Year End 2023 Results/Portfolio Review

I’m a little late here relative to the rest of FinTwit but thought I should post some thoughts on the year that was. I skimped a little on this last year so I’m going back to the full format. I’ll give some general thoughts on performance then some highlights on each of the current names. For those unfamiliar with how I categorize my holdings, here’s a link to some of my philosophy where I outline that thinking.

Performance for 2023 was satisfactory at +25% for the full year. Nothing stellar but still something to be proud of, I think. I’ve had a lot of thoughts around performance here toward the end of the year. I track performance relative to the Russell 2000 and Microcap indexes because that’s where I tend to traffic. And I’ve had little issue beating those indexes with some regularity (there’s a whole separate discussion around the flaws/issues with those, but I digress) as you can see from my performance table here. But I think the truth of the matter, which all of us from the smallest of individual investors to the largest of institutional asset managers face, is that we should all probably be measuring ourselves by the S&P 500. You can make whatever theoretical or academic arguments you want but the practical facts of the matter are that if you knew absolutely nothing about personal finance/investing and spent five minutes googling around to get even a basic understanding you would figure out that just slamming all of your savings into $SPY/$VOO/$IVV and letting it compound is about as good as anything else you could do. For us hobbyists (including myself here) the reality is that you can spend hours of your personal time doing painstaking fundamental/technical/quantitative research and breakeven or underperform the S&P all the same. Or you can do what everyone from total novices to the wisest of investors do: put it in the S&P and forget about it. Anyway, I bring all this up because my since inception performance still looks modestly favorable against the S&P (16.7% vs 13.1%), but if you throw out the outlier performance in 2020 when I happen to do >50%, I am actually underperforming it pretty significantly since the beginning of 2021. I can talk myself in circles with logic and rationale all I want, but the fact is for the last 3 years I would have been better off just parking my assets in the S&P and figuring out a better use of my time. I’m coming up on my 5yr anniversary of running the blog this year and will have a full 5yr track record to evaluate. Will probably write more about this issue then, but thought I would put some of that out in the open now.  

In terms of portfolio activity, most of the year was “status quo”. Over the course of the year I added to every single name in the portfolio except for maybe two. Felt like I was able to do more research work this year than the last year or two, which was great. All the real activity was backloaded as I added a few small starter & special situations positions near the end of the year. As I say every year, I would really have liked to keep the blog itself more up to date but it’s hard finding the time to write between the day job and home life responsibilities. As always, I endeavor to be better in the new year – writing more and being more active on Twitter. 

In the spirit of transparency I continue to add to assets to this managed account. Part of the reason for the high cash balance through most of the year is due to monthly inflows where I did not (and still don’t) have great use for the funds. But I do like to remind readers from time to time that the account that I track within this blog is the vast majority of my liquid net worth.  

Successes: 

My Canadian cornerstones Constellation Software ($CNSWF) and Terravest (TRRVF) had stellar years returning well over 50% each. Namsys ($NMYSF) and Dole ($DOLE) also had strong years at +30%. The showstopper was little Data Communications Management ($DCMDF) which announced a transformative acquisition early in the year and (despite well over doubling it’s share price at points in the year) finished up ~90%. 

On the special situations side of the portfolio the Activision ($ATVI) deal closing was a good win that was sized decently. I nearly bottom ticked it in fall of 2022 when chances of the deal looked bleakest. 

Failures:  

Early in 2023 I finished closing out my position in West Virginian bank MVB ($MVBF). I was originally interested in all the banking-adjacent services they were adding and was always a little uncomfortable with the actual bank aspect of the position. The early year bank failures got me nervous enough to get out of MVB but not before a solid impairment of my capital and a year and a half of wasted time. I have officially sworn of banks – too hard for me. 

A small special situation that blew up in my face but luckily broke even was the Carlyle Credit Income Fund ($CCIF), a closed end fund that I bought into in January when it was still called the Vertical Capital Income Fund ($VCIF). Carlyle, the well-known global PE firm, had come in and acquired the public shell of this sleepy little RE debt CEF in order to change the investment objective and begin managing/raising capital for themselves. It was supposed to be a quick closing of the NAV discount by liquidating existing assets and Carlyle was going to throw in a special dividend kicker to make sure the vote to transfer control went smoothly. All went according to plan except the fund took a mysterious 17% haircut on asset sales against a recently stated NAV right as the old management was on the way out. Again, I more or less broke even on a 8 month hold but it’s frustrating to get screwed on the way out like that.  

By far the biggest failure for me of the year was a missed opportunity on TravelCenters of America ($TA), a network of truckstops scattered throughout the U.S. which was acquired by BP in the summer. I kicked the tires on this thing from early 2022 up until just a few weeks before the deal announcement but could never quite pull the trigger. The value was pretty obvious at the time (and even moreso in retrospect). They were sitting on a ton of assets, a decent brand, and non-market leading but still respectable position in their industry. I was worried about their capex spend as they were going to embark on refreshing a number of their older locations and opening a few new ones in the midst of pretty high inflation and still struggling supply chains. I’ve been kicking myslef since this deal got announced – would have been an easy double in about a year if I’d have bought the first time I looked at it. 

Current Holdings (as of 1/31/24) 

As I’ve done the in years past, I thought I would give a quick update/thoughts on each of the current names in the portfolio. I have segmented them into the respective mental “buckets” in which I classify them (more on that philosophy here): 

Special Situations (target % = 10-20% of portfolio, current % = 3% of portfolio): 

Saker Aviation Services (SKAS, 1% of portfolio): Saker is a weird little nanocap that has no business being a publicly traded company. I opened the position late in December 2023 when it was trading below cash on the balance sheet. They operate the only helipad in New York City that is authorized for tourist flights (and used to operate a small regional airport in Kansas until they solid it a while back). Their license to operate the helipad has been continuously been re-granted by the city of NY for a number of years but now the city is in the middle of an RFP for a new operator who will also invest in some additional infrastructure. Based on what I can tell Saker is done and heading for liquidation (not officially, yet, just my conjecture). May still be a last puff in this cigar butt until the RFP is done but downside feels pretty solid here. 

Sunlink Health Systems (SSY, 2%): Another bizarre nanocap that seems to be an amalgamation of assets. This one caught my eye when they announced they were selling a hospital facility in Mississippi for more than their entire market cap. That deal seems to have fallen through somewhat as the sale price has somehow gone from $8M to $2.5M or so. Sunlink also has some cash on the balance sheet, owns a small chain of pharamacies in Louisiana, and runs a healthcare IT subsidiary. Management seems to be riding this thing into the ground and sucking a lot of comp out of it but there might be something here.  

Mean Reversion/Deep Value (target % = 40-60%, current % = 53%): 

Namsys (NMYSF, 5%): Namsys is a steady little Canadian software company that builds products for armored car and “smart safe” users (think banks & Brink’s/Garda). I’ve been a holder since 2019 and after a few quite years where they struggled to resume sales traction during and post-COVID it seems like they are starting to show signs of life. They announced in 2023 that they would devote some of their excessive idle cash balance (usually somewhere between 20-30% of their market cap) on buybacks which was a positive development. I continue to think they are undervalued and could see either 1) resumption of topline growth that re-ignites interest in them or 2) an acquisition/merger by a larger player being strong possibilities in 2024. 

IDT (IDT, 21%): 2023 was a big year for IDT. Share performance was fine (+21%) and underlying fundamental performance still continues to be good to excellent. Net2Phone and the Boss ecosystem seem to be progressing nicely. NRS is still the crown jewel and continues to be the single most exciting aspect of IDT. NRS is probably nearing IDT’s market cap in worth – everything else is kind of thrown in for free. But I think the biggest development was the conclusion of the StraightPath litigation. In one of the more bizarre legal opinions I’ve ever seen IDT was let off the hook. That helps clear up what is already kind of a complicated SOTP story and will hopefully attract more investors to the name. I’m also hopeful that we will get some news about the Net2Phone spin this year. But all in all 2023 was pretty good to IDT and I was happy to add to the position in the later half of the year. I still continue to believe in it (obviously, as it is my largest position by far). 

Yellow Media (YLWDF, 7%): Another year, another big repurchase of shares for Yellow. Results for 2023 were a little lackluster as the stability in revenues and profitability declines worsened. Yellow has and will continue to be a terminal value problem until they can prove some stemming of the deterioration. It’s still pretty cheap but focused on returning cash to shareholders. I added to the position a bit over the course of the year but I am a little hesitant to make this a much bigger position at this point.  

Data Communications Management (DCMDF, 9%): 2023 was a big year for DCM with the acquisition of the RRD Canada business. At one point in the year the stock was well over a double. After the deal early in the year it was mostly about integrating and hitting their synergy targets, which seems to be on track. The stock is getting some credit for the good deal but is going to have to prove on the delivery. I continue to think it’s cheap (as outlined in my most recent write up) and believe in the company & management. Would consider adding on any weakness in the price this year and an comfortable with it being my second largest holding. 

Dole (DOLE, 7%): To be honest Dole has been a bit of a disappointment. Throughout my holding period the company has struggled with its Fresh Vegetable division (which it is in the midst of divesting), global weather has been a concern, and rising costs have been a headwind. It has also lost a little of the “special situations” luster (I.e. U.S. listing mid-merger) as well. Holding for now but not actively planning on adding to this one. I would like to see how the financials start to look once Fresh Veg is out and might start to look for an exit here. 

Medical Facilities Corp (MFCSF, 2%): Medical Facilites is a relatively new add during Q4 of 2023. It’s a bit of a turnaround that owns and operates several regional surgical centers and has recently re-focused on shareholder value, as outlined in several wonderful writeups from others. Scaling down is not really sexy to the market and there’s some weird structural quirks going on here with the split ownership on the hospitals, so it’s easy to see why the mispricing is there but I think management understands this and is moving to fix it. Started this off pretty small but could see myself adding here as time goes on. Looks very cheap with a fairly reliable business & asset base. 

Redishred (RDCPF, 2%): Redishred is also a newer holding from Q4. It’s a rollup of document shredding businesses across the U.S. that began life under a franchisor model. Over time they’ve begun buying out the franchisees (and generally improving their underlying economics as a result) and adding in smaller opportunistic tuck-in acquisitions around their main hubs. The business is somewhat capital intensive but I think that actually works in their favor when it comes to consolidating established sub-scale players. And they seem to have a bit of a different focus than larger players in the document management/disposal space. I think a number of factors are creating a mispricing here: the market cap (<$50M), Canadian listing despite the U.S. operations, leverage (~2-3x debt/EBITDA) and a misunderstanding of the business (high variance in their recycling revenues due to fluctuations in commodity paper pricing). Have already added to this in 2024, will probably continue to add more. 

Long Term Value (target % = 40-60%, current % = 27%): 

Constellation Software/Topicus/Lumine (CNSWF/TOITF/LMGIF, 5%): Same old same old with the CSU machine. I keep looking for a spot to add to CSU itself as well as Topicus & Lumine, but there’s not really been any great times to take advantage of soft pricing. Have not devoted nearly enough time to digging into the spinouts but hoping to remedy that sometime soon. 

Terravest (TRRVF, 9%): Terravest continues to execute exactly to plan. Have been pleased with their deal activity post-COVID. With the benefit of writing this a month and a half into 2024, it’s already shaping up to be another great year for this little gem. Starting to get a lot more attention on Fintwit (and hopefully in the real world now that they are in the $1B market cap range) and still looking pretty cheap.  

Dream Unlimited (DRUNF, 7%): Dream had a decent 2023, all things considered. But I’d be lying if I said that I hadn’t had some anxiety about the rates, rising costs, and liquidity concerns facing everyone in the real estate space over the last year or two. I did hold my nose and add a bit through 2023. In the very long term I still feel solid about what DRM is doing and the quality of it’s assets and organization but I’m not nearly smart enough to be slamming a ton of capital in here.  

IAC (IAC, 6%): IAC is the one name in this bucket that I have seriously considered bailing on and, given an appropriate exit price window, I would probably move on from in the near future. But every time I run my sum of the parts numbers here the valuations are just too compelling. Assuming markets in 2024 carry through with some of the momentum we saw in late 2023, we might start to approach a reasonable valuation here. I still continue to believe in value creation happening at IAC between the team, mission, and execution but I’m starting to understand the time to buy something like IAC is right after one of the big spins (my initial purchase was right on the heels of the MTCH spin) but you have to be smart about when the valuation peaks out. When you hit a big dry spell like what I’ve held through, where there’s no big value catalyst, it just trades at a perpetual discount. And as much as I like the team here it’s possible that the way they’ve handled the Angi part of their business hasn’t been ideal – it’s largely swamped the rest of the good work they are doing elsewhere.  

Thanks again for following along for another great year. As always, you can find me on Twitter. Please feel free to reach out.  

Herzfeld Caribbean Basin Fund (CUBA)

I have been working on an interesting “special situations” kind of idea that might interest some readers. Here’s a (very) quicky & dirty little write up with all of the context that I am aware of around this opportunity. I am interested in any feedback you might have, holes in my logic here, etc. if anyone has it.

I ran across this closed end fund trading at a huge discount (~50%) to NAV and looked into it. The Herzfeld Caribbean Basin fund (symbol CUBA) invests for long term capital appreciation in public & private equity securities of companies who derive 50% or greater of their revenues from, have 50% of their assets in, or whose stock is listed on exchanges in “Caribbean Basin” countries (Cuba, Jamaica, Bahamas, DR, etc.). That sounds scary but if you look at most of the companies, they are US listed and of decent size/liquidity.

The top 15 positions are 75% of the fund. There are a lot of recognizable names (Royal Caribbean, Norwegian Cruise Lines, Martin Marietta, Vulcan, etc.) here. Most of these in the screenshot above are US listed and those that aren’t seem pretty reputable (Wal-Mart de Mexico is the Mexican Wal Mart entity, Becle SAB distills Jose Quervo). I don’t believe there’s much in the way of questionable or fraudulent holdings from what I can see. 

The management firm is headed by Thomas J Herzfeld. Seems to have a decent reputation. CUBA is the only public vehicle left, but they apparently run some separate account strategies that are Morningstar reported.

There’s a lot going on with the fund. The NAV discount exploded earlier this year when they announced a rights offering for 3x their current shares – meaning the existing 7M of fund shares outstanding will, at worst, become 28m shares with the new 21m shares being issued at the 4 day trading VWAP leading up to the expiration date of the rights offering (not NAV). VWAP over the observed trading period (4 trading days 12/8-12/13) was ~$2.55 and NAV is $4.96/share. Obviously, the big discount is existing holders realizing that they are going to heavily dilute that ~$5 NAV by issuing new shares at <$3. To combat that, the fund manager has agreed to lower their fee by 10bps (to 1.35%) but more importantly have committed to a 15% (annual) dividend distribution (first quarterly installment to be paid this month or Q1 2024) as well as a 10-20% tender of fund shares. Even with the prospect of massive dilution, I think there is an opportunity to make a quick return on the dividend, tender, and a re-normalization of the discount after the rights offering.

I did alot of the analysis below before the rights offering price was known. I ran a lot of it at the then current VWAP of $2.60, so not too far off from the actual $2.55 it will be. The big question is how many current investors sign up to almost 3x the amount of AUM for this fund (currently $35m NAV to ~$86m assuming all rights exercised at current price) when the average discount to NAV for the last 5 years has been -18%? I suspect not many. Even assuming you get the full dilution (21m shares) at roughly current VWAP ($2.60) and the minimum 10% tender offer but you rebound to a more normal -20% discount on the other side of the rights offering, I still see 15% upside in less than 6 months. 

I ran the analysis below using the 52 week low ($2.07) and 52 week high ($4.00) prices to get a range of the potential outcomes. You can ignore those here, the actual price will be ~$2.55 (pretty close to my middle column scenario).

More realistically, say they only double the share count at current VWAP, 10% tender, and trade at the historical discount. That’s ~38% return in <6 months.

You can build your own assumptions, but the main value drivers are ultimately how many new shares are issued, what price, and what % they tender. I think it is extremely unlikely that they issue the max # shares. The fund has already pushed back the expiration date on the rights once from end of November to 12/13/23. I think that indicates that they are not getting much interest. I think that’s a great sign because the less dilution you have to the current NAV, the more likely you can make some serious short term returns here. I also find it unlikely that this trades at such a dramatic discount as -50% on the other side of the rights offering considering long term it has been closer to -20%. My thinking is that once the dust settles and it’s clear that the dilution isn’t as bad as it could have been the discount will normalize over the course of a few months. The distribution(s)/tender should also get eyes on the name after the rights offering.

This is a link to the SEC filing outlining the distribution, rights expiration push back, and self tender.

https://www.sec.gov/Archives/edgar/data/880406/000199937123000497/ex99-1.htm

This is a link to the registration statement for the rights offering:

https://www.sec.gov/Archives/edgar/data/880406/000138713123010160/hcbf-n2_082323.htm

I think the potential pitfalls here are:

1. the fund manager completely balks on the distribution & tender
   1. they have communicated the intention to do both of these but are not officially legally obligated at this point to do either (have not filed a tender offer filing w/ SEC, have acknowledged in their statements that they can adjust the distribution terms as determined by the Board)
   2. In my opinion they have already cratered their price with this rights offering, if they were to bail on the distribution & tender they are going to ensure they never approach NAV on this vehicle again as management cannot be trusted.
2. The actual NAV of CUBA falls apart over the investment horizon
   1. Obviously at the end of the day this CEF holds some volatile stocks so if we have a big market correction between now and when the tender/distribution/discount re-normalization happens it won’t matter if you bought at a 50% discount to December 2023 NAV if that NAV gets cut in half.
3. Discount never closes
   1. As you can probably see from my different scenarios in the worksheet, there’s little chance of making decent returns if the fund continues to trade at a 50% discount to NAV on the other side of the rights offering. I think the market has overreacted to the rights offering and assumed a “worst case scenario” outlook. My assumption is that once the rights offering, tender, & distribution details are settled that the discount will close, but I suppose that there exists a scenario where this management team has lost all credibility. I am doubtful though.
4. Longer time horizon than expected
   1. I am expecting ~6month time horizon here for the distribution, tender, discount normalization but obviously there’s no guarantee that they don’t drag their feet on any of that and/or discount doesn’t normalize as mentioned above.

In the interest of full disclosure I have a very small position in this at $2.55/share.

EDIT (12/19/23):

Amazingly, the fund put out a press release saying they received 14.3m shares worth of subscriptions (!!!) to be issued at $2.35. I was blown away that they got that much interest. Still don’t understand how they got there. Anyway, yesterday they put out a final estimate where they have decided to only accept 9m worth of shares but at $2.31 (raising $20.8M in new assets).

I’d say it’s a little disappointing that the dilution will be so high. I honestly thought they would not raise nearly this much new AUM and I’m also surprised they didn’t accept the full 14m worth of shares. However, I don’t think the investment case is totally dead here.

When I re-run the numbers post-rights offering NAV should be ~$3.59. Shares have traded up a bit to $2.85 currently. But even from here assuming just the 10% tender & quarterly distribution payment you’re looking at a mid teens return (all previous caveats still apply – stable NAV, mgmt goes through with the distributions, etc.). And that should only take a few months to realize.

FWIW I doubled up my tiny position at $2.55 on the day the rights offering expired. Plan on holding to see how everything shakes out for the distributions.

Data Communication Management (DCM/DCMDF)

DCM is Canadian print services provider undergoing major changes to its business model and working to integrate a transformative acquisition while being somewhat underpriced by the market due to perceived industry headwinds and historical reputation for middling operational results. 

The Numbers (as of 12/13/23):

Price DCM.TO C$2.55 

Mkt Cap C$140M 

EV C$386M 

EV/EBITDA (LTM) 10.8x 

The Company:

Data Communications Management (DCM) is an established and successful print services provider undergoing significant organizational changes in an effort to pivot toward a technology “platform” business model. The legacy (and so far still the core) business is highly customized, complex spec’d outsourced printing services for large enterprises. Like most print service providers this includes the design and printing of direct mail, letterheads, envelopes, forms, labels, etc. Their newer business initiatives are really an extension of the old core business. Their DCMFlex product is a workflow management platform that allows users to find, customize, and order branded template materials within their organization. ASMBL is a newly launched digital asset management platform that integrates further upstream within clients’ existing marketing workflows. They also have a suite of other offerings around marketing campaign management, personalized video, and regulatory-mandated communications.  

One recent change at DCM has been the acquisition of a major competitor – the Canadian print services operations of RR Donnelly (RRD). DCM announced the deal in February of this year and closed the transaction for C$135M in April. The acquisition will be significant to the business, nearly doubling revenues (~C$250M annual revenues from RRD Canada) and headcount while providing access to ~400 net new clients. DCM has called out opportunities for gross margin improvement and have identified C$30-35M in targeted cost savings through integration. The deal comes on the heels of the broader RRD business being taken private by PE firm Chatham Asset Management in late 2021. In addition to the obvious benefits of new customers and additional resources, the sale from Chatham also suggests the newly acquired business may have been seen as non-core and therefore neglected or potentially under-invested. 

Post-acquisition DCM will serve nearly 3,000 clients across a variety of industries in Canada including major banks, insurance companies, national retailers, government agencies, healthcare service providers, energy & utility companies, etc. Revenues are derived from 1-5 year service contracts that generally contain volume, raw material cost, and inflation pricing adjustment clauses. Pre-acquisition DCM boasted of >95% retention rates and claimed to work with 70 of the 100 largest Canadian companies. 

Another major change at DCM was the arrival of current CEO Richard Kellam. Kellam was appointed CEO in early 2021 and brought to the role 35 years of extensive international business experience from stops at Goodyear, Mars, Wrigley, and Playtex in addition to CEO experience at Advantage Group International (a consulting/business development organization working with international consumer goods & retail brands). Kellam initially found DCM through a consulting engagement with the company and was enticed enough with the business and opportunity to come aboard as CEO in a time of post-COVID upheaval at the company. Since his arrival, Kellam has demonstrated notable business acumen and leadership by rationalizing business operations and completely refocusing a sleepy ho-hum printing business around what he calls a “print-first to digital-first” transformation initiative. To boil the DCM thesis down to its simplest terms, Kellam is engineering a transformation from a high-competition, low value-add business (customized printing) to a significantly more valuable business via upstream software product integration. The phrase “platform business” is cliched at this point, but ultimately that is the objective at DCM – moving from a simple service provider to a wholistic digital-to-print solution for clients with complex needs.  

The Good:

Having been a shareholder of DCM for some time now, I have been impressed with management – particularly Kellam. Since his arrival in Q1 2021, DCM has gathered significant operational momentum and appears to be aligned under a reasonable and potentially underappreciated new strategy (as discussed above). Phase one of this pivot has been a rationalization of the legacy business. Through Q1 2023, Kellam and DCM have reduced bloated headcount by >15%, consolidated operating facilities, focused on increased operating efficiencies in production and billing/collections practices, and reduced net debt by about a third (C$96M in Q4 2020 to C$59M in Q1 2023). Over the course of Kellam’s tenure from Q1 2021 through Q1 2023, the numbers are not necessarily “blow you away” improved but are certainly impressive within the broader context of the inflationary environment and volatile business landscape. You can see the incremental progress in the metrics shown below (displayed as a percentage of TTM Revenues, beginning Q4 2020 which was one Q before Kellam’s appointment as CEO). Most expenses are down marginally over this time frame while operating income is on a nice upward trend.  

What’s more encouraging is that the slight uptick in Total Expenses and corresponding downtick in Operating Income in Q1 2023 was the result of one-time charges related to the aforementioned RRD acquisition. Adjusted for this extra expense the Q1 2023 TTM Operating Margin would have been 8.3%, well over double where margins were in Kellam’s first quarter (Q1 2021) at the helm. It should also be noted that top line revenues were up ~15% over the time frame displayed above. I am not totally confident in assigning that success to DCM versus just chalking it up to lagging post-COVID normalization and/or contractual inflation adjustments baked into their service agreements. But, nevertheless, the improvement in dollar terms is quite meaningful as TTM operating income in Q1 2021 improved from C$7M to C$23M in Q1 2023 (adjusting out the RRD acquisition costs). Is DCM’s management team the greatest operators of our generation? Are two years of operating trends in a challenging business environment and an uncertain global macro backdrop unassailable proof of a sure fire turnaround? Certainly not. But I do think that the incremental improvements herein are in line with Kellam/management’s commentary and some credence should be given for a job (so far) well done. 

I belabor the point around Kellam/management and their abilities because I think that it is the foundation for the forward looking investment case for DCM. I think you need to have some respect for management’s capabilities to optimize the newly acquired RRD operations in line with what they have done at DCM and continue to generate traction on their new offerings.  

The new business initiatives are a little fuzzier in terms of progress. The Flex platform sounds to be the most mature offering. To expand on the description above, Flex is a software platform that allows the large, complex clients that DCM works with to manage their marketing workflow, content creation, regulatory compliance requirements, etc. across physical and digital channels while integrating directly with DCM’s manufacturing capabilities. Although DCM does not report segregated individual product revenues, management has pointed out that roughly 30% of revenues (as of mid-2021) were “tech-enabled” (with Flex being the backbone of this offering) and are targeting 75% by 2025. Granted, there is little visibility into the economics of Flex but management has specifically pointed to Flex as a “means of increasing gross margins” as they continue to roll it out to existing clients and onboard new prospects. Management has also alluded to the more “pure ARR” nature of four other nascent products (including ASMBL, a holistic “digital asset management” platform, and PRSNL, a customizable video delivery platform).  

What might all this mean in actual economic terms? EBITDA margins for the 5 years pre-COVID (when the business was decidedly more focused on traditional print services) ranged from 5-7%. Calendar year 2022 saw full year EBITDA margins of 14% and management explicitly identified (pre-RRD acquisition) 5 year targeted EBITDA margins of 18-25%. Post-RRD acquisition, they seem to be backing off a bit identifying only >14% as their stated target. I think the low hanging fruit in terms of cost reductions at DCM has probably been harvested, but the new RRD operations may provide more runway yet. They have targeted C$30-35M in cost reductions as they integrate the operations and also identified some room for improvement on gross margins at RRD. Assuming all these costs savings fall to the bottom lines, we’re looking at C$70-75M in EBITDA in the relatively near future.  

The large RRD acquisition did introduce a fair amount of debt into the capital structure as it was financed largely with new debt. DCM spent the last few years paying down old debt from ~C$150M in 2019 to ~C$59M in Q1 2023. Post-acquisition net debt now stands at C$246M (C$102M ex-lease liabilities, with an additional C$15M in asset sales under contract which will further pay down debt balances early in 2024) and management has communicated a target debt level of ~1x EBITDA . Despite the debt load, I believe that as the market understands the higher quality of the “new” DCM and they prove out their ability to move further up the value chain and become more embedded with their clients’ workflows via the platform offerings we should see multiple expansion to reflect the improving business quality. We’ve already seen an appetite and ability to pay down debt fairly quickly – I would expect the same in the future. 

I’ve discussed Kellam’s leadership at length but I believe it is worth mentioning that he, as well as other insiders, have considerable alignment with shareholders. The collective value of RSUs, options, and shares purchased in the open market totals ~C$10M for Kellam. Cumulatively, insiders (many of which are, admittedly, former executives who acquired their shares during employment but remain involved on the board) own ~23% of shares. 

The only other point I feel compelled to mention here is that DCM’s path seems pretty simple to me. Like basically any other business (especially mature small/micro caps) they are trying to build new offerings adjacent to their (successful) core legacy business. They have decades of experience and are moving further up the workflow with their existing customer base (and hopefully new ones). I really like companies that launch new/adjacent initiatives from a position of strength (I.e. a reliable core competency which provides stability as they incubate new offerings). For DCM, they have been in the printing business a long time and understand their customers’ challenges. Evidence suggests they have been successful in servicing those needs, as indicated by the size and quality of their customer base. They are probably the second largest printer services provider in Canada at this point and now have dynamic leadership at the helm. I think at the end of the day, at current valuations, you are paying for a solid (but not yet sexy) business that is underestimated by the market and has plenty of upside potential if they can execute according to plan. 

The Bad: 

To state the obvious, printing physical materials for other businesses in an increasingly digital world is not particularly sexy or lucrative. In a 2021 investor presentation, DCM cited an expected annual growth rate for the “conventional print solutions” sector of ~2%/year. Based on a few data series I’ve reviewed, I’d say that’s a pretty generous outlook. Canadian “print related activity” GDP readings were declining ~2%/year before COVID and current levels are down ~25% from pre-COVID levels. As a result, over the course of the last 15 years or so DCM’s EV/EBITDA multiple has largely been anchored in the 4-6x range. Obviously some of that could be attributed to its small size and historical execution issues, but I think the vast majority of such a paltry valuation is attributable to the fact that they operate in what is widely acknowledged as a declining industry (printing). The most directly applicable comparison that I was able to find in public markets (Transcontinental Inc, $TCL in Canada) seems to suffer from similar valuation woes. Other operators in the space, such as RRD’s old printing business and Xerox’s printing operations, seem/seemed to be treated as step children within their larger organizations. Presumably because of their “melting ice cube” outlooks (and their economics aren’t much to write home about, either). I highlight all of this to make the very real & valid point that the landscape is not exactly titillating to less detail-focused investors and might continue to be an overhang on valuation. But I do want to circle back to my point from earlier that they are actively trying to re-define their “TAM” (yuck, hate using that phrase). I continue to believe that if they can prove traction on the software/platform side of the business that will be the true value unlock here.  

One key element that you may have noticed missing from this discussion so far has been valuation. I must confess that I have been a shareholder in DCM for over two years now (I am very late on getting this write up published). When I established my initial position in Q3 of 2021 I bought at prices significantly lower than the current market price (although I have added at prices higher than current, too). I think the story was a little simpler then because valuation was pretty low (in the 6 to 8x EV/EBITDA range). Today, current valuations are a bit more aggressive. The acquisition cost are still fresh and causing some noise in the reported metrics but even using DCM’s reported adjusted EBITDA measure, shares are trading around 10x EV/TTM EBITDA today, but is being obscured by expectations of higher profitability as RRD is integrated. Let’s remember that when the RRD deal was announced, the pro-forma entity would reportedly have ~C$500 in combined revenues. We did not, however, get much information on the underlying economics of the RRD operation at the time. I, and probably most reasonable investors, presumed that since it was being carved off and sold by RRD’s P.E. ownership that the business wasn’t exactly humming (and that’s been borne out in the 2 quarters of consolidated financial results since the closing of the transaction). But, if one assumed that DCM’s management team would successfully be able to get RRD’s profitability to roughly similar levels of current DCM operations (let’s say 14% EBITDA margins, as reported for FY 2022) you’d at some point over the next 12-24months have a combined entity producing ~C$70M in EBITDA across a CAN/U.S. footprint with green shoots of software/ARR-products baked in on a <3x EBITDA levered business. So, based on actual results thus far that 10x valuation may seem a little lofty (remember DCM has been stuck in 4-6x range for the last 15 years before the RRD acquisition), but if you think Kellam et al can whip RRD into shape then you’re really looking at a more historically-reasonable 5.5-6x type multiple (C$386M EV on fully synergized/normalized $70M EBITDA). My whole point here is that the market is somewhat baking in the fact that the combined economics will improve beyond what’s currently reflected. And make no mistake when I say “baking in” I mean “expectations” – which can be devastating if not met. Especially for small/micro caps in shrinking industries. For what it’s worth, I added significantly to my position in August of this year, well above current market prices. Obviously DCM has been a win for me already, but I still believe the market is underpricing the optionality of the developing platform business and the ability of the management team to deliver above expectations. 

The Key Variables: 

• Continued successful integration of the RRD business (looking good so far – per the Q3 they are on track with their 18mo timeline having reduced some headcount and consolidated some facilities while moving anticipated synergies up by ~C$5m/yr)
  • This is two pronged: we should see cost synergies as well as revenue increases from new offerings to RRD clients
• Demonstrated traction in the DCM Digital initiatives (this is coming piece-meal from earnings calls as they have not disclosed these in their filings/press releases. ~25% growth YoY in Digital revenue as of Q3 2023 call with targets of >60%) 
• Continue progress on debt paydown
  • Maybe not as important to some investors, but being that DCM is small and this was quite a bit of debt added to the balance sheet with the RDD acquisition, I would like to see continued progress on the debt paydown to their 1x EBITDA target 

Although not totally de-risked, I believe DCM to be an attractive and fairly high quality opportunity in the market right now. Management has demonstrated the will and ability to drive organizational change and now have the opportunity to prove themselves on a larger platform thanks to a transformative acquisition. DCM screens as a boring and somewhat overvalued business but a fundamental assessment of the underlying details will offer patient investors the opportunity for attractive returns.  

Assuming DCM can accomplish all of its strategic objectives discussed above and establish itself as more than a simple printing services provider, I see a path to the company doubling its equity valuation on a 5 year time horizon.  

As of the writing of this post DCM (held as shares of DCMDF) comprises 10% of my managed portfolio. My average cost basis is USD$1.24. 

Quarterly/2022 Year End Results Round Up

 In an effort to stay more regular with content on the blog, I am going to start writing up some (brief) thoughts on the incremental quarterly results for the portfolio holdings. And maybe some miscellaneous thoughts here and there on other names that I might be researching at any given time.  

With all the names having reported Q4 and full year 2022 results at this point there is plenty to cover. I don’t plan for this to be comprehensive, more of a chance to highlight interesting results/developments.  

Without further ado:  

Data Communication Management (DCM/DCMDF)  

I have yet to do the full write up on DCM but it’s been a huge year for them so far. The stock is up ~60% YTD as I write this thanks to a huge announcement of their acquisition of competitor RR Donnelly’s Canadian printing operations. This is a big deal for them as RRD generates annual revenues of C$250M, roughly the size of DCM’s revs (C$274M in 2022). To state the obvious this will effectively double DCM’s business from both a financial and human capital perspective. DCM disclosed a C$123M purchase price with a planned C$30M sale/lease back on 3 real estate properties and all financed on bank and private debt. Beyond that they’ve not mentioned anything concrete in the way of expected synergies or existing economics of RRD. The big question is probably what have we paid for here? Assuming the economics are even half as good at RRD as at DCM, the net C$90M purchase price might imply somewhere in the 5-6x range (assuming 6.5% EBITDA margins on C$250M revenues) before baking in any synergies.  

I’m pretty bullish on the prospects given the effectiveness of management team’s right-sizing and growth initiatives over the last few years. Full year results look pretty solid as DCM continues to launch new product lines aimed at integrating themselves higher up into the workflows and tech stack of their existing customers. For 2022, revenues were up 16%, gross & EBITDA margins have improved, and costs continue to be streamlined. That all augers well for the go-forward combination of two similar businesses with a massive footprint and ample opportunities for cross-selling of new products.   

This is also probably a nice case study in under-appreciated and ignored micro/small cap names like DCM. Even if you bought the stock a full week after the acquisition announcement you’d be up ~25% and the stock is continuing to drift higher as more investors digest the details.   

IDT (IDT)  

IDT reported FY Q2 early in March and, as has usually been the case, I find the results to be nothing but encouraging. NRS continues to grow every operating metric at breakneck speeds and is increasingly a meaningful part of IDT’s overall economics (~25% of consolidated EBITDA contribution). The product offerings and features within the NRS ecosystem seem to grow each quarter with delivery integrations, e-commerce solutions, and working capital advances now being offered alongside the POS & advertising offerings. Boss Money saw a big uptick in transaction volume and revenues as they continue to increase presence in new corridors. Net2Phone saw a nice gain in seats & revenues while management pointed out some signs of what I view as a maturing business perspective (improving unit economics, renewed focus on cost control & ROI on customer acquisition). It sounds like the spin of Net2Phone is still on hold given market conditions, but the underlying business continues to make strong fundamental improvements. Traditional Communications is still seeing some contraction in economics (as to be expected) but management highlighted the launch of new product (Zendit, a prepaid as a service platform that will live within the IDT Payment banner of the Traditional Communications segment) that they were very bullish on.  

Overall, results were strong and inspire optimism, as they always do. I do still have concerns about the impending result of the Straight Path lawsuit which was delayed earlier in the year. The question was asked on the earnings call but was moved on from pretty quickly. One of the co-defendants in the case (Davidi Jonas, son of Howard) agreed to settle for $12.5M in December. That doesn’t exactly imbue confidence in the potential outcome for IDT if one of your co-defendants settles at the 11^th hour. I alluded to it in my 2022 year end review, but were it not for this potential $600M (?) liability hanging over the stock I would not hesitate to have it as a larger position in the portfolio.   

Dole PLC (DOLE) 
Dole turned in fine Q4 and full 2022 results. It seems they were able to push along some of the inflation costs over the course of the year. The big news here is they have agreed to sell of the struggling Fresh Veg segment to Chiquita for roughly 1x revenues. Maybe not a stellar sale but they struggled to get this segment cash flow positive so perhaps it was time to throw in the towel here. I still continue to find Dole attractive on relative and absolute basis. The stock has been doing fairly well YTD, seemingly driven by the sale news. 

Dream Unlimited (DRM/DRUNF) 

After a stellar 2021, 2022 was not so kind to Dream. But Cooper & company continue to execute on their vision of transforming Dream into a more diversified real estate behemoth. The individual pieces of Dream are not without their challenges, but DRM continues to bring new cash flowing assets online, win big development projects, and gather AUM as an asset manager. Understandably, the market has taken a more pessimistic view of the business but I tend to think there has been some over-correction if you maintain a long term perspective. Tyler over at Canadian Value Stocks wrote up some more detailed thoughts that I found particularly insightful (as always with any of his writing)

Terravest (TVK/TRRVF) 

Terravest reported their fiscal Q1 (calendar Q4) in early February and they seem to be plugging along. They continue to note strong demand in their service and product offerings in the LPG/NGL space and headwinds in the raw material pricing for their production lines. Their self-reported “cash available for distribution” metric came in at C$20.7M for the Q, which is notable in that this Q alone represents just under 40% of their total FY 2022 results for this metric. They note that Q1 & Q4 tend to be their strongest in terms of results, but YoY that number is up 60% (on a raw $ basis and per share basis). 

Of some note in the Q results was the mention of another acquisition in October of TSX Transport, a “drop deck” trucking provided based in Quebec. No mention of financials or purchase price. As far as I know this the only business they have in the generic logistics/transport sector. I believe that have some trucking/transport built into the “service” segment of their business, but from their commentary it seems to be strictly O&G services related. Perhaps lacking a better home for it, they included TSX in their discussion of the “HVAC Equipment” segment. 

Namsys (CTZ/NMYSF) 

After a somewhat disappointing 2021, FY 2022 was a little kinder to Namsys. YoY Revenue growth (~8.5% for FY 2022) is again slowly approaching the low teens mark that it had been running at pre-COVID. Over the course of 2022 there were some organizational changes that I hope will lead to a re-focusing on business growth. And the addition of a CISO position to the organization contributed to a significant bump in SG&A costs for the year, but I hope this is moving in the right direction of building the administrative infrastructure to support continued growth.  

I would love to see management do something with the C$5M in cash that seems to perpetually sit on the balance sheet without a well defined use case. Over the last 5 years the cash balance has represented 15-30% of the market cap of the whole company. They could issue a 20% dividend right now and still have C$1M in cash on the balance sheet. 

Odds & Ends

Yellow Media (Y/YLWDF) continues to be too cheap while keeping a level head about their future prospects/capital allocation priorities. I have been topping off my position as the price has come in a bit.

Constellation (CSU/CNSWF) continues to chug along and successfully spun of Lumine (LMN) recently. LMN trading has been choppy but I imagine that will subside at some point.

Activision (ATVI) continues along in regulatory purgatory, with the occasional drip of good news (UK regulators giving it a pass). Still feel good about this one regardless of the deal.

Tegna (TGNA) has been interesting of late. There’s been a ton of coverage as it relates to the FCC’s actions and Standard General announced legal action in retaliation. This one continues to be messy and probably much more of a long term hold than I had originally planned, but downside seems limited at this point and the spread is extremely wide assuming this deal gets done. Not exactly sure what to think here.

2022 Year End Portfolio Update

Greetings to all and Happy New Year! As I have done in years past, I’ve compiled some high level observations as well as a more comprehensive holdings review below.

This is, unfortunately, becoming a mainstay in these annual portfolio reviews but I’d like to acknowledge that my writing output on the blog has been pathetic this year. As ever, I hope to improve this in 2023 and look forward to the changing of the calendar as a fresh start in which to deliver on this goal. Whoever you are and however you have found this blog, thank you for taking the time to read it. I endeavor to be a better writer and investor in the new year.

To be honest, overall portfolio performance was somewhat disappointing this year. The portfolio was down about 25% over the course of the year vs. -21% and -22% for the Russell 2000 & Microcap. While not wildly off the mark, this was the first calendar year of underperformance against my benchmarks in the short life of this blog/portfolio. Optically, full year performance was uncomfortably close to the benchmarks, although month by month performance was less correlated which makes me feel better. (Long time readers may remember that I take pride in looking different from the benchmarks)

It was a very quiet year in terms of portfolio activity. I exited two positions (GRVY, RBCN), added to a few current holdings (IDT, NMYSF, YLWDF), and added two merger arb names (ATVI, TGNA). Although I added substantially to the existing names, there were no new meaningful additions to the portfolio this year. The market volatility this year was odd in that I felt comfortable with adding to existing holdings but found little else of interest that offered obvious value. Things have, without a doubt, gotten cheaper but I find that I am having trouble pulling the trigger on much of anything. Interestingly, my research output was wider in scope but shallower than in previous years – i.e. I investigated many more new names than usual but did not dig as deep on them.

In looking at the full year performance for the individual portfolio holdings, one thing I noticed is that my smaller (by market cap) names held up better than my larger names. DCM, Yellow Pages, TerraVest, and NamSys were among the best performers and all are <$400m or so in market cap. Which isn’t to say the rest of the portfolio is composed of behemoths by any stretch of the imagination: IAC is now < $5B and only Constellation is above $10B (among the non-arbitrage holdings). As I look at the portfolio and continue to research new names I find myself gravitating toward even smaller candidates in search of simpler businesses/situations that offer that small/micro information asymmetry opportunity.

Name	Ticker	2022 Performance (%)
Rubicon Technology Inc	RBCN	42.03
Tegna Inc*	TGNA	16.22
Activision Blizzard Inc*	ATVI	15.77
DATA Communications Management Corp	DCMDF	4.12
Yellow Pages Ltd	YLWDF	-2.68
TerraVest Industries Inc	TRRVF	-6.68
NamSys Inc	NMYSF	-9.87
Constellation Software Inc	CNSWF	-15.99
Dole PLC	DOLE	-25.15
IDT Corp Class B	IDT	-36.21
DREAM Unlimited Corp	DRUNF	-38.20
Topicus com Inc	TOITF	-44.39
MVB Financial Corp	MVBF	-45.33
IAC Inc	IAC	-66.03
Vimeo Inc	VMEO	-80.90

*not held in portfolio for the full year

Successes

As you might imagine in a year like this, there is not a ton to discuss in the way of positives. About the only bright spot this year was the exit of Rubicon Technologies (RBCN). RBCN was a small net-net name that I originally added in late 2020 based on the thesis that it was a controlled liquidation/deep value sort of a situation with some smart & trustworthy players involved. Well the value finally materialized this year when Janel Corp (JANL) tendered for 45% of the shares (presumably with the intention to later take a controlling stake and monetize the tax assets at RBCN). For me, the tender was a great opportunity to exit at ~90% gain at a < 2 year holding period. In retrospect, I could have juiced it a few percent more if I had played the timing just right between the tender and special dividend (I exited just before the tender date) but I was happy with the outcome nonetheless- I just wish the position had been larger!

Besides RBCN, I was enthused to see the smaller and more ignored micro-cap names in the portfolio hold up well while continuing to make progress in the underlying businesses. Falling markets and scarce bids can be a scary time for low float stocks but I was happy to see some of my fellow shareholders in these names stay the course.

Failures

Readers may recall my tumultuous relationship with South Korean game developer Gravity (GRVY) from previous blog entries. Well, 2022 finally saw the end of that relationship as I completely exited the last of my position in May. It’s hard to call a position in which you make money a failure, but between all the buying/selling & what could have been (shares peaked above $200 in early 2021 while my average exit price was just ~$60) it’s been a frustrating situation that resulted in returns well below my target hurdle rate. Not to mention I think there is still a ton of value here between the franchise quality, strong balance sheet, etc. But ultimately, I concluded that it is a captured (by parent GungHo) and ignored foreign small cap that has low probability of unlocking said value anytime soon. For me, this one was more a waste of time and opportunity cost than anything.

MVB Financial (MVBF), although not fully liquidated yet, will go down as a swing and a miss for me as well. I tried to get outside of my comfort zone with this name but ultimately I don’t think I have the conviction to see it through. See further discussion below.

I imagine that as we distance ourselves further from 2022 my failures this year will be those of omission rather than commission. As discussed above I was relatively inactive this year despite many names getting significantly cheaper. I suspect in the future there will be several names that looked inordinately cheap at the time that I was unable or unwilling to take advantage of.

Current Holdings

Special Situations (target % = 10-20%, current % = 4%):

Activision Blizzard (ATVI, 3% of portfolio)

I never got around to writing up ATVI (or TGNA below) but chances are you are well aware of the situation here. The market is largely worried about regulatory interference here – and there has been a ton of press to warrant that I suppose – but I am a firm believer that the path of least resistance for all deals of this magnitude (excluding utilities and high profile targets) is to close successfully. Furthermore, I don’t think Microsoft would have engaged ATVI and risked endangering their relatively clean anti-trust profile (post-1990s browser monopoly case) if they weren’t pretty certain they could close this deal. As I write this, the spread is still juicy at >20% with what I expect to be a 2023 close date – so quite compelling IMO.

Tegna (TGNA, 1%)

Tegna is mid-sized media company that primarily owns/operates television stations (60 or so). Early in 2022 TGNA announced it had come to terms with Standard General and Apollo with a few assets being carved off for Cox Media Group. SG is a hedge fund/PE outfit with extensive experience in both media and undervalued assets. Apollo is Apollo, and CMG is there to solve some anti-trust issues (from what I can tell). There will be headlines and hand wringing but here again I see a deal that finds a way to close. Regardless, TGNA seems modestly valued (especially relative to peers) and reading through the deal documents suggests there are a number of other potential suitors if this particular set of buyers falls through. Current spread is roughly 15% for a deal that has every incentive to get done as quickly as possible.

Mean Reversion/Deep Value (target % = 40-60%, current % = 59%):

IDT (IDT, 28%)

I have to admit, I’ve never been excited to hold a name that’s down almost 60% from its peak – but here we are with IDT. Despite being down almost 40% on the year and (correctly) scuttling their Net2Phone spin in 2022, it was a really strong year for the company. The traditional communications business came back to Earth after some COVID tailwinds, but continues to be a cash machine. The emerging parts of the business like Net2Phone, Boss Money, and NRS continue to make moderate to stellar progress within their domains. NRS continues to look like a gem of a business to me. I come away from each and every one of their earnings calls more excited than the last. I increased my shares by about 50% over the course of the year, keeping it at about 30% of the portfolio throughout.

Dole PLC (DOLE, 9%)

Dole has had a tough year given the macro environment, but has delivered results roughly in line with or ahead of peers. I continue to think it is undervalued and overlooked with a strong competitive position. If I’m being perfectly honest with myself, I probably got too big too quickly in the position. It was a low double-digit position heading into 2022 and being overly aggressive so early on has left me hesitant to commit more capital as it has drawn down.

Data Communications Management (DCMDF, 9%)

DCM is a name that I am committing to writing up soon. 2022 was a great year for the share price and honestly a pretty good year for the fundamental business. Revenues saw strong growth on new business & some initial roll outs of their “tech-enabled” subscription services. Margin and EBITDA growth were also very good as costs came down with continued rationalization of resources. I think the low hanging fruit has probably been harvested (i.e. cost cuts, headcount reduction, facility consolidation) so 2023 will probably be a real test of their new strategy validity, especially if the business environment slows amidst a recession.

Namsys (NMYSF, 5%)

It was a pretty ho-hum year for NamSys. Early year revenue growth was mid-single digit YoY but there was a decent spike up in their CY Q3 results to ~10% YoY – some of that is likely currency fluctuation as they transact most of their business in USD but report in CAD. In general I was hoping to see more development in the financials as they continually point toward the return of conferences/industry trade shows in 2022 and beyond as big marketing events for them. I presumed some of that would kick back in during the year, but some of their commentary suggests it may now be 2023 before those get into full force. On the positive side, they mentioned exploring new verticals with similar logistical challenges like the traditional CIT business lines they currently serve. Nonetheless, the company is still sitting on 20% of their market cap in cash, no debt, and valued sub 10x EV/EBITDA. Still an attractive set up for a solid little business.

Yellow Media (YLWDF, 5%)

Despite a pretty volatile path, share prices ended roughly where they began 2022 for Yellow. Along the way the company paid ~4% in dividends and repurchased roughly a third of their shares outstanding. They still carry ~$40M in cash on the B/S (15% of market cap) and have been debt free for over a year. Revenues continue to decline but the rate of change has continued to slow over the last 2 years. And I continue to have confidence that management has a sober perspective on the profile and prospects of the business. Yellow still trades at ~3x current cash flow  – I understand most investors ignoring a clearly declining business but the value here is too attractive to pass up IMO. Unfortunately, I got too cute when the pro-rata repurchase happened and did not reinvest my proceeds back at the depressed price level in October. However, I think there may be an opportunity to add at attractive prices early in 2023 as one of the majority shareholders has filed to sell roughly half of their position.

MVB Financial (MVBF, 3%)

Late in 2022 I began liquidating my position in MVB. I plan to sell of the rest of the shares in early 2023. All the reasons that drew me to MVB in the first place (new, tangentially-banking-related business lines aimed at creating diversified growth) are still present but I have gotten too uncomfortable with the core banking business. This was the first true bank/financial that I’d dabbled in and, as much as I tried to get myself comfortable with those risks/industry dynamics, I never felt at ease with the foundations of the business. To be honest, all the crypto/fintech related blow ups elsewhere in the markets has spooked me over the edge. MVB is just a little too close to those elements for my comfort. I am totally prepared to look like an imbecile here as I think there is still plenty to love about MVB but I think this comes down to a bad fit as a holding for me personally.

Long Term Value (target % = 40-60%, current % = 25%):

Dream Unlimited (DRUNF, 8%)

Shares were down pretty significantly for Dream in 2022 as the Canadian real estate market begins to reconcile with a higher interest rate environment. Undoubtedly, that will have some impact on Dream’s direct and indirect holdings in the short to intermediate term. But there’s also plenty to be excited about as Dream continues to have great success gathering new assets. As of the Q3 reporting, they’d added >$2B in new fee earning AUM. Other big developments in 2022 included launching a residential REIT vehicle, a joint venture with a sovereign wealth fund, and a joint buyout of Summit Industrial REIT. I do worry about the macro real estate environment and expect the short term might be bumpy, but I think there are plenty of signs of success here and a competent management team to see them through.

TerraVest Industries (TRRVF, 8%)

I’m not going to pretend to know enough about the natural gas market, Canadian-specific LPG/NGL supply & demand dynamics, or western Canada O&G processing equipment utilization to speculate on whether TerraVest moderately or drastically over-earned in 2022. What I am willing to say is that they had a strong year from a strategy execution perspective. I mentioned last year that I was somewhat disappointed that they were not scooping up deals post-COVID. Well, this year was much better on the M&A front as they closed 3 deals (on the heels of one near the end of Q3 2021). Metrics up and down the income statement were all up significantly on the year while shares were relatively unchanged. Given that I believe they have materially added to their earning power this year (and with some near term upside optionality assuming we may see a shift in the energy regime), I think their low absolute valuation (10x P/E, 9x EV/Adj EBITDA as I write this) continues to misconstrue the underlying value here. The only element that gives me pause here is the debt growth. Term debt is up 50% YoY and financing costs have risen dramatically. They are pretty levered relative to cash flows at this point, so I think that eventually will weigh on their ability to do deals (although to be fair their deals skew small).

Constellation Software/Topicus (CNSWF/TOITF, 7%)

Shares were down for Constellation/Topicus this year, but by all accounts, the businesses are chugging along as always. This was a big year for capital deployment back the mothership CSU – I’ve seen ~$1.7B in new acquisition spending quoted, which would be the most they’ve ever done. It also looks like there will be another spin off in conjunction with an acquisition of WideOribit & merger with the existing Lumine group. I continue to be a long-term holder and look forward to what Leonard & company have in store.

IAC/Vimeo (IAC/VMEO, 2%)

It was a very tough year for IAC. Shares were crushed along with other tech/venture-oriented names. ANGI got absolutely smoked and MGM was down >25% on the year, so even the look through names got blasted. The integration of Meredith seems to be moving pretty slowly and with some material bumps along the way. Turo filed an S-1 which could catalyze some value short term, but we’re not exactly in a hospitable IPO environment. Digital advertising spend in general took a noticeable step back, which impacted some of their other businesses. However… I still see a ton of value here relative to the share price. Excluding the look through ANGI & MGM interests the rest of the businesses are trading at ~$1B in market cap. I get that IAC is out of favor at the moment, but I continue to see compelling value and a talented/competent management team with a long term perspective. To be honest, I should have been adding to it on the way down this year but I’ve been trying to find the bottom. I think we are close and I expect to be adding early in 2023.

Names of Interest

I haven’t done this in previous years, but I’m going to include a few names below that I have done some work on at some point this year that never materialized in the portfolio (but still may!). I’d be interested in hearing from you if you’ve done any work on the names. Or perhaps this could serve as a jumping off point for you to do some work if your interest is sufficiently piqued.

Sally Beauty Holdings (SBH) – Sally is a retail chain of cosmetics/beauty products. Think poor man’s Ulta with more of a focus on hair products and “professional” retail (i.e. independents & salons). I liked the steadiness of demand for their products with some upside potential for a post-COVID bump as people continued to ramp up in person events. It looked cheap over the course of 2022 but I ultimately passed. There’s a lot of debt here, they are actively cost controlling/shrinking the store footprint, they’re pretty clearly behind on their digital offerings, etc.

TravelCenters of America (TA) – TA operates just under 300 travel centers (i.e. fueling & service stations mostly aimed at truckers but increasingly standard passenger vehicle traffic) across the U.S. The industry is fairly small for these niche stations and TA is a distant 3^rd. A new management team took over and is in the downslope of a big transformational turnaround plan. Similar to SBH I like the simplicity and resiliency of the business but I had some hesitations about the leverage, capex plan in this environment (they are rehabbing many under-maintained locations at a time where labor and materials are scarce and expensive), and strategy moving forward (they’ve introduced a franchise model but have been very slow rolling those locations out). I thought there was a lot to like here but the downside profile gave me enough pause to pass. I will likely keep an eye on this one.

Brilliant Earth Group (BRLT) – Brilliant Earth is a small-scale retail jewelry concept (in the vein of the Signet brands) with a bespoke/high fashion spin. BRLT has ~30 showrooms across major metros in the U.S. where they sell mostly custom (but some off-the-shelf type products) jewelry with a high-touch service model. They offer primarily appointment-only “jewelry consultations” with an emphasis on personalization and ESG awareness around their products. They describe their model as asset light (they hold little inventory as most pieces are built by the customer with custom components/combinations) and agile (reduction in obsolete inventory as tastes change & they proclaim to be data/analytics driven on consumer behavior). To be honest, the business model is the most interesting part here – I think there is some strong potential in the concept. The stock, however, is kind of a mess. It’s a busted SPAC that’s down >70% from the combination merger, the financials are typical of a firm squarely in “growth at all costs” mode, and as much as I like the concept I don’t know that its fully proven yet. This is a name I will probably keep an eye on, but just can’t get comfortable with at this point.

Conclusion

There you have it. Thank you for reading this far and I hope you found something useful in here. Here’s to a great 2023 for us all (and hopefully a few more blog posts from yours truly)!

Sawbuckd

Terravest Q4 Results

*As I mentioned in the year end wrap up for 2021, I am hoping to write more (smaller) quarterly updates on specific names in the portfolio. I doubt I will write something for every Q for every company, but I am hoping to increase the volume of content and force myself to incrementally analyze news around my holdings. This is the first of  one of these posts.* 

Terravest (TVK, TRRVF) is one of the names in the portfolio that I have not done a full write up on yet. Maybe that will change sometime this year. But for now I wanted to quickly highlight a few things from their most recent Q results, which they reported on Feb 10^th. 

By way of general introduction here’s how I’ve described Terravest before: 

“This Canadian small cap is basically an opportunistic small-scale roll up strategy in the energy services space and is lead by a capital allocation-focused management team…The company selectively acquires small niche service providers and manufacturers in the general oil & gas services domain for extremely cheap valuations.” 

Overall, the Q seemed fine. Ex-their two new acquisitions (see below), base sales were up 17% due to increased demand across their 3 operating segments (fuel containment, processing equipment, and services). However, margins were pretty rough thanks to rising raw material pricing and supply chain issues. And they continue to see labor shortages and COVID impacts (they’re based in Alberta, CAN). Given asset-intensive nature of the business I expect they will continue to struggle as inflation/work shortages/supply chain issues persist. The rising energy prices seem to be helping to offset these issues somewhat. 

On to the more interesting tid-bits from the Q: 

Q4 is actually FY Q1 2022 for Terravest and it was the first that included results from their newest acquisition:  Green Energy Services (operating as Fraction Energy Services), a provider of water management and environmental solutions. Terravest was previously a minority stakeholder in GES but took their ownership to 2/3rds of the company in early November. 

It was also the second quarter (but the first full Q) with results from their other recent acquisition – ECR International, a nearly 100 year old manufacturer of heating and cooling products. 

So the question is, what have we gotten with these two recent acquisitions?  

Source: Terravest 2022 Q1 – MD&A

ECR, which they’ve classified into their “fuel containment” operating segment, did about $25M in sales & $2.3M in net income. Back in Q3 when the deal was done, they reported $11M in sales and $1.1M in net income for the partial quarter. That’s annualized net income from ECR of ~$7M for a company that did a consolidated $36.6M in net income for FY 2021. That’s a 19% increase to the bottom line before any synergies (if there are any). And, per the Q3 financials, Terravest paid $37.5M for ECR. That’s .5x sales and 5x earnings. Of course that all comes with the huge caveat that we have only seen a quarter and a half of financials. Two more quarters from now we will have a more complete idea of what full year financials look like for ECR, but so far it’s pretty interesting. 

GES is a little harder to gauge given that we only got one partial Q. Sales for GES alone were $9.8M (which was ~2.5x what the rest of the “service” operating segment did in the Q) and posted a slight loss. Terravest paid $16M for an additional 41.4% of GES. ~$7M in cash plus ~$9M in TVK shares implies a valuation for all of GES at $39M, of which Terravest now owns 67% ($26M by their own valuation). Again, it will be helpful to get more incremental data as the year goes on, but it is interesting that Terravest 1) was an existing owner and was convinced enough to add more capital at a premium to their first tranche of shares and 2) GES will supposedly add some complimentary offerings to their “service” and “processing equipment” operating lines, per the filings. 

2021 Year End Portfolio Update

Happy New Year to all! I hope that 2021 was kind to you and that 2022 is treating you well so far. I will get the apologies out of the way here – I was not nearly as active on the blog this year as I would have liked. There were two primary reasons for this. First, on the personal side of things, I changed jobs mid-year and had less discretionary time than usual as I got up to speed at my new gig. Second, I don’t feel like there was all that much for me to write about in the back half of the year. As I will talk about below, there wasn’t a lot of portfolio activity and for many of my portfolio holdings there are ample resources/write-ups available from others that are well informed. I hope to remedy this inactivity in 2022 as I re-commit myself to a more regular writing schedule. I’ve tended to shy away from shorter-term quarterly updates on specific names because generally I don’t feel there’s a lot of value in focusing on earnings noise/news buzz/etc. But I’m considering doing shorter, more-regular write ups this year as a way to keep up the flow of content on the blog and force myself to stay on top of developments at portfolio companies. I’m also considering writing more about “watch list” type names as I do work on them throughout the year. If you’ve taken the time to read any of my posts this year (or any of my archives) thank you and I hope to have more for you in the coming year. 

Overall portfolio performance this year was fairly strong at 25% vs. 15% and 19% for the Russell 2000 & Russell Microcap indices. Q1 was a tough period of relative underperformance as the portfolio sorely lagged the benchmarks amidst the meme stock craze that hit small/micro caps. The portfolio gained ground and then some through Q2 & Q3 as my largest position, IDT, really took off. Q4 felt very choppy but ultimately was slightly positive to end the year just above the benchmarks. 

I now have about 2.5 years of recorded track record here on the blog and I have been fairly pleased with the results thus far. Admittedly, this has been a great period for stocks in general but the returns on the portfolio have been good on an absolute and relative basis (despite the eye-popping results elsewhere on fintwit). Overall the portfolio is doing what I had hoped to do with a concentrated selection of “value”-oriented holdings. Volatility has been similar to the overall small/micro universe but with more idiosyncratic returns (by design). In the average month, returns are usually 3-4% off whatever the benchmarks have done with some monthly differentials reaching as much as 10%. I view this as a positive because it means I am doing something meaningfully differentiated from the benchmarks/broader investment universe. I like to think that this is the sort of thing you can accomplish with moderately informed stock picking in a fertile area of public markets – I suppose time will tell. I don’t know that you can attribute much “skill” to the portfolio management at this point, but I’ve certainly felt that I’ve learned a lot and have gained more confidence as an investor, so it has been worth it from that perspective alone. For what it’s worth, changing jobs has also allowed me to consolidate some of my funds and I now run a significant portion of my liquid net worth in this portfolio. 

Successes 

Many of the names in the portfolio provided strong contributions this year, but the standouts were newcomer IDT ($IDT) and the Canadians: Dream Unlimited ($DRM, $DRUNF), Terravest ($TVK, $TRRVF), and Constellation ($CSU, $CNSWF). I don’t have much specific commentary on the 2021 performance of any of these names beyond what you will find below, other than to say they are great companies with excellent management teams that continue to execute on their given strategies.  

It feels like a lifetime ago now, but 2021 also brought to a close the best investment I have made in the portfolio thus far – Collector’s Universe ($CLCT). My first buy was in March of 2020 at $16.55 and the take out was done at >$90 less than a year later. A great example of right place at the right time for an extremely compelling business (despite the fact that it was probably taken from us a bit too early). 

It’s a little bit awkward to call this one a success because I still hold the name, but I also sold the majority of my Gravity ($GRVY) position in March to lock in ~300% gain on the position. That was after it had run up to $200 at one point but with an initial purchase around $30 and an exit around $135, it was still a successful investment. At the time I sold, I had gotten somewhat disenchanted with the constant volatility in the name and was ready to deploy capital elsewhere. For what it’s worth, I have added to the position again (around ~$70/share) – more on GRVY below. 

Failures 

MSG Networks ($MSGN) takes the top spot for me as my biggest failure of 2021. For those unaware, in mid-2021 controlling shareholder James Dolan elected to merge this beautiful cash flowing asset into his monomaniacal exercise in egotism, Madison Square Garden Entertainment ($MSGE). Under one umbrella MSGN’s cash flows can feed the money pit he’s building in Las Vegas for he and his dumbass band to make shitty music in. The lesson for me here is about understanding the dangers and motivations of unaligned controlling shareholders. The signs (I.e. the infamous “Dolan discount”) were there but I underestimated the impact it could have. In terms of pure gain/loss I closed the MSGN position at a ~10% nominal loss, but one that created 1.5 years of additional opportunity cost. 

I briefly held a small position in Canadian liquor and cannabis retailer Alcanna ($CLIQ, $LQSIF) for less than two months during the year. At the time it seemed like there were some interesting moving pieces in that they had just separated their cannabis retail operations from their legacy liquor retail operations. The liquor retail business looked fairly cheap and steady while they retained a large equity stake in the cannabis operations. Seemed like there was some optionality for either side to be taken out by a larger competitor. Ultimately I sold and moved on to work on other ideas. In October, cannabis operator Sundial Growers ($SNDL) proposed to acquire Alcanna in a stock for stock deal – which seemed to somewhat validate the thesis – but it looks like there may be issues with voting the deal through and at the current prices I wouldn’t have made any real money anyway. In terms of failures, this is certainly not the worst outcome but this felt like situation where I spent too much time and sort of spun my wheels. 

There were two very small “special sits” type situations that I was briefly involved in during the year: CCUR Holdings ($CCUR) and American Virtual Cloud ($AVCT). Neither were meaningful in size or tenure in the portfolio, so I won’t get into details but both ended in negligibly small losses to the portfolio. But I think the overarching theme for Alcanna, CCUR and AVCT was that I was a little too quick on the trigger to jump into these names before I had a handle on the full scope of the situations. I think if there’s one facet of portfolio management that I could definitively improve, it is making sure that I fully understand the investment thesis, risks, players, etc. in every prospective holding thoroughly before I initiate that first purchase. It’s something I plan to improve moving forward. 

Current Holdings 

As I’ve done the last two years, I thought I would give a quick update/thoughts on each of the current names in the portfolio. As I did last year, I have segmented them into the respective mental “buckets” in which I classify them (more on that philosophy here): 

Special Situations (target % = 10-20%, current % = 1%): 

1% – Rubicon Technology (RBCN, 1% of portfolio): Not much change in RBCN this year other than the announcement that they shut down their pharmaceutical delivery business, which was immaterial to financials but was at least some effort at developing a new operating business – with that gone they are just back to existing LOB and a bunch of cash on the balance sheet. They continue to burn cash modestly. I still believe the folks in control to be smart and aligned, meanwhile the stock trades at a discount to cash on the balance sheet. This is a bit of a zombie position for me – the discount isn’t large enough and the lack of catalysts isn’t compelling enough to add to the position but I have not gotten to the point where I need to deploy the capital elsewhere. I could see myself selling this for a more compelling opportunity at some point this year. 

In general, I have been struggling with this section of the portfolio. I like the idea of having a number of small holdings that are event-driven (less market correlation), hence this bucket existing at all. But I also want these to be small 1-2% positions to mitigate the downside risk and protect me from myself somewhat. I struggle to find candidates for this bucket because I find that I have to put as much time/effort/research into them as I do for a larger position in the other buckets. If I had more free time to do research, I think I could fill this back up but it’s very difficult at the moment. I still believe in this portion of the portfolio but I could see myself cutting it entirely at some point.  

Mean Reversion/Deep Value (target % = 40-60%, current % = %): 

IDT (IDT, 25%): IDT is simultaneously the best investment I made in 2021 and the name I am the most excited about in 2022 (and beyond). It’s become somewhat of a FinTwit darling after AltaFox released their research (and made a subsequent direct investment in NRS). Not a lot to add to the great commentary/research that has been made public on IDT, but suffice to say it is by far my largest holding for a reason. Despite an end of the year pullback, I think the best is yet to come on IDT. 

Dole PLC (DOLE, 10%): Dole was a Q4 add that I have ramped up pretty quickly as the share price has come down. I first came across this one via Conor over at Value Situations , who has done some great work on the name. As Conor aptly argues, DOLE is way too cheap relative to peers despite having a high quality management team, diversified product portfolio, and a strong market position. I particularly love this one because it’s a solid business with a nice “special situations” twist (a private company with a spotty history and a foreign-listed small/mid-cap with little institutional coverage merge to form a U.S.-listed market leader in global fresh produce). I’ve taken to calling this one a “Greenblatt” special because it reminds me of a case study that would be right at home in You Can Be a Stock Market Genius. Limited downside, significant upside, and no one paying much attention (yet). 

• MVB Financial (MVBF, 8%): MVBF is another under-the-radar name that I found via @walnutavevalue on Twitter. I have a half written draft of a full writeup on MVBF that I just can’t seem to finish. MVBF is a bit out of my comfort zone (I typically avoid financials, especially banks) so I feel that it has taken me a while to get up to speed – and to be frank I still don’t know that I understand every nook and cranny of bank financial statements. I think the reason I am struggling to finish this write up is that, as best I can tell, MVBF is in the range of “fairly valued” as a regular old regional bank. But underneath the surface, the management team at MVBF is clearly building something more than just a bank. They’ve made a number of fintech and consulting/compliance-related acquisitions that don’t really seem to be obviously accretive individually. But when you take a step back and look at the bigger picture of the service offerings that they are building to complement their banking business, I think there is definitely something there. I am just have a hard time putting my finger on it from a valuation perspective. They have had an impressive run winning large clients in the daily fantasy sports/gambling, crypto, and fintech sectors which is helping them build a more national deposit base and improve economics within their banking operations. In turn, they are building out more services which I believe is intended to attract new banking partners and retain the existing ones. There’s a great quote from their CEO, who says “we basically want to be a tech company that happens to own a bank” in the future. That’s the vision here, and I think other small banks have executed something similar to this with some success. My real struggle here has not been identifying the opportunity, it’s putting a value on something that I am pretty certain is there. When I figure that out I may get around to posting that write up. 

Data Communications Management (DGPIF, 7%): DCM is a TSX-listed microcap that I haven’t gotten around to writing up yet. This is an interesting little company that is in the midst of a business transformation. Historically they have provided commercial printing services to mostly Canadian companies (they claim 70 of the largest 100 Canadian companies). Under new leadership they are moving to a more digitally-based “asset management” service solution. Basically they want to take their existing large customer base and upsell them into a whole software solution to design, manage, and version control all of their documents, marketing collateral, product labelling, etc. At 5x trailing EV/EBITDA with a fairly steady business profile, my hunch is that if they have much success in converting existing (or new) customers to this offering the economics could get very enticing. More to come on this name later. 

Yellow Media (YLWDF, 6%): Yellow has really taken me for a ride. You can find my original write up here. I initially bought in early 2020 right before the impacts of COVID began to be apparent. I ended up selling in April (around $5/share for YLWDF) after losing about a third of the position because I was concerned about the ability of the business to withstand the impacts of shut downs. (In case you didn’t read the write up linked above, Yellow is the old Canadian Yellow Pages telephone books business. They still have that service but have since pivoted to doing marketing services for small mom and pop businesses. Leadership has right-sized the workforce and business assets while trying to stem the tide of evaporating revenue.)  To my disgust, the business was not significantly impacted and I watched as they continued to execute their strategy through late 2020 and early 2021: paying off their last C$100M in debt (going debt-free), building their cash balance to C$100M, and doing ~C$100M in Adj EBITDA. Seeing the continued progression here, I bought back in averaging in at $11.18/share. Yes, 2x what I stupidly sold for in 2020. Truly idiotic in retrospect, and as is often the case I would have been better off doing nothing. Anyway, I am back in the name now with the exact same thesis: it’s a melting ice cube that will either 1) return enough capital to shareholders that it won’t matter that the business continues to get smaller 2) turns around and get multiple and/or denominator expansion or 3) gets bought out. 

Side note, if you like the sound of this you will love Thryv (THRY). It is a similar situation (old dying yellow pages business, but in the U.S) to Yellow but instead of going into marketing services they built a complementary SaaS product instead. Every day it looks more and more like picked the wrong horse here (THRY +180% in 2021).  

Namsys (NMYSF, 4%): Namsys is a quirky TSX-listed microcap software business that builds products for the Cash In Transit (CIT) and banking industries – think Brinks trucks and smart safes. It’s very small (C$5M in revenues) with just a few employees and some customer concentration concerns. But the margins are wonderful, the business seems steady with good growth potential, and they cleaned up a weird employee compensation plan that was obscuring financials. Shares had a rough Q4 but not that much has changed with the business. A return to a more normal (post-COVID) environment should help get the growth back on track. 

Gravity (GRVY, 4%): As I mentioned in the section above, I took a lot of my GRVY position off in early 2021 but held onto a few shares. It continued to do Gravity things: be pretty volatile and full of surprises with each earnings announcement. Looking at a price chart, you might think GRVY had a terrible year but I’m actually as bullish as ever on the future for the company. I think the shareholder base is pretty retail centric and looking for booming growth – GRVY was mostly just steady (in terms of financial results). But underneath the hood they are doing interesting things like exploring merchandising, internal development, tinkering with release schedules, landing new (and continuing existing) big partnerships. Plenty to be excited about at a pretty low multiple. 

Long Term Value (target % = 40-60%, current % = %): 

Constellation Software/Topicus.com (CNSWF/TOITF, 7%): Not much to say about Constellation or Topicus this year. Constellation continues to do their thing and Topicus is just figuring out/refining theirs. I lump these two together because I consider them basically the same investment. If you are reading this blog, chances are you know the thesis is here and why this is a great investment. Mark Leonard wants to lower the hurdle rate on acquisitions? Great. They bought and spun a European version of themselves? Great. I am fully along for the ride at this point. I don’t know if many “serious” portfolio managers would cop to this but I hardly ever think about this position. I’ll do that the day Mark Leonard steps away or kicks the bucket. 

IAC/Vimeo (IAC/VMEO, 6%): I lump these two together just for the ease of reporting, this is not a “same investment” scenario like Constellation. Actually, in retrospect, I should have sold VMEO the day it spun. Holding it was more a reflection of the fact that it was a tiny position in the grand scheme of things and that the IAC spins tend to do fine. Maybe a lesson learned? Time will tell. As for the mothership, IAC continues to execute wonderfully. We got the great Meredith (MDP) deal, the MGM investment seems to be going fine, DotDash is showing it could be an asset instead of an ice cube. Pretty good year, all-in-all, despite the shares being a little choppy in Q4. I continue to be impressed with the management and think IAC is perennially undervalued. 

Dream Unlimited (DRUNF, 10%): Dream, both the stock and the business, had a great 2021. There were almost too many acquisitions and moving pieces to really keep track of this year, but Cooper and company continue to execute, particularly in the burgeoning private asset management business that they have spun up (which Tyler over at Canadian Value Stocks had an great, detailed write up on). Dream has been a great investment so far and seemingly still has tons of runway.  

Terravest Industries (TRRVF, 7%): By way of brief introduction, here is how I described Terravest in last year’s year end writeup: “This Canadian small cap is basically an opportunistic small-scale roll up strategy in the energy services space and is lead by a capital allocation-focused management team with ties to another very interesting Canadian investor, George Armoyan (and his Clarke holdco). The company selectively acquires small niche service providers and manufacturers in the general oil & gas services domain for extremely cheap valuations.” 2021 started off pretty rough for Terravest. Sales were lagging as demand for their O&G equipment services was not following oil price recovery in Western Canada and the company was still fairly dependent on on-going Canadian government subsidies. Q2 saw some pick up in the various business lines and a few other interesting developments. First, the Granby subsidiary acquired ECR International, a New York based heating and air conditioning manufacturer (think boilers, furnaces, etc.) with 200+ employees that has been in business almost 100 years. Second, Terravest announced a follow in investment in an oilfield services business where they now own a majority stake. And lastly of note, they mentioned entering the “renewable natural gas equipment” market via several new contracts, would be a new vertical for them. I would say my primary disappointment in Terravest was their inactivity in 2020. Their whole strategy is rolling up smaller businesses in fragmented markets – a pretty scary operating environment following the COVID outbreaks seemed like the perfect time to pounce on some good deals but they were relatively quiet. It’s good to see the activity picking back up a little. Ultimately, this position was always about trusting the team and the strategy execution – which I still feel comfortable with. I would like to get Terravest written up in more detail at some point in 2022.

If you’ve made it this far, thanks for taking the time to read through my ramblings. I hope to be more active on Twitter and the blog this year (an evergreen but hollow sentiment at this point, but I am going to really put forth the effort this year) so I hopefully you will be hearing from me soon. In the meantime, feel free to reach out to me on Twitter and sign up for email notifications at the menu bar at the top right hand side of this page.  

Chaos: Making a New Science by James Gleick

This book review is a little different than the others on this blog. I tend to write up interesting books related to investing but, as you may have surmised from the title, this one is not directly an investing/business book per se. But I hope that you will indulge me and follow along.

It’s been almost a year since I wrote up a book review on the blog. I’ve read some pretty decent books between this and the last write up, but nothing I felt overly compelled to write about. Plus, between portfolio company write ups and busy personal & professional lives, I’ve not had a ton of time for a book review post or a lot of recreational reading, frankly. Luckily, my family and I spent a few days on vacation recently so I had the opportunity to catch up on some reading. I find that when I am laying by a body of water, I prefer to read something that’s not directly business related. So, I took along an old book that I picked up for $1 at a local library liquidation – Chaos: Making a New Science by James Gleick. I can’t say exactly why I picked up this book to being with – I don’t know anything about science or physics beyond basic high school/undergrad classes and anecdotal readings – but the price was right and “chaos theory” has always seemed like a seductive sci-fi phrase that peaked my interest.

I would bet if you are reading this post you, like me, suffer from the paradox (affliction?) in which your brain tries to relate anything you read/hear/discuss back to investing/markets/business. I am a big fan of the Value: After Hours podcast (highly suggest it if you have not listened before – the content is pretty unstructured and tends to be more of a conversation than a formal discussion). One of the hosts on the show, Jake Taylor, regularly presents a segment where he discusses observations from a wide range of fields of study (like biology, power generation, gardening, etc.) and relates those to various investing concepts. I suppose this is a nod to the modern “mental models” fascination that seems to be popular with hard core philosopher-investors. Anyway, I bring this up to say that I’m blatantly stealing this schtick for this post. As I read through Chaos, I couldn’t help but see parallels to investing all over the place, so I’ve collected a few of the more memorable passages and put together some quick thoughts around each.

Before we get started, a very brief background on the subject matter: Chaos (as in “Chaos Theory”) is this fascinating intersection of science and mathematics. From this outsider’s perspective it seems most closely akin to physics, but has seen contributions from practitioners and academics across mathematics, meteorology, biology and many other branches of science. The book is quite dated at this point (published 1988) and it seems to me that “dynamical systems” is the more professional and widely accepted term for what began as chaos theory. And to be honest that seems more descriptive of what “chaos” actually is – the study of complex non-linear systems. At it’s core, the work is about finding order in what appears to be randomness. As it turns out, that makes it widely applicable across a great number of disciplines (including some attempts at applying it to economics and financial markets). The book points out that one of the major accomplishments of chaos was the reversal of the trend toward increasing specialization within scientific fields, which seems to be pushing forward innovations faster as a result of more collaboration across disciplines. The book follows the birth and growth of chaos as a legitimate field of study and includes a colorful cast of personalities accompanied by easy to follow explanations of core concepts. Overall, it was a very easy and interesting read for me and if you’ve ever had any sort of inclination toward physics/mathematics I would imagine it would be interesting to you as well.

With no further ado, here are a few of my favorite selections:

Chaos breaks across the lines that separate scientific disciplines. Because it is a science of the global nature of systems, it has brought together thinkers from fields that had been widely separated. “Fifteen years ago, science was heading for a crisis of increasing specialization,” a Navy official in charge of scientific financing remarked to an audience of mathematicians, biologists, physicists, and medical doctors. “Dramatically, that specialization has reversed because of chaos.” Chaos poses problems that defy accepted ways of working in science. It makes strong claims about the universal behavior of complexity. The first chaos theorists, the scientists who set the discipline in motion, shared certain sensibilities. They had an eye for pattern especially pattern that appeared on different scales at the same time. They had a taste for randomness and complexity, for jagged edges and sudden leaps. Believers in chaos – and they sometimes called themselves believers, or converts, or evangelists – speculate about the determinism and free will, about evolution, about the nature of conscious intelligence. They feel that they are turning back a trend in science toward reductionism, the analysts of systems in terms of their constituent parts: quarks, chromosomes, or neurons. They believe that they are looking for the whole.

This excerpt captures the core tenant of much of the book. I look at this and think about how investing has also trended toward specialization over time – sell side coverage on specific industries, hedge fund pods that execute some extremely specific arbitrage, etc. On the other hand I don’t think specialization in the world of investing is nearly as dramatic as it seems to be in academia/sciences. Maybe that’s because in the world of investing even the most niche strategies are impacted by tangential factors and market events. Nonetheless, I think it’s an interesting parallel with the idea that there is some value in being a generalist in markets and having a wider perspective than any one specific niche.

In fluid systems and mechanical systems, the non-linear terms tend to be the features that people want to leave out when they try to get a good, simple understanding. Friction, for example. Without friction a simple linear equation expresses the amount of energy you need to accelerate a hockey puck. With friction the relationship gets complicated, because the amount of energy changes depending on how fast the puck is already moving. Nonlinearity means that the act of playing the game has a way of changing the rules. You cannot assign a constant importance to friction, because its importance depends on speed. Speed, in turn, depends on friction. That twisted changeability makes nonlinearity hard to calculate, but it also creates rich kinds of behavior that never occur in linear systems. In fluid dynamics, everything boils down to one canonical equation, the Navier-Stokes equation. It is a miracle of brevity, relating to fluid’s velocity, pressure, density, and viscosity, but it happens to be nonlinear. So the nature of those relationships often becomes impossible to pin down. Analyzing the behavior of a nonlinear equation like the Navier-Stokes equation is like walking through a maze whose walls rearrange themselves with each step you take. As [world renown mathematician John] Von Neumann himself put it: “The character of the equation […] changes simultaneously in all relevant respects: Both order and degree change. Hence, bad mathematical difficulties must be expected.” The world would be a different place – and science would not need chaos – if only the Navier-Stokes equation did not contain the demon of nonlinearity.

Lot of things to like here. First off, the “demon of nonlinearity” is  a great turn of phrase – love it. And I don’t know if I’ve ever heard a better allegory to financial markets than: it’s “like walking through a maze whose walls rearrange themselves with every step you take.” Nonlinearity is probably not so novel for those of us in the investing world given that financial instruments exhibit that sort of behavior all the time but I thought the hockey puck example was illustrative. This is just a glimpse at the broader discussion of nonlinearity that the book covers, but throughout I couldn’t help but think how we try to pave over nonlinear relationships with linear ones in markets. One of the core building blocks of professional portfolio management (CAPM) is a hilariously oversimplified linear model for an unbelievably complex (chaotic?) system, attempting to bypass the “demon of nonlinearity.”

Chaos should be taught, he argued. It was time to recognize that the standard education of a scientist gave the wrong impression. No matter how elaborate linear mathematics could get, with its Fourier transforms, its orthogonal functions, its regression techniques, may argued that it inevitably mislead scientists about their overwhelmingly non-linear world. “The mathematical intuition so developed ill equips the student to confront the bizarre behaviour exhibited by the simplest of discrete nonlinear systems,” he wrote.

Along the same lines as the previous passage, this one reinforces the sentiment more directly. Just replace “scientist” with “investor” in this paragraph and it could be in a modern white paper or Institutional Investor article.

How can we calculate how quickly a cup of coffee will cool? If the coffee is just warm, its heat will dissipate without any hydrodynamic motion at all. The coffee remains in a steady state. But if it is hot enough, a convective overturning will bring hot coffee from the bottom of the cup to the cooler surface. Convection in coffee becomes plainly visible when a little cream is dribbled into the cup. The swirls can be complicated. But the long-term density of such a system is obvious. Because the heat dissipates, and because friction slows a moving fluid, the motion must come to an inevitable stop. Lorenz drily told a gathering of scientists, “We might have trouble forecasting the temperature of the coffee one minute in advance, but we should have little difficulty in forecasting it an hour ahead.

The “Lorenz” referenced here is Edward Lorenz, a highly influential mathematician (and meteorologist) who’s early ground-breaking research established many of the core principles of chaos. This quote from Lorenz reminds me of the old Ben Graham quote: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” As a value-oriented investor myself, I like to think we can have more confidence about outcomes over an appropriately long time frame while the shorter term is noisey and less predictable.

It was just a vacuum tube, really, investigated in the twenties by a Dutch electrical engineer named Balthasar van der Pol. A modern physics student would explore the behavior of such an oscillator by looking at the line traced on the screen of an oscilloscope. Van der Pol did not have an oscilloscope, so he had to monitor his circuit by listening to changing tones in a telephone handset. He was pleased to discover regularities in the behavior as he changed the current that fed it. The tone would leap from frequency to frequency as if climbing a staircase, leaving one frequency and then locking solidly onto the next. Yet once in awhile van der Pol noted something strange. The behavior sounded irregular, in a way that he could not explain. Under the circumstances he was not worried. “Often an irregular noise is heard in the telephone receivers before the frequency jumps to the next lower value,” he wrote in a letter to Nature. “However, this is a subsidiary phenomenon.” He was one of many scientists who got a glimpse of chaos but had no language to understand it. For people trying to build vacuum tubes, the frequency-locking was important. But for people trying to understand the nature of complexity, the truly interesting behavior would turn out to be the “irregular noise” created by the conflicting pulls of a higher and lower frequency.

This anecdote is followed by some discussion of information theory (which ties into the “irregular noise” phenomenon) but I like this section because I think about how, when it comes to stocks or markets or whatever, we find what we are looking for. That means that a slightly different perspective or frame of reference can lead to dramatically different findings. My mind immediately connected this to Greenblatt’s example of Marriott’s good co/ bad co spinoff in the You Can Be a Stock Market Genius book where most investors were focused on the franchise operations (good co) and ignoring the debt laden, real estate rich bad co. Every investor in good co had to know about bad co, but it wasn’t what they were focused on and wasn’t what they were looking for, which left an opportunity for shrewd investors like Greenblatt.

A few dozen yards upstream from a waterfall, a smooth flowing stream seems to intuit the coming drop. The water begins to speed and shudder. Individual rivulets stand out like coarse, throbbing veins. Mitchell Feigenbaum stands at streamside. He is sweating slightly in sports coat and corduroys and puffing on a cigarette. He has been walking with friends, but they have gone on ahead to the quieter pools upstream. Suddenly, in what might be a demented high-speed parody of a tennis speculator, he starts turning his head from side to side. “You can focus on something, a bit of foam or something. If you move your head fast enough, you can all of a sudden discern the whole structure of the surface, and you can feel it in your stomach.” He draws in more smoke from his cigarette. “But for anyone with a mathematical background, if you look at this stuff, or you see clouds with all their puffs on top of puffs, or you stand at a sea wall in a storm, you know that you really don’t know anything.

I like this passage for two reasons. First, despite this book being largely exposition, I do think Gleick is a pretty solid writer and I think this shows off some of his true writing prowess. Second, I really love the ending quote from Feigenbaum (highly influential physicist in his own right) – particularly the visual of standing at the sea wall in a storm. I like to imagine this metaphor applied to finance undergrads and EMH academics trying to make sense of meme stocks and crypto in 2021.

The question was so deep that almost no one had thought to ask it before: Does a climate exist? That is, does the earth’s weather have a long term average? Most meteorologists, then as now, took the answer for granted. Surely any measurable behavior, no matter how it fluctuates, must have an average. Yet on reflection, it is far from obvious. As Lorenz pointed out, the average weather for the last 12,000 years has been notably different than the average for the previous 12,000, when most of North America was covered by ice. Was there one climate that changed to another for some physical reason? Or is there an even longer-term climate within which those periods were just fluctuations? Or is it possible that a system like the weather may never converge to an average?

I love this paragraph because it is so directly applicable to investing. I feel like I hear this conversation non-stop in the quant and institutional research communities. There’s a mountain of white papers and journal articles that contemplate this exact same problem but reference factors, valuations, econometrics, etc. rather than climates. I also like this because it re-raised for me the idea that maybe averages/medians/(insert your favorite summary statistic here) just don’t matter. If you assume there’s no real equilibrium state (i.e. markets have a “chaotic” quality about them) then you’re just chasing phantoms by trying to time any portfolio decisions based on irrelevant historical data.

That’s all the quotes I’ve got for you. If this peaked your interest at all, I highly recommend reading the book. There’s obviously much more detail than I could cover here in a single blog post, but I found it to be an easy and interesting read – hopefully you will too.

Anyway, if you’ve made it this far thanks so much for reading. If you aren’t already, feel free to follow me on Twitter and/or subscribe to get email updates whenever a new post goes up on the blog (see the top right hand side of this page to enter your email).

@sawbuckd

IDT Corporation (IDT)

• IDT is an ignored and undervalued collection of assets with an impressive track record of capital allocation and shareholder value creation
• Unlike most SOTP situations, IDT catalyzes value recognition by spinning assets into standalone entities (a la IAC) or selling them outright
• IDT is on the cusp of another spin with several other embedded attractive “options” at the remainco, a profitable core business, and a strong balance sheet

The Numbers:

Price: $22.20 (Sawbuckd cost basis $17.35-19.05)

Mkt Cap: $571M

EV: $455M

EV/EBITDA: 8.3x

P/E (LTM): 13.4x

The Company:

IDT was founded in 1990 by Howard Jonas with the designed purpose of providing cheap international long distance telephone rates to U.S. consumers. After building a successful international telecom business through a series of savvy business moves and technical innovation, Jonas parlayed that momentum into a platform for significant shareholder value creation across a diversified array of industries using IDT as the incubator. IDT’s history of spinning off or otherwise successfully exiting businesses is impressive and extensive – here is an abbreviated timeline of IDT’s track record:

1996: IDT is publicly listed as an international long distance carrier and wholesale servicer to other telecoms

2000: IDT sells the original net2phone subsidiary (a leader in VoIP technology) to AT&T for $1B

2006: IDT sells its Russian Telecom business for $129M

2007: IDT sells IDT Entertainment to Liberty Media for $220M

2009: IDW Media Holdings (IDWM – a collection of comic book, television, board games, books, etc. IP) spun off to shareholders (market value subsequently stabilized around $30-40M, has been as high as ~$300M)

2011: Genie Energy subsidiary (GNE – electric and natural gas services) spun off (average market value over the past decade has been ~$200M)

2013: Straight Path Communications subsidiary is spun off to shareholders and would eventually be purchased by Verizon for $3B in 2018

2014: IDT sells Fabrix subsidiary (cloud storage and network delivery tech) to Ericsson for $69M

2016: Zedge subsidiary (ZDGE – mobile device content development) is spun off (market cap has been as low as $10M since the spin but currently sits at $125M)

2018: A number of real estate holdings and Rafael Holdings (early stage pharmaceuticals) subsidiary are combined  spun off (RFL – has grown from $60M to $600M in market cap since spin)

Today, IDT continues to execute the same playbook they have been since 1996. The legacy telecom business produces consistent cash flow that is deployed into new lines of business that are incubated and monetized in one way or another. The company currently divides itself into 3 operating groups: fintech, Net2Phone, and traditional communications. The “fintech” segment includes a payments/money transfer business and a point of sale (POS) terminal network. Net2Phone is a comprehensive cloud based communication service for domestic and international commercial customers. The “traditional communications” segment includes the legacy telecom lines of business: a consumer-focused international calling service, a consumer-focused mobile “top-up” offering, as well as a carrier/platform services offering that caters to cable providers and telecoms.

One interesting thing I noticed about the current collection of businesses that compose IDT is that while each of the business lines might appear fairly incongruous with one another, they all build on a core strength of the legacy business. IDT’s legacy telecom services in the consumer space were aimed directly at immigrant communities, who have an obvious need for long distance international calling service. IDT’s current portfolio is a group of offshoot businesses that dovetail with that existing customer base or utilize some of IDT’s existing internal infrastructure. The money transfer service is a natural need for existing long distance calling customers that want to send money abroad (the payments business even carries the same branding as their legacy calling service) while the POS network is marketed primarily to independent convenience and liquor stores that typically serve immigrant communities. Even the Net2Phone business line carries certain synergies with the legacy telecom operations and give them reach into a number of foreign markets. I will note, however, that IDT is no one trick pony; this sort of tangential relation to their core business is not a necessity. As I listed in the timeline above, IDT’s spinoffs include a media company (IDWM), an electric/gas services company (GNE), a pharma company (RFL), and a mobile phone content business (ZDGE).

The Good:

Any discussion of IDT must begin with the company’s founder and visionary, Howard Jonas. Joe Boskovich of Old West Investment Management did an entire podcast about Jonas on Bobby Kraft’s Planet Microcap Podcast, which I found to be an extremely valuable resource (and what ultimately lead me to look at IDT in the first place). My conclusion, much like Joe’s in that podcast, is that Jonas is a highly capable leader with a fierce business acumen and the track record at IDT to prove it.  I hope that the timeline included above, which cumulatively reaches into the billions of dollars worth of shareholder value created over multiple decades, speaks for itself. Beyond merely the impressive historic record, the Jonas family itself is aligned with shareholders. Each of Howard’s nine children (including one of Howard’s sons who is the acting CEO) hold shares via trust with the family collectively controlling about 33% of the shares in IDT (and ~75% of the voting power).

Before I get into some of the nuts and bolts valuation, I want to say a little about why I think this opportunity exists. Despite the aforementioned insider alignment and strong track record, IDT continues to be (unbelievably, IMO) ignored. Beyond the small market cap, I think the primary driver for this lack of attention is the “complicated” nature of the company. The valuation for IDT is not really as simple as slapping a multiple on trailing earnings. The business is nuanced – a declining but cash generative legacy business feeds capital into growth-oriented internal startups with indeterminate runways that might be sold or spun in the near or distant future if incubated to success. Like many of the businesses I find myself looking into, this one requires more than a superficial glance which means it’s automatically bypassed by many market participants. Even the in realm of value investors, IDT seems to be a known but forgotten commodity. The CoB&F and VIC threads are basically dead and haven’t been particularly active since 2013. Even on Twitter the chatter is pretty sparse; Joe’s discussion of it in Old West’s letters and the MicroCap Planet podcast were certainly the first I’d ever heard of the company.

 I generally do not believe in the much maligned sum of the parts (SOTP) style valuations, however I think IDT is one of the rare instances where the methodology is valid (along with a few of my other portfolio holdings). In my mind I compare IDT to an IAC, albeit a lower quality version. Much like IAC, IDT is a collection of related or unrelated business that benefit from being part of a holdco for a time but must ultimately stand on their own. When the right moment presents itself, the parent must be willing to let that happen. And it’s precisely because IDT/IAC do this frequently and with success that the market is forced to recognize the previously obscured value of the new standalone company. This is all pretty well understood market dynamics and operational philosophy, but I think my point here is that it takes conviction to execute that playbook and relatively few companies do it well and consistently, but those that do can create tremendous value.

The slide below is from the most recent (Dec 2020) investor presentation for IDT. Management, presumably understanding the very issue I have spent the preceding two paragraphs discussing, has made their case painstakingly simple for anyone with the intellect and perseverance to… visit their corporate website and download a PDF. Here, management gives you an idea of what they think the range of value is for each of the key lines of business and what that rolls up to at the enterprise level. Obviously, there was a ton of upside (in their opinion) back in December when shares were still <$10. Today, the stock has run to the $20ish range, but I still think there is plenty of upside left here.

Source: Dec 2020 investor presentation

Below, I will give a little background on each of the business lines and try to outline a bear/base case scenario for each. Before we get there, I should acknowledge a few things. As I alluded to earlier in this write up, the basic IDT playbook is to use the cash flow from the “traditional communications” legacy business to incubate and grow new diversified lines of business (currently the money transfer, POS network, and cloud communications subsidiaries). So as I try to value the “parts” below, it’s important to remember that these are still relatively early stage enterprises that have not reached stand-alone scale. As far as I can tell only the money transfer division is profitable and even that is a recent development and unlikely to be reliable moving forward, IMO. There’s a reason management is using revenue multiples and not EBITDA or operating income to value these – it’s reflective of the fact they aren’t mature enough to be cash flow positive. Also it’s probably indicative of how they think public markets might value these given today’s market environment (i.e. revenue multiples and growth vs. profitability). I fully recognize that good valuation work and the phrase “revenue multiple” do not often go hand in hand, but I do believe it would be completely disingenuous to say there’s no (or little) real value here. If I were trying to evaluate each of these as standalone entities in public markets it would be pretty challenging to get comfortable enough with any of them to buy shares individually. However, given that they are merely a component of broader IDT portfolio at the moment and benefit from the company’s strong financial position and management, I tend to view them as embedded call options. You may only need one of them to really payoff to make it worth the risk here. Anyway, here we go:

The engine that powers IDT is the Traditional Communications segment. This is the legacy telecom business that throws off all the cash that is fed to the more aggressive “growth” businesses. The segment breaks down into 3 sub-segments: Boss Revolution Calling (their consumer facing international long distance calling service), Mobile Top Up (allows customers to transfer calling, data, and messaging credits to other international and domestic mobile accounts), and Carrier Services (which is the core legacy business that provides wholesale voice and SMS facilitation and traffic management to other telecoms). Each sub-segment accounts for somewhere between 20-40% of revenues for the group. Collectively, the Traditional Communications accounts for 90-95% of IDT revenues and typically all of the operating income.

Source: various IDT SEC filings

As you can see from the figures above, there are some definite questions about the future of some of the business lines. Carrier Services has been the hardest hit over the last few years as the industry has moved away from traditional long distance international voice providers and price competition from larger wireless and sovereign telcos has increased. IDT has openly admitted that they are no longer maximizing revenues or utilization within this line of business but are instead optimizing for economics. I’m generally more optimistic about the consumer facing business, Boss Revolution Calling, which has seen a more modest contraction in revenues despite accelerating competition from traditional wireless carriers (Verizon, AT&T, etc. are increasingly offering international calling as part of standard mobile plans). Unlike the Carrier Services division, IDT is still aggressively competing in this segment. They currently serve about 4M customers through both DTC apps/web portals and a retail partner network that boasts 30k locations and continue to add new services/offerings/features. Reading between the lines, economics seem to be moving in the right direction as more retail customers move to the DTC mobile app which I expect reduces costs to service & acquire customers. The last notable line of business in this segment is Mobile Top-Up which has seen increasing demand amongst users over recent years as IDT has added additional mobile providers and bundling option offerings. This appears to be the only sub-segment within Traditional Communications to see sustained top line growth in the last few years. Much like their other business lines, Top-Up seems like a niche space but an important need to IDT’s target customers. There appear to be several digital-only competitors in the space, but I suspect IDT’s mixed physical retail and digital offerings give them a branding and familiarity advantage here. Collectively, the Traditional Communications group did about $40M in operating income in FY 2020 but about $20-25M in the preceding 3 years. I think it’s reasonable to assume that the huge jump was partially driven by increased demand for their services due to COVID but through two quarters of FY 2021 the group is on pace to do $70M (I expect the actual may come in lower due to seasonality of the business) and, in alignment with their comments about optimizing economics, costs seem to be declining faster than revenues at the group level. It’s hard to say what forward expectations should be, but $30M in normalized operating income feels like a pretty conservative estimate to me given that you expect some regression on the recent results. D&A add back plus drag from corporate overhead (each ~$10/yr) offset one another to yield an “EBITDA” figure of about $30M from the business unit. As I write this, the EV for IDT is sitting at about $455M. If you ignored every other line of business that I will discuss below and just focused on the legacy core business, you’d be paying approx 15x EV/TTM EBITDA or 8x P/run rate operating income (i.e. $571M market cap on $70M in est. FY 2021 operating income). Maybe that seems expensive for a telecom business facing headwinds, but certainly not an absurd valuation. Not to mention IDT has $80M in cash, $80M in debt/equity investments and PP&E, and carrying no debt. To me, a 4x normalized EBTIDA valuation feels pretty conservative for the legacy telecom + corporate overhead portion of IDT which would give us a $120M valuation.

Boss Revolution Money Transfer (BRMT) is an international money remittance service launched in 2013 that provides connects U.S. residents to 60 foreign countries. Initially, the service relied heavily on a retail partner network for distribution, which seemed logical at the time given shared “Boss Revolution” branding between it and the calling business, plus the fact that many target customers dealt in cash. From what I can tell, the serious growth has come since 2017 when they launched a mobile app that seamlessly integrates the money transfer and calling services. BRMT collects revenue via transaction fees from customers and benefits from some currency fluctuation. Revenue growth has been strong (>100% from FY 2019 to FY 2020) and I suspect the business might be at breakeven/slightly profitable over the last two quarters. BRMT competes with both traditional retail based money transfer services like MoneyGram (MGI) and Western Union (WU) as well as digital-only offerings like Xoom (a PYPL service), TransferWise, Remitly, and World-Remit. When thinking about the valuation, I don’t think that MGI and WU are good comps given their brick and mortar footprint (and MGI seems like kind of a debt-laden tire fire) and the fact that BRMT is doing the majority of their business digital DTC (app or web) already. The digital-only comps are all private with limited valuation information, with the exception of Xoom which was acquired by PayPal in 2015 for ~$900M. From what I was able to find based on private valuations and reported user bases, the digital-only comps are valued at anywhere from $375-700 per user. I’ve not found any disclosure of the user count for BRMT anywhere, so we will need to make assumptions about that to get to a valuation. The Boss Revolution Calling business claims 3.7M monthly users and thus far BRMT’s marketing focus has been cross converting Calling customers into their user base. Let’s assume they can convert just 25% of those users (and ignore any potential new customer acquisition) and let’s give them half the valuation credit of their lowest rated private peer (WorldRemit, who recently raised at a $1.5B valuation with 4M users = $375/user). So we’d conservatively value BRMT at $375/2 * 25% * 3.7M = $170M. That works out to about 4x sales, which seems pretty conservative to me for a business that grew >100% YoY with plenty of avenues for additional growth (onboarding additional retail partners, acquisitions, etc.). As for what I really think a reasonable valuation might look like, your guess is as good as mine but “payments” in general is a hot space right now. A higher conversion rate for Calling customers (or god forbid brand new customers), fuller valuation credit relative to peers, or sustained revenue growth anywhere near their current pace – or  any combination of these things – would pretty easily get to something like management’s midpoint estimate ($300M) IMO.

National Retail Solutions (NRS) is a POS terminal system marketed to independent convenience, liquor, bodega, etc. stores. NRS is the youngest and smallest (by revenue) of the IDT “growth” lines of business, but has seen strong adoption thus far. IDT builds the terminals in house and charges $20/month per terminal to customers. They estimate their target market of independent store so be approximately 200k locations in the U.S. As of the end of January 2021, NRS had about 13k terminals across 10k retailers and projects to add 1k terminals per quarter (however, this seems a bit aggressive relative to actual results over the last few years). NRS also derives some revenues from display advertising and data/analytics resale, which should both compound in value as the network grows. IDT mentions time and again in their commentary that they believe their specific target market is underserved by more mainstream competitors like Square, Clover (owned by Fiserv), and NCR. That makes some sense to me as the IDT target market is fragmented and likely too small to move the needle for significantly larger organizations. Management cites a 7.5x-10x estimated revenue multiple based on peers (and also on 2021 FY projected revenues), which seems aggressive to me. Something like 3x revenues feels fair given the growth profile and potential runway here, which would land us at a bear case valuation of about $60M. Management’s low end estimate would peg valuation at about $150M and I have no reason to think that’s not possible, so let’s call that the optimistic scenario.

The last piece of IDT that should be discussed is the Net2Phone (N2P) business, which is a unified communications platform (which IDT refers to as Unified Communications as a Service – UCaaS) that allows businesses to manage their phone call, text, and chat traffic via one integrated application across the entire organization. Net2Phone also offers analytics/reporting capabilities as well as third party integrations like Salesforce, Slack, Zoho, and MS Teams. Since its U.S. launch in 2015, N2P has expanded to major South American Markets (Brazil, Argentina, Columbia, Mexico) and Canada (2018 acquisition) and Spain (2019 acquisition). IDT notes that they are specifically targeting new markets based on high market fragmentation, low UCaaS penetration, and general lack of attention from global market leaders. IDT cites future growth potential via increased features, new APIs, additional third party integrations, increased focus on specific industry verticals, and even a potential DTC offering (they recently launched some video chat functionality). N2P is playing in space that feels pretty crowded to me, especially with larger and more established players like Vonage (VG), 8×8 (EGHT) and RingCentral (RNG). But I appreciate that IDT is pursuing lower hanging fruit, rather than trying to compete head to head, and seems to be having some level of success. N2P is on course to do about $35-40M in revenue for FY 2021 and has been growing 20-30% YoY. I think N2P (and to some extent, this whole UcaaS trend) is still in the early innings from a macro perspective as several of the other publicly traded players in the space seem to be enjoying solid growth as well (even pre-COVID). To some extent, UCaaS looks to me like any other tech vertical nowadays – reaching critical mass in terms of customers will make or break the long term economics and viability of the individual players. To that end, you can see that IDT has accelerated their investment in the business as costs and capital deployed for acquisitions have really ramped up in recent years. Although there have been no disclosures of imminent plans, IDT has pretty decisively signaled that N2P is the next spinoff from the mothership. The story should be relatively easy to market to investors as a stand alone entity, the question is what kind of reception to expect from public markets. Management cites a 5-10x revenue multiple based on peers, and the public comps above seem to suggest 4-8x – so we are in a similar ballpark. At the lower end 5x multiple on today’s revenues we get to a $175M valuation and at a more aggressive 8x multiple we get $280M. This feels like a reasonable range to me right now.

Now, I know that was a lot to digest and, to be honest, it only scratches the surface of each of the underlying businesses. But the big picture here is that if you take all those valuation figures and put them together you get range of $525M to $850M which, as I mentioned in the section on the legacy communications business, ignores a lot of the optionality at the IDT holdco given it’s rock solid financial position and strong leadership. But given this valuation range you’re looking at a pretty limited downside and modest to significant upside in company that has a habit of creating it’s own catalysts.

The Bad:

There are two or three key issues I see with IDT. First, as I acknowledged above, I am pretty wary of assigning revenue multiples to businesses as a means of valuation, even if done conservatively. I could completely understand some level of skepticism applied to any of the comps or theoretical multiples discussed above. But I think that is just baked into the situation here. We are trying to value sub-scale businesses that are not ready to be standalone entities yet. Part of why this write up is absurdly long is that I wanted to provide context beyond just revenue multiples for each of the underlying business lines. As I alluded to previously, I think you could have any one (or multiple) of the businesses turn out to be less valuable than anticipated but still have a good outcome if another one is a homerun. Again, I sort of view IDT as a collection of embedded call options on any of the businesses creating a ton of unexpected value.

I mentioned above that Net2Phone will likely be the next spin (more on that reasoning below). Once N2P is spun, you’ll be left with the legacy communications business, NRS (the POS network), and BRMT (the money transfer business). To me, N2P makes a ton of sense as a standalone business – it is more of a true software business with lots of potential for growth and seemingly limited synergies with any of the other businesses beyond normal corporate overhead. Theoretically the next two options for future spins will be NRS and BRMT, but after having dug into those there seems to be tighter integration with IDT’s legacy communications business. For instance, the money transfer service is braded under the same name as the consumer facing calling service (which is part of the legacy communications line of business). To that end, consumers access both products via the same app and, in my mind, think of them as basically the same integrated service. I think that makes it pretty awkward to spin BRMT into a standalone when it shares the same app/consumer mindshare with a line of business left back at the IDT mothership. Alternatively, I suppose you could spin the calling business along with BRMT, but that probably complicates the narrative and reduces the “sexiness” of the payments angle for investors. Shifting back to NRS, I think we are a ways off from realistically considering that for a spin candidate. It’s still in the very early innings and I presume it has pretty different economics from any of the other businesses. NRS, too, seems to have pretty close ties with the legacy business in that they are targeting the existing retail footprint of the Boss Revolution products. In my mind, it remains to be proven if NRS can build out a large enough customer base to be viable long term. The Boss Revolution consumer calling product is distributed through 26k retail partners while management cites the 200k potential market for NRS. Even assuming 100% overlap between those two customer bases, I’m not sure we have enough info at this point to know if NRS growing to exactly the same footprint would be enough to be valuable as a standalone entity. I guess my large point here is that there is a pretty clear path to Net2Phone’s spin while the timing and prospects of the next catalyst(s) (i.e. spins) are a little less certain.

Joe was also on another one of my favorite podcasts, Andrew Walker’s Yet Another Value Podcast, to talk about another Old West holding (WildBrain). Early on in the pod, they chat a little about IDT/Howard Jonas and Andrew brings up the point there is some question about the fairness of IDT/Jonas dealings with minority shareholders. I think Andrew raised a fair question here. In the pod, he cites the recent 8-K that IDT filed announcing that Howard and Shmuel (Jonas, current CEO and son of Howard) were each granted 5% equity in the Net2Phone business. The grant is subject to meeting certain operational criteria (doubling run rate revenue and a $100M valuation) and only exercisable in a spin, sale, IPO, etc. It’s great that there are some strings attached here, but that’s 10% of Net2Phone that IDT has given away to two insiders (not even spread across the management team) and the bar has been set pretty low, IMO. The SOTP graphic above is from the company’s December 2020 investor deck and this grant was announced in early October. Notice that management already expects the value of Net2Phone to be well above the $100M criteria specified in the grant and, given the resources being allocated to N2P, I don’t expect the revenue goal to be difficult to achieve in the next couple of years either. To me, this looks like more of a reward than an incentivization tool. Now it’s pretty hard for me to know whether the Jonases were crucial to the success and future trajectory of N2P but apparently the board felt that way. Perhaps it’s a little heavy handed, but I guess at the end of the day IDT shareholders will also do well if N2P is successful. On a separate note, Howard Jonas and IDT are also involved in litigation related to the sale of their Straight Path spinco to Verizon in 2018. Several institutional investors allege that Jonas personally hijacked the company sale process in order to ensure IDT avoided certain liabilities related to FCC violations that Verizon would later pay $600M to settle. I’m not exactly sure what to make of this, but I highlight both of these issues to make the point that although Jonas and company appear to be talented value creators, it’s important to go into the situation with eyes wide open about the incentives and motivations of those in control. For me, it ultimately comes down to the fact that as a fellow equity holder, if Jonas and family/insiders are prosperous then I should be too.

The Key Variables:

• Continued progress of Net2Phone –  As the obvious next spin, the continued success and growth of Net2Phone will be of particular interest. I also hope/expect that IDT will continue to be more transparent around N2P’s reporting and guidance ahead of a spin.
• Deterioration of the legacy communications business – a severe decline in economics of the legacy business could be problematic. IDT has acknowledged that they are maximizing profitability here but if the money faucet gets shut off it becomes much harder to feed their growth-oriented businesses.
• Roadmap for NRS & Money Transfer businesses – I think the NRS plan is fairly straightforward, simply roll out more installs and build the customer base. For Money Transfer it would be nice to see some signaling or outright communication about the intentions with that business. As I have stated above, I think the monetization of that business line is less clear at the moment.

Conclusion

If you’ve made it this far, I am grateful. This is by far the longest write up I have ever done and took me 2-3x as long as normal to actually write. Unfortunately, as a result of the extended writing time, the company has run quite a bit since I started writing (and since my initial purchase). And that is in addition to a meaningful surge in the shares over the last few months (notice that the investor presentation graphic above shows a current EV/share at the time of $8.35!). Still, as I hope I have made clear by now, I think this is still a great opportunity to own some undervalued assets and ride shotgun with some great capital allocators. I put IDT into the portfolio at ~8% position at cost and consider it part of my mean reversion/deep value bucket of the portfolio. GLTA, DYODD and feel free to reach out with thoughts, questions, or comments.

Sawbuckd

2020 Year End Update Extravaganza

Happy New Year to all – I hope that your 2021 is off to a great start and treating you better than 2020. As I mentioned on Twitter towards the end of the year, the last month or two of 2020 were very quiet for the blog and portfolio. I was swamped with work at my day job and trying to enjoy what little free time I had during the holidays. Now that I’ve had a bit of a breather, I am refreshed and ready to get 2021 kicked off.

I am a little late getting this update out so, much like your gluttonous eating habits over the holiday season, I suspect you have already gorged yourself on a buffet of vague market platitudes and are leery of another heaping helping of hindsight bias as has been offered on Fintwit. So I will skip the rambling commentary and get right to the specifics. I’ll talk a little about performance and then give a brief update on each position in the portfolio. I also want to discuss some of my bigger blunders this year, so we will cover that towards the end.

If you haven’t already, be sure to check out the portfolio page, which has been updated through 12/31. I closed the year out at +51% for 2020, which is pretty hard to believe given the course of events that unfolded. Despite the eye popping numbers coming out of some corners of Fintwit (looking at you, SAAS guys), I am extremely pleased with this outcome. The year started a little wobbly with Q1 escalating into a full blown crash by the end of March. The few percentage points of outperformance during this period were mostly because I wasn’t fully invested – had I been fully deployed I don’t expect I would have faired any better than the R2000 or RMicrocap. A ton of the performance this year was driven by two stocks, which I have covered on the blog before: Gravity (GRVY) and Collector’s Universe (CLCT). Performance over the summer was especially strong as both of these position really started to take off and continued to hold strong through the end of the year.

Next, I thought I would give a very brief update on each position in the portfolio. If there is a corresponding write-up I will be sure to link to it below. I generally write names up as I put them into the portfolio, but there are several that do not currently have full  write ups – one of my projects for 2021 is to remedy this. I am also going to sort names by which of the 3 portfolio “buckets” they fall into. If you want more info on how I think about the different sections of the portfolio and my general investment philosophy, check out this post.

Special Situations (target % = 10-20%, current % = 6%):

Rubicon Technology (RBCN): So far, so good with RBCN. There’s not much to update here outside of what I have already written on the blog.

Cellular Biomedicine Group (CBMG): CBMG is small merger arb position that I haven’t gotten around to writing up in the blog. This is a management buyout situation with some outside private equity fund involvement. Management has been trying to pull together a deal for over a year now and seems to be pretty close as they have a special shareholder meeting lined up for February 8th to vote on the current $19.75/share offer. If all goes according to plan, CBMG will return about 15% from my entry price in mid-November.

PDL BioPharma (PDLI): H/T to @AlphaVulture on this liquidation situation. I would have never found this or invested had it not been for their great write up on the situation. [Full disclosure: at this point the stock doesn’t trade anymore as the company is liquidating, but I still recommend reading AV’s write up for the though process and analysis.]

Mean Reversion/Deep Value (target % = 40-60%, current % = 57%):

MSG Networks (MSGN): MSGN has been an interesting ride. My largest tranche of capital was invested in December 2019 with two smaller additions in January and February of 2020. Although I am now approaching break even on the total position, I could have had the shares at a much cheaper price shortly after I stopped buying, when COVID hit. This was one that I really wanted to add to during the COVID drawdown but I had already hit my personal limit for averaging down. In my short time as a shareholder, MSGN has continued to do dumb Dolan stuff like add James’ son (also a musician) Aidan to the BoD. Despite this, I still think this is an incredibly attractive situation. The company trades at a mid-single digit trailing P/E, they continue to pay down debt and buy back stock, and here in the early days of 2021 there have already been serious rumblings of legalizing sports gambling in NY which could be a meaningful tailwind for the business.

Ituran Location & Control (ITRN): ITRN is probably the name I feel the least confident about. COVID has been difficult on the business as people across the globe have been travelling less and therefore providing less demand for the company’s telematics products/services. Their international operating results, particularly in Brazil and their recently acquired Mexico venture, have been disappointing. I think there’s a lot to be optimistic about here: they are adding new product lines (like telematics integrated with auto insurer’s offerings), they are exploring exciting new markets (JV in India), and there is potential for substantial re-rating of the business as the Latin American economies normalize and their Mexican JV integration begins to bear fruit. If I had to choose a name that was closest to being sold in the portfolio, ITRN would probably be it.
 

Gravity (GRVY): 2020 was an incredible year for the Korean game developer/publisher and I think 2021 could be another big year. GRVY has a lot of momentum going into the year as they continue to launch new games (with notable success) and explore new partnerships across their various geographical markets. At this point it’s hard for me to envision adding more to my current position, but I also don’t think GRVY is at insane valuations relative to peers.

Namsys (NMYSF/CTZ): Namsys is one of the names I have not formally written up in the portfolio, but probably one of my favorites. They are a small Canadian software company that builds cash management products for “cash in transit” (CIT) service providers (basically armored truck companies, most notably Brinks $BCO) as well as multi-location retailers and banks. From a price action perspective, 2020 was pretty choppy for Namsys but I continue to be intrigued by this situation because of the consistency of growth and the niche nature of the business. NMYSF is intriguing but has a few notable wrinkles. The aforementioned Brinks is a key relationship that presents customer concentration that could be viewed as a potential threat or huge avenue for growth. The company also has a long term employee bonus plan that dictates that when 50% of assets or shares of the company are sold/transferred OR an outside party crosses 20% ownership, the company owes the employees and officers 15% of the transactions consideration. I always found the bonus thing to be quite odd, but I suppose it was a way to entice high-demand technical talent to work for a tiny (<25 employees IIRC) Canadian SAAS company. Anyway, there’s a major shareholder that is getting close to tripping the bonus and there’s a bit of a time crunch based on the when certain parts of the bonus pool are to be paid. So 2020 was pretty interesting based on these shareholder developments but I expect 2021 will likely be even more interesting as things catalyze one way or another.

Collector’s Universe (CLCT): CLCT was a situation in which my timing could not have been better. I added the name to the portfolio in April after having my eye on it for quite awhile. I was able to buy just ahead of Alta Fox’s activist campaign going public, which brought tons of attention to what I thought was a mis-managed company with lots of potential given a number of emerging tailwinds in the current market environment. Although the shares look a bit expensive o a trailing basis, I think Alta Fox (and others) have laid out compelling cases for value creation in the near to intermediate term. Late in the year, former Alta Fox board candidate and avid card collector Nat Turner joined forces with Steven Cohen and other PE backers to bamboozle the CLCT board into giving away the company at an underwhelming $75.25/share price point. But several large shareholders have now indicated that they plan not to tender, so early 2021 will likely hold some interesting developments for CLCT as well.

Long Term Value (target % = 40-60%, current % = 31%):

Constellation Software (CNSWF/CSU): Constellation is another name I have never really discussed on the blog. That is largely because I have nothing to add to the public discourse and do not believe I hold much of a differentiated view. I also feel quite guilty that it does not really fit my microcap/smallcap criteria for the portfolio, but I simply cannot help myself when it comes to this company. I love the management team, culture, execution, opportunity set, etc. that Constellation presents. There are many that are trying to execute the exact same strategy but even when I develop a wandering eye, I am never as smitten with any other VMS rollup as I am with good old CSU. Constellation is a portfolio holding that I rarely think about at all and will probably hold for a very long time. I am currently awaiting my Topicus shares with baited breath…

IAC (IAC): IAC was another addition during 2020. I’ve long admired the company and kept fairly close tabs on it but the MTCH spin earlier this year presented too tempting an opportunity to pass up. IAC is another holding that I feel quite guilty about because of their market cap, which is well out of the small/micro cap range. But ultimately I think of this portfolio and my whole “value” orientation to be more about finding misunderstood opportunities – it just so happens that those occur more frequently in small/microcaps so that is where I focus my efforts. But mid/large caps can have the same problem – especially in the much maligned SOTP situation. Where IAC gets the SOTP problem right is by trying their hardest to force those value gaps closed with spinoffs. That and the impressive track record of Diller and Levin were just to much for me to continue to pass up when I added the position in the late Summer. I could certainly see myself adding more to this position over time, perhaps even in 2021 depending on how the Vimeo spin goes.

Dream Unlimited (DRUNF/DRM): Dream was a new addition this year that I have written about on the blog. Not a lot to update here as the management team continues to execute and the market continues to ignore.

Terravest Industries (TRRVF/TVK): Terravest is another one of the names that I have yet to cover on the blog, but that I hope to remedy in 2021. This Canadian small cap is basically an opportunistic small-scale roll up strategy in the energy services space and is lead by a capital allocation-focused management team with ties to another very interesting Canadian investor, George Armoyan (and his Clarke holdco). The company selectively acquires small niche service providers and manufacturers in the general oil & gas services domain for extremely cheap valuations. Aside from the COVID disruptions and general malaise that hung over the energy sector in 2020, the year was surprisingly quiet for Terravest. Operating results were roughly within expectations (that is to say “good” given the conditions but not particularly exciting for any other year) but I really thought they might get the chance to scoop up some good deals after Q1.

OK now that we’ve run through the portfolio and talked about performance, I want to quickly re-visit some mistakes from the year:

• Sold Yellow Media (YLWDF) @ $5.00/share on 4/6/20: this ended up being just about the worst possible time to sell Yellow as shares have rebounded to ~$9.50 as I write this. If all I had done was held, it would have turned my 30% loss to a 30% gain. I mentioned it in one of the portfolio updates during the year, but my thinking was that they were going to start bleeding customers uncontrollably (they provide a suite of digital marketing, website maintenance, etc. services to small businesses in Canada), which had been their whole problem to begin with. Even before COVID their customers were dropping them which is why the multiple was so low to begin with. From reading through management’s comments and the financials, I still don’t fully understand why they didn’t struggle more. My thinking was that marketing budgets would be the first thing cut in a pandemic, but it doesn’t seem to have effected them. It’s still puzzling to me, which is the only reason I haven’t re-entered the name (it still looks incredibly cheap and could still be at an inflection point with their turnaround). Still not sure what the lesson is here – I felt like this was a good opportunity (and might still be) but something just isn’t making total sense to me.
• Sold FitLife (FTLF) @ $11.00/share on 6/1/20: this reasoning was very similar to my logic on Yellow above, namely that the pandemic would be extremely detrimental to the business. But I think this was just a case of not doing enough work to build my conviction sufficiently. I thought FTLF was already in trouble because their primary retail partner GNC had filed for bankruptcy – not only because of potentially unrecoverable receivables but also because I thought it was meaningful part of their distribution. Plus, although FTLF has ample online distribution, I assumed from personal experience with nutritional supplements that brand loyalty would be relatively weak and the demand would not follow to the digital space. Not only did this proved to be wholly inaccurate, but the economics of online/DTC distribution were significantly more favorable for the company. As a result, they turned in one of the strongest quarters in company history in Q3. The shares currently sit at $21, which would have been a 45% gain had a held instead of a 25% loss. This was a small position for me, but I think the takeaway here is to really be sure about the level of my conviction before I put anything on or decide to bail. I think I could have looked a little harder at this and built the resolve not to sell.

Updates on other posts/non-holdings:

• Aaron’s separation: In September I wrote a quick post about the upcoming lease-to-own retailer Aaron’s split into two distinctly traded entities. The structure/naming convention was a little confusing but ultimately the company split into Aaron’s (AAN), which remained the legacy lease-to-own business, and PROG Holdings (PRG), which is a much sexier consumer financing business, on November 25th. At the time, my conclusion was that I saw the business logic in the separation but didn’t see a clear path to a lot of market value creation – so I elected not to buy any shares. The current market cap of the two companies combined is about $4.5B vs. about $3.5B when I wrote it up on September 8th. That’s about a 30% gain if you bought in early September, but is roughly in line with mid and small cap indices’ performance over the same time period. It’s a relatively short period of time, so I don’t know that there are any big revelations to discuss here, but the situation has roughly tracked with my expectations. There is still plenty of time for PROG’s shares to really take off and make me look like an idiot, but so far so good.

• StoneX (SNEX): StoneX was another name that I devoted a lot of energy to and wrote about, but could not ultimately get on board. I still think the company is very interesting and has a lot of attractive qualities. Since the write up shares are +10% and about +15-20% from when I was doing my initial research. Even then, I think I was a little late to the party – the price was already up pretty significantly before I heard @puppeh1 discuss it on a few podcasts. Not much else to say here other than I continue to keep an eye on the company.

So there you have it. I know that was probably boring, but thanks for suffering some additional naval gazing here at the beginning of 2021. I am looking forward to another year of research, posts, and interaction with all of you. Please do not hesitate to reach out to me on Twitter or leave a comment here on the blog – I always enjoy talking to readers and fellow Fintwit folks.

Thanks for reading.

Sawbuckd