequently) with poor weather and non-linear problems around availability of runways, gates, crew time, surface equipment, etc. begin to escalate.

This is where PSSR's service / solution / revenue generation comes in. The company integrates its own sources (PSSR) with other available data sources (ADS-B, ASDE-X, Mode S, En Route Radar, Airline OOOI data, ACARS, fleet databases, etc) as a data feed to flight and airspace information, then runs the data through its own algorithms and uses it to provide better analysis for predictions and performance, which ultimately supports better decision making by its customers.

It sells services and software systems via subscriptions that provide more efficiency in various aspects of the airline industry. Large material customers include $LUV and $JBLU in their most congested regions that experience weather.

I hate to rely on cliches and jargon but this where I'll throw out the term "big data" with a link to an HBR article about how PSSR - and Sears Holding (lol) - are using "big data" to improve operations. (take it FWIW, I felt I had to reference the article).

A key question here when we reflect on the world of big data is why aren't other people doing it, why is PSSR still independent, why aren't revenues higher, etc? 

On the face of it, having better resources to solve these problems sounds like a “no-brainer”. However, based on our research and our understanding of the industry, there are headwinds to customer adoption of both solutions.

• On ETA / ETD, it’s not generally seen as a complicated problem where the benefits of shrinking the ETA / ATA gap is seen as critical. When a plane leaves late it can fly faster, weather remains an acceptable excuse for delays and with the exception of the most congested airports, “good enough is good enough”.

• On on-ground performance and turnaround times, the biggest factor is planing and deplaning customers. A subscription service that improves on ground performance without improving that process does not appear to be a problem customers feel need solving

• And finally, reference the quote at the beginning of this post. A source I spoke with at a competing company who said the PANYNJ, which manages some of the busiest airspace in the world, is a huge obstacle to investment in new technology for reasons as simple as "turf battles".

In light of these obstacles, the answer to selling a customer a solution to a problem they don’t feel they have and in a crowded and competitive field is to increase and improve selling and marketing function. PSSR is doing this, it appears with early initial success albeit with some degradation of margins (EBITDA margins now 28% down from the mid- 30% range; we'll get to this in a minute).

But the investment thesis that underlies the opportunity for material long term gains is that there will be an evolution in how these problems are viewed by the customers.

We have seen examples in other markets and industries where marginal improvements were deemed unimportant and unnecessary until eventually they became essential and ubiquitous.

That is the path to a maximal and exciting return. For the patient investor, if that evolution occurs and customers are willing to pay, there could be material gains. In the meantime, you're getting some solid "blocking and tackling" at a low multiple.

FINANCIAL PERFORMANCE
We see a company growing revenues and backlog, this as a decent cash flow generating growing business trading for a low multiple at today’s prices.

Revenue and Subscription (aka backlog) Growth
The evidence demonstrates that since losing contracts in 2012/2013, quarterly revenues have been growing through 1Q16 (quarter ending 1/31/16) with pronounced sequential and y/y over growth over the last four quarters. The company indicated the "lost contract" was not a recurring revenue "core" program but a one-off for DHS.

This chart tells the current growth story (revenues) as well as the future growth through two balance sheet items that capture the equivalent of “backlog” (ie subscriptions); they are deferred revenue netted against accounts receivables. Higher levels of subscriptions should lead to continued higher levels of revenues over the next 12-months leading to potential growth acceleration.

Balance Sheet Improvement 
When we think about a business and its all-in consistency, we look for companies with good balance sheet management as reflected in growth in shareholder equity. Here the improvement since 2012 has been slow and steady . The bulk of improvement prior to that came via a partial recapitalization / debt to equity conversion in 2012. The company’s primary shareholder GS Beckwith Gilbert owns 4M shares (53%) and is also the note holder on the $3.5M in outstanding debt.

High EBITDA Margins, but Investments in SG&A a Headwind
Until recently, EBITDA has largely kept pace with the growth in revenues. However, new hires in the last 12 months have absorbed a greater share of expenses.

The new hires that impact SG&A include back office talent as well as customer facing talent:

• David Brukman, CTO.
• David Henderson, CFO
• Leo Prusak. Former FAA Deputy Director to head airport operations
• Bob Junge, formerly head of JFK airport operations, to sell airport solutions
• Howie King, formerly of competitor Saab Sensis, to be a director in business development

Other evangelists for the product include …

Jim Barry, CEO
Tom White, head of product
Chris Maccarone, airline performance

The impact of these new hires might be evident in future revenue growth but it is certainly evident in current SG&A which at 1Q16 had increased 38% to $1.6M; it is as high as its ever been and is now up to 48% of revenues, up from the 38% average in the prior five years.

The question of course is, can the revenues scale these new hires? The evidence from recent revenue and subscription growth is that it is on the way.

COMPETITION / CONCLUSION
Current competitors that sell “data driven” solutions tied to weather diversions, on ground performance and operations systems management include SAAB Sensis, Navtech (an airspace technology company recently acquired by Airbus) and IBM / weather channel, but none are as narrow and focused as PSSR.

The risk associated with competition should include the question: "When does google get into this space"? In some respects, though the degrees of complexity are different, the evolution of NextGen is not materially different from the evolution towards self driving cars. Many of us already use devices for routing, ETA management, etc when driving. I would argue its easier to penetrate the automobile since there's no "gatekeeper" (or union) advocating obstacles to automated driving the way there is keeping it out of the ATC or cockpit.

To this aspect, I see the company's legacy through the lens of that initial quote as a benefit. The company's real estate in the cockpit, ATC, and operating control room has value; the company is trusted and present. Best of all, they have been evolving slowly and successfully in the right direction.

As I've dug into this industry, I've been surprised with how "old fashioned" it is. On the front end, the customer interface seems to have leapt forward with ticket ordering and boarding pass apps and the evidence shows that overall safety has improved as well.

However, on the back end, based on what I've learned, many companies continue to operate inefficiently - and more critically - airports, municipal authorities and ATC's are as well. As someone told me recently, "the air traffic control system in this country is so antiquated, it would scare the shit out of you if you knew about it."

Because airlines, airports and ATC's are all partners in the industry ecosystem, the full benefits of an improvement by one agent - an airline say - in on time arrival might not result in faster turnarounds if the airport or ATC doesn't improve efficiency and a gate isn't available. Again, this is the reason for NextGEN.

It makes for an interesting investment quandry, because the situation can go on indefinitely. Ultimately however, my investment thesis is driven by the view that while improvements in efficiency can be overlooked and ignored eventually they became essential and ubiquitous. And in the meantime, you're getting a company that has a long history of quality management,

RISKS

There are obvious risks with investing in general, nano-cap specifically and in particular companies - like this one - with ownership concentrated in the hands of one person.

Beckwith Gilbert owns ~53% of the equity of the company (4.1M shares) plus the $3.5M note paying 6% interest. He is by many accounts committed to the success of the company and was willing to stand by when it had financial difficulties but it is unclear he is committed to returning shareholder value and that's made me cautious on this position in my portfolio.

Two issues specifically give me pause:

1. His compensation. Mr Gilbert is paid  $300k / year for his role as the Chairman, which is as much as the CEO, Jim Barry, who does most of the heavy lifting. I have no view on what Mr Gilbert does to earn his compensation but it is in addition to the interest he receives on his $3.5M in debt to the company. Viewing that $300k comp as a form of interest expense on the debt, the implied rate on the debt is closer to 16%, which is well in excess of junk yields.

At face value, perhaps it should be viewed as an indication of the speculativeness of the investment with as high a degree of risk as a junk bond.

2. A comment to me about his goals for the company. I recently attended the shareholder meeting and followed up with questions after digesting what I'd learned. A final question of mine, which I like to know from all executives of all my investments, is what are the goals for company, or in short: "why"? Why be in business? Why do this? Often its just lip service but sometimes there's a commitment to customers, to employees, to shareholders, etc.

In this case, when asked why they're still independent (given that some have rolled up and been acquired) his answer was along the lines of "b/c it's more fun to be independent and take on the big boys."

And when I asked about the long term goals for the company, where they expected to be, etc. there was no comment beyond "having fun".

I don't think that's untrue - there is something refreshing about that - but what does it mean for shareholders and maybe even about the employees who don't have the same financial independence as he has.

I think its much more fun to have winning investments. 

ABBREVIATED GLOSSARY OF AIRLINE TERMS
ADS-B. Automatic Dependent Surveillance - Broadcast

ASDE-X. Airport Surface Detection Equipment, Model X


ERAM. En Route Automation Modernization.

TAMR. Terminal Automation Modernization and Replacement. "The TAMR program is upgrading air traffic control systems at terminal radar approach control (TRACON) facilities across the national air space (NAS) with the Standard Terminal Automation Replacement System (STARS) platform."

TRACON. Terminal Radar Approach Control

STARS. Standard Terminal Automation Replacement System

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ALL RIGHTS RESERVED. THIS IS NOT A RECOMMENDATION TO BUY OR SELL SECURITIES IT IS MY OPEN BOOK / EDUCATION OF A SINGLE COMPANY THAT LCA AND / OR ITS CLIENTS MAY OR MAY NOT OWN AT ANY GIVEN TIME. THIS IS NOT A SOLICITATION FOR BUSINESS. DO YOUR  OWN HOMEWORK.