Tag Archives: Portfolio

Pulse Seismic $PSD.to – opportunity?

Mean reversion can create opportunity. The set up of an established business with experienced management coupled with very low expectations looking ahead can create opportunity. I have had some success with mean reversion in cyclical industries. It can be hard to think that the current out of favor companies will see brighter days ahead (at some point).

Enter Pulse Seismic

It’s been about 3 years ago since I owned Pulse. Here is a quick update from the summer of 2017.

Pulse recently released their Q1 2020. Top line was weak. Who would have thought that record low oil prices coupled with the covid lockdown would have led to the lowest utilization of their data library for as long as I can remember. During Q1 they and to negotiate the covenants on their debt which sent the shares up over 50% initially. Shares are down 50% and 60% ytd and over the last year. At $0.96/share Pulse has a market cap of just over 50mil and an EV of just over 80mil (CAD).

Since then, the company has had a rough couple of years.  Last year they had the opportunity to purchase their largest competitor (Seitel) in the WCSB. The purchase price was very attractive given the cost to shoot new data.

The Deal

See below for a statement on the deal from the 2019 President’s Letter. Highlights are mine. 

For many years Seitel Canada Ltd. provided Canada’s largest library of licensable seismic data, growing aggressively by shooting its own 3D data in active play areas. Pulse had wished to acquire Seitel for quite some time. I would say that the combination of the extended industry downturn and a change in ownership of Seitel’s U.S. parent company last year improved the prospects for a transaction.
Pulse’s overarching desire was to position itself for a longer-term industry recovery, at valuations that would set us up for success in the emerging environment. Bluntly, while others appeared to be giving up on Canada, we were casting a vote of confidence in the producing sector’s long-term future. This was, for us, the optimum set of conditions to bring home the deal.
We did, however, expect the short term to remain difficult, probably as bad as last year and perhaps even worse. So we structured the acquisition financing to have low principal repayments and favourable debt-to-EBITDA covenants. Combined with our absence of debt going in, our strong cash position, low costs, lack of a dividend and continued shareholder free cash flow amidst record low sales, we were confident that we were properly managing
the acquisition’s financial risk.
For $53.6 million cash (plus up to $5 million more based on sales over the next two years), we have acquired 36,354 net square km of 3D seismic data, enlarging our most valuable asset by 126 percent, and 379,207 net km of 2D seismic data, increasing our 2D data by 84 percent. (For further details please see the January 15, 2019 press release or the MD&A for the year ended December 31, 2018.) The 3D data, from which most of the revenue will likely be generated, is complementary, having minimal overlap with Pulse’s 3D data, while the widely spread 2D data is also complementary for the most part, with slightly more overlap than the 3D.
The valuation is very favourable, with the price per square km being approximately one-third the price Pulse paid in its Divestco acquisition in 2010. The Divestco metrics amounted to an estimated 10 percent of the costs of shooting new data. The valuation of the Seitel acquisition, at $1,600 per square km (with zero value assigned to the 2D data), amounts to perhaps 3-5 percent of shooting costs. While the two libraries have been largely depreciated in balance sheet terms, their replacement value is, therefore, in the billions of dollars. We formerly  provided an estimated replacement value for Pulse’s data library, but the figure for the combined library would be so large that it no longer sounds credible. Certainly, replicating Pulse’s data library would take decades of work. And a quick reminder for newcomers to the Pulse story: our seismic library consists of data–pure information — not software. It does not become obsolete, deteriorate or expire, and it can be relicensed and reused an indefinite number of times.

Read that again, the deal was done at 5% of shooting costs. That’s crazy. Having capital at the right time in the cycle can be very lucrative.

Covid and oil prices

If you have been under a rock during lockdown, your internet was cut off and you have made zero effort to pay attention to economy; you would have missed oil trading below zero and making headlines. Thankfully, the same people who seen the trade war, flash crash and the pandemic coming came out during the oil price crash and told everyone what they should have done. Nonetheless, activity in the WCSB is at an all time low. Active rig count is a good proxy for activity in AB and WCSB. Below is a 10 year chart.

Summary

They now have over double the revenue generating opportunity with very low incremental operational costs. This was already a business that generated substantial cash for shareholders over the entire economic cycle, and now it’s pretty much twice the size. The replacement cost of the assets is easily worth more than the market cap of the company and they are still producing cash at this level of activity. Since 2008, their average quarterly EBITDA and CFFO was 7.4mil and 6.9mil or just under $30mil and 28mil annually. They are now twice as big. If they can even get back to that level of activity with twice the data library then they are trading at about 1.4x EV/Average EBITDA and 1.5x EV/Average CFFO. I believe that EBITDA and CFFO are decent metrics for what the business can generate for the owners and feel comfortable using them.

Again, they have almost doubled the size of their data library without materially increasing opex. Management has proven to be make shareholder friendly decisions in the past with dividends, buybacks and debt reduction.

Low risk, high uncertainty for sure.

 

Thanks,

 

Dean

Disclosure: The author is not long shares of $PSD.to at time of writing, but I may initiate at any time.

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Getting caught off guard; Recro Pharma ($REPH)

If you’ve been in this game long enough you are going to get caught off guard once in a while (unless you are part of Fintwit where everyone bats 1.000). I would say that of all the executive functions, emotional regulation is probably my weakest. It is kind of funny given that I realize that it takes a higher EQ than IQ to be successful at this investing thing.

There are usually some minor positive or negative surprises on quarterly or annual financial statements. More often then not these lead to a minor reaction in the share price, say 5-10%. These “surprises” are usually easily explained on the conference call or in the MD&A. Once in awhile, you really get a surprise and the stock rises or drops by 25+%. The company releases numbers and the stock gaps up or down. You had no idea and where caught off guard. These are the moves that test your conviction in the company and in your process. It’s easy to take credit for the positive surprises and blame management for the negative ones. In reality it doesn’t matter who’s “fault” it is, but how you pick up the pieces and move forward is what is important. It’s so hard to remember that in 2 or 3 years, you won’t care about this specific quarter unless you did something you regret based on the results.

This recently happened to me with REPH as they released numbers and the stock gapped down 40%. I’m going to share how I am approaching the situation now.

Here is a good post on REPH. The author does a great job going over the business and valuation. Check it out before continuing.

Despite not being in an industry that I’m familiar with, the REPH investment thesis was fairly easy to articulate:

  • decently high barriers to entry
  • deep relationships with customers
  • producing drugs that are not going away anytime soon
  • split of the 2 businesses (CDMO and specialty pharma) to focus on core competencies
  • not immediately or materially affected by COVID (at least from what I understood)
  • discount to peers and previous buyouts
  • issued guidance for the business and previously beat guidance
  • there is likely to be a push for drugs to be produced in North America given some supply shortages of certain critical drugs during the Covid pandemic

There were some things to get comfortable with:

  • high cost debt
  • no CEO for the CDMO business
  • not cheap on an absolute basis
  • not expecting stellar growth (though I am not expecting negative growth either)
  • management communication has not been great
  • compensation seems high for a business of this size, but that does seem to be normal for pharma companies

Given all this, I took half a starter position or about 3%.

Now with shares about 45% lower than when I bought, I’m left with a pretty small position.  At a this point REPH is about 2% of my portfolio. When the shares crashed, REPH occupied way more than 2% of my bandwidth. I needed to take a step back and reassess. I could average down, hold or lick my wounds and blow out the position.

Here are some questions I ask myself whenever I get one of these surprises:

  1. Is this a temporary bump in the road or is this quarter indicative of the long term prospects of the business getting worse?
  2. Is there a reasonable explanation for the surprise? Did management do everything in their control?
  3. When communicating bad news, did management take accountability?
  4. If you didn’t already own shares, what would you do?

Here’s what I came up with:

  1. I don’t think the long term prospects of the business have changed and the barriers to entry have lessened.
  2. Yes and No. They were expecting a re-entry of a competitor into their market (Mylan) and seemed to have the underestimated the impact. Covid has led to delays in reorders as customers have worked through some inventory on hand. As well, business development efforts were paused due to Covid.
  3. I do feel that they took accountability for what they could control and revised guidance was issued. They have set up a Covid task force to help navigate the pandemic. They adjusted costs and are looking to save 2 mil.
  4. If I didn’t own shares, I would likely wait on the sidelines.

Given that the position is quite small and I don’t have a better use of the capital at the moment, I’m going to hold on to my shares and not add or sell. I realize that this means that I am missing out on a potential rally in the shares.

I have come up with tangible milestones to build confidence in management before adding to my stake and working towards a full position. To me, these should all be complete by the end of the year.

  • Have a better idea of how the new competitor in one of main markets
  • Hire new CEO for the CDMO business
  • Refinance high cost debt
  • Signs of significant growth in new products to fill existing capacity
  • Meet previously issued guidance

When’s the last time you got a negative surprise? What did you do?

Dean

*the author owns shares of REPH at time of writing

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Caldwell Partners (tse: cwl)

I recently took a small position in Caldwell Partners and I thought I would would do a post on why I bought. Just to be clear, it’s quite a small position relative to my other holdings. As usual, I stole this idea from others (h/t Gerry Wimmer and DeepDiscount).

I view Caldwell as a position that has good risk/reward profile and will make a nice addition to a portfolio that’s primarily driven by faster growing (and more expensive companies).

Background

Caldwell is an executive search firm that specializes in finding the highest levels of management and operations across many geographies and functions. They have been slowly expanding the number of partners over the years.

The numbers

At $1.20 Caldwell has a market cap of 24.5 mil and an enterprise value of 8.1 mil. Yeah lots of cash. It trades at about 6.5x ebit and 2.2 ev/ebit. That’s statistically quite cheap. One would expect a slow growth (or no growth) business for those prices. They also pay a dividend that is yielding 6.7%.

See below for the income statement

There is top line growth with some operational efficiencies being gained.

See below for geographical mix.

Canada has been flat to slightly up while the US has been consistently growing.

See below for some quick analysis by geography. Note the different axis min/max and Europe is starting from a relatively low base.

The last quarter was particularly strong in Europe, we have seen this before.

 

Positive Comments

The news release from the latest quarter had positive comments that indicates that momentum may continue.

“This was an outstanding quarter, bringing the firm to a new high-water mark for revenue,” said John Wallace, chief executive officer. “Our search teams throughout our geographic regions drove strong growth in both search volume and the value of assignments, despite pressure from foreign currency rates. We are especially pleased with the quarterly profit of our UK operations. With the largest level of new bookings and revenue in a single quarter in our history, we are positioned well for the fourth quarter. The significant increase in volume and our sustained focus on strategic additions to our partner team is creating search execution support needs, for which we will continue to hire in the fourth quarter.”
Wallace continued: “There is a lot of positive momentum inside our firm right now – our updated brand has been very well received since its debut, and we are excited about the recent expansion of our Agile Talent offering with the launch of our Value Creation Advisory Solution. We have an exceptional team of talented professionals at every level, all working towards a common goal – to provide value to our clients and shareholders – and it shows.”

Risks

I think the most obvious risk that came to my mind was LinkedIn taking away market share in executive search. Anecdotally, I would have expected this to have been a bigger impact on lower and mid level managers and not senior leaders in important roles. One would think that LinkedIn could actually be leveraged as a tool by Caldwell. I would think that given how important the roles are in the organizations that quality of candidates matter more than anything. I see the Caldwell brand as particularly important.

The other big risk that I can think of is the economy. Less hiring equals less need for Caldwell’s services. One does tend to get nervous after 9 years in a bull market.

These risks are not going away, so you will have to get comfortable with them if you take a position. For me, I will control these risks by limiting exposure to Caldwell.

Management

  • CEO – John Wallace. He jointed in 2008 and has previous experience in another executive search division of Hudson Highland Group. John owns about 20% of the shares.
  • COO & CFO – Chris Beck. Joined in 2013 as CFO. Recently appointed COO as well. Also has experience at Highland Parnters (which is a division of Hudson Highland Group).
  • Total compensation seems a little high, but much of the total compensation is based off performance bonuses.
  • Both of these gentlemen have employment agreements in place.
  • I think a key metric to think about is revenue per partner, which has been trending in the right direction.

Board

  • The board is comprised of 5 members with 4 of them being deemed independent.
  • The Chair of the board is not the CEO of the company.
  • The board is comprised mostly of corporate directors.
  • Many of the board members are also on the board of other public companies.
  • Almost all board meetings had full attendance in 2017.
  • Compensation is a mix of fees and shares. Average 2017 compensation was $40k/director.
  • I did some digging on the board members and there seems to be pretty good mix of strategic, operations and public market presence.

Summing it Up

I think a starter position is warranted. I would be willing to add with continued confidence in operational leverage or other positive news. Caldwell is nice because you get paid to wait.

Disclosure: the author is long Caldwell Partners at time of writing.

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