Category Archives: Company Analysis

Servotronics – $SVT

Another quick and dirty look at a net-net.

I discovered SVT when looking through the Grahamian Value site.

  • Price – $7.35
  • Shares – 2,397
  • MC – 17.6mil
  • EV – 22.6mil

Background

Servotronics, Inc. designs, manufactures, and markets control components and consumer products in the United States and internationally. The company operates in two segments, Advanced Technology Group (ATG) and Consumer Products Group (CPG). The ATG segment provides servo-control components to the commercial aerospace, aircraft, and government related industries; and medical and industrial markets. This segment’s principal components include torque motors, electromagnetic actuators, hydraulic and pneumatic valves, and related devices that convert an electrical current into a mechanical force or movement, and other products. It also offers metallic seals of various cross-sectional configurations to close tolerances from standard and special alloy steels. This segment markets and sells its products to the United States Government, government prime contractors, government subcontractors, commercial manufacturers, and end-users. The CPG segment provides cutlery products, including steak, carving, bread, butcher, and paring knives for household use, as well as for use in restaurants, institutions, and the private industry; fixed and folding knives for hunting, fishing, and camping; and machetes, bayonets, axes, strap cutters, and other tools primarily for military and rescue/first-responder use, as well as for commercial markets. It also offers various specialty tools, putty knives, linoleum sheet cutters, field knives, scalpels, and micro-spatulas; and plastic and metal fabrication, as well as engineering, design, and OEM/white-label manufacturing services to customers in the consumer and commercial industries. This segment markets its products through its sales resources and independent manufacturers’ representatives to big box, hardware, supermarket, variety, department, discount, gift, drug, outdoor, and sporting stores, as well as through electronic commerce. Servotronics, Inc. was founded in 1959 and is headquartered in Elma, New York.

https://servotronics.com/about-us/

The two segments are very different and can be analyzed independently.

ATG

Selling anything on an airplane requires tough to obtain certifications and the relationships are very valuable. Especially if those relationships carry across multiple types of aircraft.

https://servotronics.com/capabilities/

As you can see the ATG segment has grown from it’s base of less than 6 mil quarterly revenue to well over 12 mil before covid. This part of the business is consistently profitable (before covid).

There is some customer concentration risk in the ATG part of the business which is typical of these small parts suppliers in aerospace. This also leads to some lumpiness that can create some opportunity as many orders are delayed not canceled.

Covid has hit this part of the business hard. The last quarter was the first operating loss in 10 years.

CPG

The company designs and manufactures are variety of knives with a variety of applications. Below is the subsidiary’s website.

https://ontarioknife.com/collections/all

I don’t know anything about knives, but the business looks really competitive. I’m not sure of the brand value that this company carries.

they have been losing money consistently in this segment of the business.

The opportunity

5yr chart

Couple to lower expectations of the business with the increase in current assets gives you a net-net. Net-nets obviously have low expectations built into them. The low valuation takes some of the risk of future execution off table as they really can continue to do what they are doing and you can sell for a profit once some confidence returns. Many will argue net-nets are not fantastic businesses. This is completely valid. But there are examples of great businesses today starting out as a net-net that have been transformed into something substantially bigger and better. A good example is Sangoma Technologies, which several years ago was a lumpy product business trading at less than net cash.

Below is the current assets of the consolidated business.

One of the risks I look for in net-nets is the obsolescence risk of inventory. Some quantifiable ratios coupled with qualitative guesswork can reduce this risk.

As we have seen with SVT, the ATG part of the business was growing well. With this growth comes the increase in inventory. It’s worth looking at the Cash Conversion Cycle and overall Working Capital to look for some potential concerns.

Inventory and working capital have grown relative to sales but they are still not what I would call worrisome. Given that ATG has been hit hard from covid lockdowns I feel relatively comfortable with using the current inventory value in my margin of safety. There is currently 25mil of inventory carried on the balance sheet. As well there is 12 mil in PPE carried on the balance sheet which can give an additional margin of safety if we puchase based on a discount to assets.

Split the business?

The obvious thing to an outsider would to split/sell/spin-out/divest the CGP business. Though this is easy said than done, it likely would unlock substantial value.

If we use our imagination and covid lockdowns don’t continue to drag on for longer than the next 2-3 quarters and the aerospace business returns to pre covid levels of profitability of 6-8mil EBIT annually, I don’t think 8-10x EBIT is unrealistic. This leaves a value of 48-80 mil in the ATG business with no incremental growth. That’s at least double the current market cap of SVT.

Valuing the CPG business is harder. What do you think a (non Saas) business that has yet to produce earnings is worth? There are about 10 mil in identifiable assets carried on the balance sheet. This is without considering any liabilities. CPG did 8.2 mil in revenue in the TTM and 6.7 mil in 2019. There has been increased interest in the CPG products recently and the loss in the last two quarters has been the smallest in several years .

Really the value to be unlocked is just getting SVT to be valued based on the aerospace business alone. One could argue that diversification in business lines reduces the risk overall to the entity. I’m not sure that’s fair given CPG has not earned a profit in many years and we (up until 2020) experienced an economy that is growing with minimal inflation.

This is where things are uncertain. What’s the likelihood of the spin/sell/divest catalyst? I have no idea.

The current CEO is also the chair of the board. He controls (personally and from his father’s trust) controls 21% of the shares. He is also the President and CEO of the company’s knife subsidiary (Ontario Knife Company). He’s been with the company since 1993.

The rest of the board controls less than 1%. Harvey Houtkin and FMR LLC control about 20%. The Employee Stock Ownership (ESOP) Trust has another 20%. The participants in the ESOP have the right to vote on the share that have been allocated, while company representatives vote the unallocated shares. 84% of the ESOP shares have been allocated.

Conclusion

SVT is an interesting set-up. Expectations are low, but even with a return to a post covid world there may not be a massive amount of upside in the shares. Even if the economy reopens sooner rather than later, there are no guarantees when the ATG business will return. Of course there is a debt with SVT that adds some risk (although I think that is minimal).

SVT may be a good candidate for a net-net basket.

Anyone else look at SVT recently?

Thanks,

Dean

*the author does not have a position in SVT at time or writing.

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Dawson Geophysical – $DWSN

Here is a another quick write-up on a net-net I stumbled on after looking at the Grahamiam Value site.

Background

  • Market cap 41mil
  • EV -3mil
  • 23.4mil shares outstanding

Chart via TIKR

Dawson Geophysical Company provides onshore seismic data acquisition services in the United States and Canada. The company acquires and processes 2-D, 3-D, and multi-component seismic data for its clients, including oil and gas companies, and independent oil and gas operators, as well as providers of multi-client data libraries. Its seismic crews supply seismic data primarily to companies engaged in the exploration and development of oil and natural gas on land and in land-to-water transition areas. The company also serves the potash mining industry. Dawson Geophysical Company was founded in 1952 and is headquartered in Midland, Texas.

They combined with TGC Industries in early 2015, so keep this in mind when looking back before 2015.

I mentioned a similar company ($PSD.to) earlier. Although Pulse will own the data and charge customers a fee to use the data for a specific timeframe and they have change in control measures in place in the event that the data changes owners.

Obviously the business has been hit hard this year. The company just reported the lowest quarterly revenue in over 10 years. They reported a fairly large operating loss of about 8mil and and EBITDA loss of 4mil. They have been able to remove some costs from the business to weather the storm. Although there is a balance between removed costs and keeping the right amount of staff to be ready for a return in activity. Either way, I don’t envy their position.

Income Statement

Given the gyrations in the business I think it’s best to look at the financials on a TTM basis.

We will likely see top line go below the previous slowdown in 2014 and 2017 as the pandemic drags on for a few more quarters (at least).

Margin of Safety

Looking at how the balance sheet, you can see that despite the business volatility the NCAV of the business has not changed much.

The drop in tangible book value has declined as the fixed assets have been declining as the depreciation is greater than the capital expenditures. There is still a further 40mil of PPE on the balance sheet as an additional margin of safety.

Risks

  • Management doesn’t own much of the common stock
  • Very cyclical and likely delayed rebound in their business
  • Many governments are pushing more and more electric vehicles that could have a material impact on demand for them

Conclusion

This is a company that does quarterly conference calls and they have been quite conservative and reasonable with investor expectations.

I also like that Gate City Capital owns over 10% of the business. They have proven to be smart capital allocators.

As with most net-nets, this is effectively a marshmellow test for adults. The business (and share price) likely recovers, but who knows when.

Anyone else look at DWSN?

Thanks,

Dean

*the author does not own DWSN at time of writing, but that may change at any time.

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Martello Technologies Group – $MTLO.v

I’ve been writing lots about more traditional and statistical investment opportunities. I think it’s important to be flexible to some degree with your portfolio. I will never be the investor who buys a business at 20x revenue, but I’m not against buying one that has not earned a profit, is growing fast, and isn’t cheap or traditional.

Martello is an interesting example. I recently picked up some shares. It’s still a small position at this point, but that can change.

Background (pasted from TIKR.com)

Martello Technologies Group Inc. develops and sells products and solutions that optimize the performance of real-time applications on cloud and enterprise networks. The company operates through three segments: Performance Analytics, Network Performance Management, and IT Visualization. Its products include unified communications (UC) performance management software, IT systems visualization software, and software-defined wide area network (SD-WAN) technologies. The company also offers Martello iQ, a service monitoring and analytics platform; ATLAS, a SD-WAN solution with security, optimization, virtual private network, and failover components; and Martello Vantage suite of products to prevent, detect, troubleshoot, and address UC performance problems, such as delay, jitter, packet loss, and poor voice quality. In addition, it offers subscription and perpetual software licensing, maintenance and support, and training and professional services, as well as hardware products, cloud connectors, and virtual LBX devices. The company serves education, hospitality, healthcare, and professional service industries, as well as enterprise networks, remote works, and service providers. It operates in Canada, the United States, Europe, Asia, the Latin America, Australia, and internationally. Martello Technologies Group Inc. is headquartered in Ottawa, Canada.

We’ve all experienced some disruptions with some virtual meetings regardless of the platform used. Digital Experience Monitoring helps businesses take a proactive approach to cloud based collaboration and productivity.

Their website has some useful information on the topic.

The company has integrated with Mitel very well and should see revenue increase if there is an increase in Mitel’s business. Mitel has sales over 1 billion and over 4,000 employees.

Financials

As you can see they just hit EBITDA break even last quarter if you adjust for some one-time expenses.

Management

The C-suite seems fairly stacked for a company of this size.

The CEO has been on BNN a few times and always seems quite measured. He also did a TEDx Talk that I think is worth a listen. He has a background in the military and experience in Cyber Security.

The CFO recently won an award and well qualified given all the capital allocation decisions in front of the company at this growth stage.

The remainder of the team has deep experience in product development, talent acquisition, marketing, among other things.

Management owns about 3% of the company. I wish it was a little more.

Board

Similar to the executive team, the board has characteristics of a much larger company.

Sir Terry Matthews is on the board as co-chair. He cofounded Mitel and is obviously well connected. He owns about 15% of the common shares.

The other co-chair is Bruce Linton of Canopy Growth Group. Canadian retail investors will be familiar with him.

The co-founder of Martello (Niall Gallagher) is also on the board as well.

The board owns about 20% of the outstanding shares with 15% coming from Matthews. The board does not give me the impression that they are simply rent seeking buddies of the executive team, which is really nice to see.

The audit and compensation committee are comprised of independent directors.

Execution to date

The company has been focused on building recurring revenue through organic growth and through acquisitions.

Of course, the acquisitions have come with increased recurring revenue and it’s likely too early to judge if the prices paid were too high or at a fair price.

Risks

  • capital raise could happen to accelerate M&A activity
  • poor outcome from a deal
  • low insider ownership
  • share count is over 200mil, I usually prefer businesses with less outstanding shares
  • retail shareholder base can lead to volatile gyrations in the share price
  • increase in expenses as the economy reopens could be quicker than revenue growth

Milestones

Some milestones I can identify that would bring me more confidence in their execution and encourage me to add to my position:

  • several quarters of positive EBITDA
  • full integration of GSX (acquired in early 2020)
  • insider buying
  • another acquisition
  • getting MRR (monthly recurring revenue) growing organically

The shirt….

In July of 2019, Bruce Linton appeared on BNN to discuss being terminated as co-CEO of Canopy Growth. He was wearing a Martello Technologies and the shares took off from 0.20 to over 0.70. Now I don’t know what his intentions were by wearing the shirt, and I’m not going to speculate. The CEO appeared shortly after to discuss the business. I think John Proctor did a good job explaining the business and managing expectations.

I think this goes to show how primitive the venture market is. Linton was in the filings for Martello for about a year. If you type $MTLO into the search bar in Twitter you get some interesting comments around this time. Hopefully, the shareholder base is a little more focused on the business not the share price now, but who knows.

Conclusion

I think MTLO is a decent bet at today’s price. There seems to be some stability in the investor base after the run-up (and subsequent run-down) in 2019. The business seems to be building a base of recurring revenue while having a service that should be in demand for the foreseeable future. Monitoring the business performance is critical at this stage in their life and risk management via position sizing is my strategy.

Anyone else own MTLO?

Thanks,

Dean

*The author is long MTLO at time of writing. Thanks Chip and Liam for sharing notes.

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