Tag Archives: HCI

Sold Hartco.

I recently sold HCI.to.

The reasoning was that the company may have lots of cash, but I don’t see it getting back to shareholders.

The underlying business is OK. They can earn close to or slightly above their long term cost of capital.

Since the start of 2010 there has been at least $9 million on the balance sheet as cash. The CCC is quite short (around 30 days) and it seems that this number may be overstating what is actually needed. There are also some equity investments that one could add as excess to the valuation.

In that time the company has earned around $10 million in operating earnings. With a market cap of $45 million, this looks really cheap. But none of it has been returned to shareholders. No dividend, and no buyback. They did purchase an equity interest in a small marketing firm.

I like when you have a decent company with a ton of excess cash. I don’t mind when cash is plowed back into the business at a decent ROIC. HCI’s ROIC is around 11% over the last 5 years. Not great, but not too bad.

If you were to get the excess cash on the balance sheet returned, I would put fair value between $4.15 – $5.35 (based on 6x EV/EBITDA). Without getting any cash you get $2.95- $4.14.

All this is assuming that the company will implement the ERP successfully in the next 6 months and not spend the cash stupidly. There is some reason to be positive as last quarterly earnings were very strong.

I think there is too much risk that you either get no cash returned or it isn’t spent wisely.

I would look at HCI again closer to NCAV or $2.00, if it gets there.

Dean

1 Comment

Filed under Company Updates

Hartco

Hartco is an IT company listed on the TSX under ticker HCI. The company has been through quite a change in the last couple of years. First, the company used to own CompuSmart and some other “not so profitable” businesses. After throwing good money after bad for years, they finally exited the CompuSmart business and focused on IT for the public and private sector. The company even converted over to an income trust in 2005, and started paying distributions. These distributions were essentially all or almost all of operating cash flow. Then in 2007, my government gave me a wonderful gift, they changed the tax laws on income trusts. The trusts had until the end of 2011 to convert to corporations. The amount of income trusts was getting a little ridiculous. Even industries as cyclical as airlines were converting into trusts. After the decision was made, there was so much confusion about mutual funds selling trusts and what “the payouts” would be that many of these companies became extremely cheap. This made my job easy. 

 The Divisions

“The Franchising and Distribution segment encompasses the Company’s distribution activities operated by Hartco Distribution Limited Partnership (“Hartco Distribution”), as well as the franchising of businesses that sell a broad range of IT infrastructure solutions to private and public organizations across Canada. Franchises operate under the banners of Metafore™, MicroAge®, and Northwest Digital®, which together include more than 50 locations from coast to coast. Segment revenues are comprised of product sales to franchisees and of royalties earned on franchisee revenues. Hartco Distribution results also include activities and expenses related to the Company’s corporate services.” 

“The Commercial segment includes the business activities operated by the Company’s subsidiary Metafore Technologies Inc. (“Metafore”), and those of a MicroAge franchise accounted for as a Variable Interest Entity (“VIE”). Since January 2010, two previously separate companies in the Commercial segment, Metafore and Microserv, have been operating as one merged company under the Metafore brand. Metafore is one of the largest IT Solution providers in Canada, with operations across the country.”

Both quotes are from Hartco’s website. 

 Thankfully a friend of mine pointed out HCI to me and I bought most of my position under $2. Though not as cheap as it was, HCI is certainly not expensive. 

 Highlights 

  • Recent anouncment that Metafore and Microserv will merge, this should start to help operational efficiency in H2 of 2010 
  • ERP (enterprise resource planning) implementation in progress, should start to see higher productivity in late 2010 
  • Revenues and margins look to have bottomed this cycle 
  • Insider own around 60% of the company 

Valuations 

  • 1ox 3ye average net income 
  • 11.2x TTM net income 
  • around TBV 
  • EV/EBITDA under 4, depending on what you use for cash and debt 
  • P/FCF under 8, but capex should get ramped up in the coming cycle. Earnings and FCF will become closer to the same level. 
  • I put fair value between 6-7, given earnings rebound and a more “normal” valuation.   

Risks 

  • IT is very competitive, margins can be pressured even in a strong economy 
  • Managment has recently awarded themselves a huge amount of stock options. Although not as bad as it sounds, it is still dilutive 
  • Illiquid shares 
  • Economy struggles for a few more years   

I am a believer that there is quite a bit of pent up demand in the IT sector. There seemed to be an over-investment in IT during the tech boom that ended around 10 years ago. I think the next cycle will see many major companies and governments spend more on IT, as technology isn’t as “scary” as it was before and its benefits are obvious. The stock options are certainly something to watch, but not all become vested immediately. I used all the recent options in my market cap calculation to be extra conservative.  HCI is a buy under 3.

Dean 

The author is long HCI at time of writing. 

Leave a comment

Filed under Company Analysis