Tag Archives: STC

Sangoma Technologies Corp (STC.v) – Update

I am going through my current portfolio and sharing thoughts on my holdings in hope of getting some feedback from readers. At the very least, it’s a therapeutic exercise for me. Please don’t expect clear succinct thoughts from these posts, it’s more of a mental dumping ground for my brain.

I originally wrote up Sangoma way back here and briefly mentioned it here. Since writing Sangoma has made some acquisitions (and integrated them), invested new products and services, and is seeking a larger share of wallet from customers. Since coming onboard, the CEO has stated that he wants to grow top line and move away from one time product sales towards having recurring revenue to remove lumpiness in the business.

All this has led to a shift in the financials as the new services, acquisitions, and legacy products all have different margin profiles. As with many analysts on the conference calls, I was somewhat skeptical of the desire for top line growth given how much cash was sitting idle. Most of the high cash net-nets sit on cash and do nothing with it. At least with Sangoma, management was acting.

All the hard work has led to a higher top line, less lumpiness through the year, and still have the combined gross margins above 60%. Operating margins have been challenged as this work was integrated and more expenses were required to market to new verticals and geographies. All this was done while maintaining positive net income over the last two years in a corner of the market that is not booming.

The tone from management has been consistent stable growth in top line will translate into a stronger bottom line eventually. Around 40% of revenue is now coming from services and the legacy products now make up about 30% of revenue.

Below is a look at their product vs. service revenue mix. Quite a change. And you can see the working capital required as a % of revenue has declined as well.

STC rev mixstc-wc

Here is a look at the new IP phones that bundle several of their products together. Demand has been strong according to the last two conference calls.

Over the last two years there have been some angry investors attending the conference calls that were not supportive of management’s actions (I could only imagine how many emails and calls the company has gotten directly). From my vantage point, management has executed the plan that they have consistently communincated to investors.

Will 2017 be the year that we see the hard work bear fruit? I am betting on it.

STC.v was also mentioned on Investorfile.

Q1 2017 results should be out really soon.

 

*author is long shares at time of writing

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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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Sangoma Technologies

I recently took a position in Sangoma Technologies (STC.v). Here is a very brief explanation of my thoughts on the company.

I have followed Sangoma ever since it was mentioned by Nate at Oddball Stocks here. It fell onto mine (and his) radar due to it being cheap, see below.

STC_valuation

The plunge in valuation was not without merit.

STC_operating_perf

You can see that the company really started struggling in 2011. Margins and ROC went one way while the capital invested in the company went the other. It looks pretty ugly.

I can’t really speak to the products themselves and their spot in the marketplace. What I am hoping for is enough margin of safety that I don’t need to know much.

Margin of Safety – Asset Value

STC_NCAV

*here is what I used to calculate liquidation value

STC_liquidation

You can see that the NCAV hasn’t changed much. That’s because most of it has been cash rolling into inventory. So you need to get comfortable with that if you are looking at Sangoma. But there is $0.12 in net cash on the balance sheet. When the CEO took over in 2010, he made it clear he is focusing his effort on growing the company and said that many costs will be incurred now while revenues recognized later.

Risks

As Saj Karsan points out in this post, there are risks involved. He is 100% correct in identifying them. They have been there for at least 2 years and for at least 2 years business owners have been disappointed.

Why Am I Buying?

I keep hearing a sentence in my head from The Manual of Ideas, “Acceptance of discomfort can be rewarding in investing…”. Many net-nets aren’t liquidated, but are turned-around (even temporarily). Annual results should be out very soon and a recent news release has pointed to growing revenue. Hopefully we will be free from write-downs, or at least only a small write-down if there is one.

Lastly, as with any investment position sizing should be taken into consideration. This company would likely fit into a basket of asset based valuation stocks as a portion of your portfolio. If Sangoma does turn out to be a winner, don’t get greedy. This is not a wonderful company at a wonderful price.

Dean

Disclosure: Long STC.v

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