Tag Archives: AEY

Finding the right Net-Net

I would assume that the majority of the followers of this blog understand what a net-net is and why investing in them is supposed to generate superior returns. The theory is easy to understand, at least the way I interpreted it anyway. Buy something no one else wants (based on a discount to some sort of liquidation value) and wait patiently for “something good” to happen to sell your shares into. Risk is low as valuation is already so depressed, that all the “bad news” is supposed to be factored in.

I have not had great luck with net-nets. Maybe it’s because I try to take a look under the hood rather than just mechanically buy shares based on valuation. I am going to profile a few net-nets I have held. It should be noted that it may be too early to call each example a winner or loser, but all of them have tested my ability to remove emotions from investing. The real test with any net-net is likely patience, as they tend to be dinky little businesses with no real competitive position. As the market grinds higher, you have the sense that you are missing out and hold an illiquid little company that no one really cares about. It’s certainly not sexy.

To be clear, I have nothing against net-net investing as I continue to hold shares in companies that trade at a discount to NCAV. I am just stating some of my experiences.

ADDvantage Technologies Group, Inc. (AEY)

I bought AEY way back in Q2 & Q3 2011. I sold over 6(ish) months in 2012. Average performance was a loss of 16%. To be fair I bought mostly at NCAV, not at a discount to NCAV (which is what Graham was doing and is recommended). A quick summary of the stock at the time:

  • about 50% of assets were in inventory
  • major debate as to true value of inventory as they carried quite a bit and sales were weak
  • heavy insider ownership
  • working towards a net cash position (cash – debt)
  • end users (major cable companies) were hesitant to engage in major projects
  • recent change in agreement with Cisco was likely negative and creating uncertainty
  • Family owned and controlled, though compensation was reasonably fair and insiders where incentivized to realize larger profits

All of these factors led to a stock at NCAV. FWIW management seemed to “get it” for the most part as far as executing a business potentially in decline and one that definitely that had a ton of uncertainty in front of it.  They made a small acquisition to push some slow moving product through, they mentioned not chasing revenue but profit, and paying down debt. What they didn’t get (as is true with most net-nets) is capital allocation. No desire to buy back shares below NCAV, no special dividend, no marketing of the story to increase valuation.

After a few painful conference calls, I decided to sell. I have moved on and haven’t really looked back until today. I was sure that the top line wasn’t going to move anytime soon and figured the inventory would eventually be written off, which would remove my margin of safety. The inventory has not been written down since I let go of the shares, but the top line has struggled.

Here is what it would have looked like had I held onto the shares since my original purchase or if I had bought (and held onto) an ETF that tracks the S&P500.

AEY_vs._SPY

LGL Group (LGL)

I still own a small position in LGL Group. As with AEY, I bought most of my shares at NCAV, not at a discount to NCAV. This sums up the stock at the time of my original purshase (Q3 2012):

  • discount to NCAV
  • stable backlog, dropping top line
  • major markets for products were soft
  • 30% of total assets in cash
  • 13-15% of total assets in accounts receivable
  • 18-20% of total assets in inventory
  • some PP&E on the books that may hide additional value
  • significant owners of the stock that may pressure for management action
  • CEO that owned very little of the company

Since purchasing there were some positives to show that management was willing to right size the organization to survive. A reorganization was done to reduce costs, a strategic review was conducted, and moderately stable gross margins.

The issue was that the continued weak top line and small reduction in what was likely a very bloated expense line has led to operating losses. I am currently underwater by about 20% on the name and undecided what to do. The strategic review did nothing to close the gap between the share price and liquidation value. The following chart sums up the recent poor performance.

LGL_asset_values

The valuation has bumped around 1x NCAV, while NCAV has fallen. My margin of safety continues to erode. Recently the CEO resigned and there have been some board changes. Maybe this will be the catalyst to unlock value, but I am considering this one an (expensive) lesson.

Bri-Chem (BRY.to)

I had watched BRY for about a year or so before taking the plunge after a 30% drop over the course of a year, (I still own). Here’s a summary:

  • CEO owns about 5%, about 2 years salary
  • Director & former President to a subsidiary (Brian Campbell) owns 25%
  • Essentially 2 companies: one fast growing (fluids) and majority of revenue and one slow growth (steel pipe) and dragging down consolidated results
  • high debt load, no cash
  • 45-50% of assets in inventory
  • 30% of assets in accounts receivable

Since my purchase I am down about 8%. Several things have happened to change the story. First of all due to them being debt heavy and light on cash, they issued shares (fairly dilutive) at a discount to NCAV. A couple of things have brought encouraged a more scrutinized look at the balance sheet (strategic review and LOI to purchase the manufacturing facility of the steel pipe division) have brought down NCAV from almost $2/share to just over $1/share now. Yikes.

BRY_asset_value

I also bought the shares with an idea that they were trading at a discount to the sum-of-the-parts. The fast growing fluids division was growing steadily with increased oil & gas activity in the US and steady activity in Canada. There was some organic growth and some acquisitions. Both seemed to require capital and I never paid attention to how cash strapped the company was.

The steel division consisted of manufacturing and distribution. I didn’t pay enough attention to how poorly the business was performing and how little management (or analysts) seemed to care. Here are the last 9 quarters of sales versus production.

BRY_steel_production

They obviously overestimated the likelihood of success with this venture and were slow to respond to lack of demand for their product. They stated a 25-30% gross margin target in late 2012, then 20-25% in Q3 2013 and 15-20% now.

There may still be value here. The fluids division has a current run rate of about 10 mil in EBIT vs. the enterprise value of 100 mil. As mentioned there is a LOI to purchase the steel manufacturing division, but not the distribution part of the steel pipe division. Though management was confident both would go in the sale. Depending on the price, we could see some cash freed up for further fluids expansion and a re-rate in the company valuation to peer level. Even though the top line is extremely seasonal, I am holding my small position until there is some more color on the steel pipe division sale.

Sangoma Technologies (STC.v)

I wrote up STC here. Currently I am up about 40%. Most of this is due to the recent attention the company received from this blog. Here is a quick summary:

  • 23-25% of total assets in cash
  • 25-29% of total assets in accounts receivable
  • 17-18% of total assets in inventory
  • former CEO owns 20% of company
  • current CEO (from Q2 2011 until present) owns very little
  • transitioning from old legacy product to new products. split between revenue 50-50
  • CEO made it apparent that top line growth is priority 1
  • revenue is lumpy
  • small player in a large market
  • at the very least they have been break even from a cash flow standpoint over the last few years if you just include maintenance capex

STC_TB_&_Rev

They actually took a large write-down since I purchased shares, but it was all Intangibles and Goodwill, so my margin of safety was never compromised. I continue to hold and might even add as I think the lumpiness in revenue has the market spooked. But they are slowly executing on transitioning to more and more “new products” and with 65% gross margins, there is quite a bit of operating leverage.

Conclusion

What seems to be a large disconnect between investors and management in the land of asset based investments is timeframe. The CEO should be looking out several business cycles and making strategic business decisions based on all sorts of inputs. What levers to pull are more important than the markets current perception of the organization. Investors (generally) want to make a quick buck. They seem to be more interested in liquidating or putting lipstick on a pig to sell to an institution. Which isn’t a bad thing per se, it’s just a different set of priorities. The CEO is losing his source of income and I don’t think it would look good on his/her resume or LinkIn profile to say that the last job was something that was pressured to break up or liquidate because even after 10 years at the helm, the company was worth more dead than alive.

Many times these net-nets are family controlled and have been in the family for several generations. They are more precious to this family than a 1963 Corvette in mint condition. It’s their legacy.

So whether it’s right or wrong to try and cherry pick net-nets, I will be at least putting even more time to do some detailed research on them. I should note that I haven’t mentioned all net-nets I have interacted with, but just pointed out 4 examples of what you could be getting yourself into if you purchase a net-net.

So far I would like to see at least:

  • growing sales or at least flat sales
  • some cash position (preferably the largest current asset)
  • no cash burn from operations

Anyone have any thoughts on net-nets they would like to share?

 

Dean

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AEY…Sold.

Just wanted to keep up to date on a few things.

I sold AEY last week before they reported numbers. Revenues without the acquisition of Adams Global are still falling. I was hoping that stbility in the housing market would mean stability in AEY’s revenue. I was wrong.

Inventory is slowly getting sold through the increase in refurbished revenue. This is a good thing as the amount of inventory was always a concern for me.

They are likely to do an acquisition soon as the are net cash.

I think the CSCO agreement changes the profitability indefinitely going forward. I overlooked the severity of this.

I will keep a close eye on the company and jump back in if I see something I like.

Dean

Disclosure: None

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Update ADDvantage…

Let’s get some of the background out of the way…

Here are 2 links that provide bullish cases

Whopper and NZhedge

and one that provides bearish (or at least cautious)

Oddball Stocks

my original is here

OK, now we are caught up.

Since my purchase I have had AEY lose a fair bit of value, going from $3 to $2.25. Though I can’t say for sure whether I am right or wrong, I can say I was definitely early.

When I first read Ben Graham’s work, it made sense. It still does, but it has limitations. NCAV is nice, but sometimes things don’t belong in the “current” side of the equation. Some things that are in the “long lived” or “non-current” belong in the “current” side.

Obviously I am talking about things like inventory, receivables, even cash on the current asset side. Some inventory or receivables can take longer than a year to turn into cash. As such they should be in the non-current side. Under GAAP and IFRS they may not need to be put there. A perfect example is the inventory at AEY. Some of it is turned over 6-8x per year, others aren’t. Does it mean that it is worth less? No, but you may not see that money soon. Conversely, a company may be selling a piece of equipment that is not current according to accounting rules, but certainly is current in reality.

You are asking why the cash may not be “current”. Many times it sits on the balance sheet doing nothing at all. Eventually it could be spent on something STUPID. I can see it and I find it hard to listen to on conference calls. “Strategic acquisition”, “weighing our options”, etc. are common excuses. Sometimes it makes me want to throw up. I mean buyback shares or issue a dividend already.

NCAV – the learning curve

Putting zero value to equipment will eliminate many companies from your NCAV screen. Though the assets aren’t liquid, they are usually worth something. Putting a % discount on them doesn’t make much sense either. To arbitrarily assign 50% or 25% of stated value may seem OK, but it probably shouldn’t replace some number crunching. Looking at equipment values relative to production capacity and stated value (net of depreciation) are two simple ones if you can find them. That’s where NCAV does make sense, you get all the PPE for free. At the same time you could be overlooking a company that is trading at 10% of liquidation value because all its value is in plants, or real estate.

ADD thoughts

I still own AEY. I have learnt the hard way about having a margin of safety with companies in decline and initial position sizing. Essentially I bought too much too soon. I have been buying on the way down and now have a position larger than what I am comfortable given the risks involved.

The biggest risk is still the inventory and the Cisco agreement. The Cisco agreement prevents them from selling new Cisco products in Latin America and only selling to select end users in North America.

Cisco is a good chunk of revenue and new inventory, so this is actually a decent hit to a potential return to previous profitability. There will be lower margins on the Cisco products going forward as well.

The inventory is the largest part of the valuation mystery. There has been decent amount of older and refurbished inventory in preparation for a push into Latin America. This is why the latest acquisition makes sense to me. AEY now can push its old inventory through its new channels in Latin America. At least that’s how I see it. Though it remains to be seen.

AEY is still cheap. Less than NCAV and tangible book. I should have demanded a larger margin of safety on my initial purchase. I have retooled my trigger numbers for a company like AEY and it seems that all trigger numbers should be asset focused, not earnings. On that basis AEY is a buy under $2.35.

Yes we have hair on this one. I mean what do you expect with a NCAV stock. But I think there is a decent margin of safety. The latest agreement sucked. That’s the thing with NCAV stocks, the business usually sucks (at least in the short term).

Trying to envision a catalyst seems wasteful. Earnings will be driven by major whether short term and housing starts long term. This is of course only what my brain can see at this time, other catalysts may emerge.

Dean

Disclosure: The author is long AEY.

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ADDvantage Technologies

Despite the recent “pullback” the market isn’t offering any low hanging fruit for deep value investors. I find in tough to find really cheap companies without the too much risk. Expectations are quite high, even though QE2 is ending and we don’ really know if the economy will support itself. Maybe my mind is too anchored to the panic of 2008-09.

I began looking at ADDvantage Technologies a month ago. It trades for less than tangible book, 1.05x NCAV and has a EV/E of less than 10. ADDvantage Technologies has been written up by Saj Karsen here and more recently by Whopper Investments here.

For those who haven’t heard of them, this is from their website:

“We are a supplier of a comprehensive line of electronics and hardware for the cable television (“CATV”) industry (both franchise and non-franchise, or private cable). Our products are used to acquire, distribute and protect the broad range of communications signals carried on fiber optic, coaxial cable and wireless distribution systems. These products are sold to customers providing an array of communications services including television, high-speed data (internet) and telephony, to single family dwellings, apartments and institutions such as hospitals, prisons, universities, schools, cruise boats and others.”

Inventory

The first thing that jumps out at you is the amount of inventory and how low the inventory turns are. I will do my best to minimize the inventory risk. Management has even said that their biggest risk is inventory. The reason that AEY carries so much inventory is that they feel they can supply a certain niche. The stock old, new and refurbished components. Their relationships with suppliers and customers are important to prevent the inventory from becoming obsolete. This is part of their “On hand, On demand” motto.  According to management, the older inventory is not available from OEMs so AEY supplies it as part of just maintaining existing infrastructure rather than being forced to upgrade to the latest and greatest component. They carry the largest amount of inventory of resellers. They also do this because many of their customers will pay extra for the same day delivery.

As the chart show, inventory turns has been volatile. It was quite a bit higher in 2005-07 before falling off a cliff in early 2008 and finally bottoming in Q1 2010. With inventory representing over 50% of assets in all of the last 7 years we have to be careful. The inventory turns are more a function of lower sales than anything. That doesn’t mean that AEY doesn’t belong in my portfolio, but extra attention to inventory is required.

The first check I did was their auditor, Hogan Taylor LLP. They are not one of the big 4 (like that matters). The other companies that they audit have not run into any problems with misstatement of earnings. I could only check a few though. In addition, the Auditor’s Report gave the company a clean opinion. Neither piece of information provides conclusive evidence that inventory balances are “OK”, but at least they provide some comfort. If either of these findings were different, I would stay away from this company.

So we can see that most of the inventory is classified as new with only 2006-08 having a higher than normal amount of refurbished inventory.


Recent moves have reduced the level of inventory to free up liquidity. Inventory is also lower than in the boom years as their customers are only maintaining current infrastructure not building anything new.The amount charged to expenses is interesting. If the company is taking write-offs larger than the amount they charge to expenses then they are under reserving. What jumps out is the dollar amount that is charged to expenses has risen dramatically. Other than in 2006 and 2007, the write-offs have been smaller than what has been charged to expenses. But there are still write-offs meaning there may be some signs of obsolescence. The allowance is now the highest it has been, both on an absolute basis and as a percent of total inventory. It is now 9.5% of inventory versus 5-6% historically. This is even though the majority of inventory is “new”. The high allowance will likely show up in increased GAAP earnings, if there are no more write-offs, as these have already been charged to expenses. The acid test ratio, (cash+short term investments+accounts receivable)/current liabilities, is almost 3, it has been as low as 0.70.

Let me make it clear, if management wanted to mislead investors with false inventory numbers, I don’t think there is anything I could do to catch it. If they are smart enough, they will be able to food the auditors as well. This is why it is important to have executives to have skin in the game.

Their latest investor presentation says they want to increase efficiencies by getting a fully automated inventory management system. If this is implemented (and there are no write-offs) then this could be a catalyst for the market to trust the financial statements a little more and price AEY at a premium to tangible book value.

Management

There has been some chatter on the other posts as management being unfriendly to shareholders. I don’t see this. There are some related party transactions, but they don’t seem to be unreasonable. The company pay rent on a building owned by insiders, but the rates seem reasonable compared to the other facilities they lease.

Compensation is always a tough subject for me. I honestly don’t know what is fair and what the best way for management to be compensated is. Executive compensation consists of two parts for AEY: base salary and performance based bonus. Salaries may be a little high, they are around 270k. But there is a bonus plan that can have total compensation run well above 400k. The bonus is based on EBIT gains, which is better than revenue, and encourages a better capital structure if required. Last year total compensation was 360k.

Insiders own about 70% of AEY. This helps put some of the inventory risk into perspective. Knowing that if I go broke so does the CEO lets me sleep a little easier at night. The CEO and chair have 20x their compensation in the company. It helps when the CEO said “we they chase profits not revenue” on the last conference call.

Another note is that growth has come through acquisition. The amount of goodwill on the books has remained the same (no write-downs) throughout the last business cycle. This is a positive sign.

Valuation

As you can see AEY has historically traded at higher price to book, price to sales and price to operating earnings. I used EV for the sales, EBIT and EBITDA valuations. Though there was panic in 2009, we are sitting at the low end for historical valuation. There is almost as much cash on the balance sheet as there is debt. This hasn’t been the case until recently. Management has stated that they won’t retire their debt early as it is subject to an interest rate swap, and early retirement would mean a $1 million penalty. It should be noted that AEY has lower sales today than in all previous years other than 2003.

Despite the falling sales, AEY has managed to stay profitable. This is nice to see as a return to pre-recession sales is likely a long way away.

I have EPV, DCF and the Graham formula all over $5. This may be too aggressive but there seems to be a decent amount of margin of safety here. I think around $3 seems like a fair price to pay.

Cisco Agreement

There has been a recent Cisco agreement that has helped reduce the amount of inventory that the company requires. This is part of a push by the company to free up some capital tied up in inventory. Under the agreement AEY will purchase Cisco products from a primary stocking distributor rather than from Cisco. This means there will likely be a decline in gross margins for Cisco products. The products purchased can only be sold to end-users in North America. This wasn’t what AEY was hoping for. I believe they were hoping to push the Cisco products overseas into Latin America were the older models of equipment would be easier to market.

On the positive side, AEY is now a premier partner and can also sell Cisco IT and SPVTG (Service Provider Video Technology Group) products. This may be a potential growth market of management can execute.

Summary

Given the strong ROC that AEY has (nearly 20%) and management team on your side, I think that a premium to book value is fair. Average price to tangible book over the last 7 years has been 1.52x or $4.96 for current tangible book value. Even using as average valuation to sales, EBIT and EBITDA, AEY should trade at least at $4. But again, previous sales were growing rather than slowly sinking like today. Management has stated that their customers are only maintaining current infrastructure, not expanding capacity.

Last quarters earnings were a disappointment, so expect volatility with this one. New home starts are a key driver for revenue.  Given how low expectations are, this seems like a decent opportunity in today’s market.

Dean

Disclosure: The author is long AEY at time of writing. For the record, I bought before and after last quarters earnings.

AEY 2011 Investor Presentation

Company Website.

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