In the stock market (and in life), incentives matter.
Charlie Munger summed it up well when he said, “Show me the incentive and I will show you the outcome. I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it.”
This is the reason why I’m so focused on insider ownership when evaluating micro-caps.
If you have a micro-cap CEO who owns very little stock, but collects $1MM+ in annual compensation, his incentive is going to be to keep his job, not maximize shareholder value.
If a buyout offer surfaces, it’s likely the CEO will not be interested in selling the company. He would rather keep receiving $1MM in annual compensation.
When I originally recommended BBX Capital (BBXIA), I noted that I was a little worried about poor historical corporate governance. Specifically, the Levan family controlled (and still does) the majority of voting shares of the company and as a result, had complete control over executive compensation (executive compensation has historically been high).
However, I ultimately got comfortable buying the stock because the Levan family owned 42.2% of class A shares and had more to gain from increasing the value of the company than from milking it for excessive executive compensation.
And that was a good decision as the stock is up over 100% since we recommended it.
This week, the company announced that it will commence a tender offer to buy back 4,000,000 class A shares at $6.75 ($27MM in total spend). This represents a buyback of 21% of shares outstanding!
The transaction makes all the sense in the world as the company is buying back its stock at a massive discount to book value.
Today, book value per share is $16.00. The stock is trading at a price to book value ratio of 0.42x.
If successful with its tender offer, the company will spend $27MM to retire 4MM shares.
Book value per share will increase from $16.00 to $18.41. If the stock trades at $6.75 after the tender offer is complete, it will trade at a price to book value ratio of 0.37x.
Why did the company announce this transaction? Because the Levan family wants to increase its wealth. Remember to follow the incentives!
With this news, I’m switching the stock back to Buy with a limit of 6.75.
Even if you don’t like the company, it makes sense to buy the stock below 6.75 to sell it back to the company at 6.75 in their tender offer.
I still ultimately believe (again…incentives!) that the Levan family takes the business private below book value (perhaps at 10 or 12 per share), and so, if the stock appreciates to that level, I will likely sell.
The next issue of Cabot Micro-Cap Insider will be published on Wednesday, June 9, 2021. As always, if you have any questions, don’t hesitate to email me at rich@cabotwealth.com.
Changes This Week
Switch BBXIA from Hold Half to Buy under 6.75.
Updates
Aptevo (APVO) has stabilized. I think it’s partly due to the fact that Tang Capital has maintained its position, and per the latest hedge fund disclosures, there are many other hedge funds that own the name. Thus, I think it’s likely that Tang Capital has significant leverage in order to proceed with its proxy fight. At the current valuation (after backing out royalty payments), Aptevo’s pipeline is being valued at $17.3MM. This seems overly pessimistic given that Aptevo’s lead compound, APVO436, has generated one complete response and another partial response in difficult to treat AML patients. Further, Tang Capital owns over 40% of the stock and will eventually be successful in getting a board seat. Ultimately (within a year), I believe a process will be run and Aptevo will be sold to the highest bidder. In the earnings release, Aptevo noted that it will publish data on its lead compound APVO436 later this year. This could serve as a key catalyst. Original Write-up. Buy under 40.
Atento S.A. (ATTO) reported a solid quarter recently. EBITDA margins were slightly disappointing at 10.5% but it was due to the seasonal impact of Brazilian wage increases. Management maintained full-year guidance of 12.5% to 13.5% for EBITDA margins. Constant currency revenue growth came in at 8%, ahead of mid-single-digit guidance. On the call, management indicated that the quarter was ahead of their expectations. All in all, the investment case remains on track. I see over 100% upside in the stock over the next couple of years. Original Write-up. Buy under 25.00.
BBX Capital (BBXIA) was covered above.
Donnelley Financial Solutions (DFIN) recently reported a great quarter with 11% revenue growth, significantly ahead of consensus expectations. Non GAAP EPS of $1.15 also beat consensus and the stock performed well. DFIN then pulled back after an analyst downgraded it to Hold, but the stock has rebounded sharply. Donnelley is executing well and is still too cheap trading at 8.5x free cash flow and 6.9x forward EBITDA. Original Write-up. Buy under 25.00.
Dorchester Minerals LP (DMLP) recently paid a $0.30 quarterly dividend. At an annualized rate, the annual dividend yield is 7.9%. In 2020, the company generated $39.4MM of free cash flow. Given the pandemic, we can view this free cash flow generation as a trough. As such, DMLP is trading at 13.3x trough free cash flow. This is an extraordinarily cheap multiple for such a high-quality royalty business. Given oil prices are back to pre-pandemic levels but the stock remains depressed, I’m recently increased my buy limit to 17.50. Original Write-up. Buy under 17.50.
Drive Shack (DS) is my newest recommendation. Its traditional and entertainment golf businesses are set to boom in 2021. Given substantial recent cost cuts, operating leverage should drive earnings growth in 2021 and beyond. Longer term, growth will be driven by new Puttery Venues, which have high potential. At its current valuation, Drive Shack’s share price gives minimal value to the strong upside potential from new Puttery Venues. Finally, alignment is high as management and directors who own 16.3% of shares outstanding have recently bought in the open market. My price target implies over 100% upside. Original Write-up. Buy under 3.00.
FlexShopper (FPAY) recently disclosed that its chairman and a director both bought the stock in the open market. This gives me strong confidence that strong results should continue. Recently, the company reported another excellent quarter. Revenue increased by 32.0%, beating consensus slightly. Adjusted EBITDA increased by 20% to $2.4MM. New originations increased 21.7%, which implies that revenue and earnings growth for 2021 should be very strong. I continue to like FlexShopper. It is a rapidly growing company in the virtual lease-to-own market. Despite rapid growth and margin expansion, it is only trading at 7.6x 2021 earnings. My 12-month price target for FlexShopper is 4.70. Original Write-up. Buy under 3.00.
Greystone Logistics (GLGI) is primed to continue to perform well. I recently had a chance to speak to the CEO and learned a bunch of new information. Why did I want to speak to the CEO? Greystone had recently reported a quarter that looked awful at first blush. Revenue declined in the quarter by 26% while EPS declined by 65% to $0.02. However, the 10-Q revealed that the decline in revenue was primarily due to a timing issue. In March (one month after quarter end), Greystone received an order for $7.8MM. If that quarter had been received in February, revenue would have grown by 13% and earnings would have grown significantly as well. I wanted to get clarity on what was going on. I called the company and within 30 minutes, I was on the phone with CEO Warren Kruger. For the next 20 minutes, I asked Kruger a ton of questions about the industry and his business (he owns over 40% of shares outstanding). He was very candid and direct. I think it was the most informative 20-minute conversation that I’ve ever had! I had two big takeaways from the call: 1) The customer that previously decided to diversify away from Greystone for its pallet orders reversed its decision. This is a major positive. 2) The long-term outlook for the company remains bright and Kruger remains highly engaged. The stock is trading at 8.6x current fiscal year EPS estimate of $0.15 (fiscal year ends in May) which is too cheap given strong growth. I expect strong EPS growth in 2021 (fiscal 2022). Greystone Original Write-up. Buy under 1.30.
HopTo Inc (HPTO) recently filed its 10-Q to disclose Q1 earnings. Disclosure was limited but revenue grew slightly in the first quarter. The company also disclosed that it sold some patents for $269.8K. The company didn’t disclose how many patents were sold, but it’s good to see that the company was able to monetize at least a portion of its patent portfolio. All in all, the investment track remains on track. Insiders own a significant stake in the company and have an incentive to growth revenue and earnings to increase value. I believe HPTO is worth ~0.80 per share. The stock is currently trading at an EV/EBIT multiple of 5.7x. This is way too cheap. To put it in perspective, the software and Internet industry trades at an average EV/EBIT multiple of over 50x. Original Write-up. Buy under 0.55.
IDT Corporation (IDT) has performed well since reporting strong earnings in March. Consolidated revenue increased by 5%. National Retail Solutions (NRS), BOSS Revolution Money Transfer, and net2phone-UCaaS subscription revenues increased by 151%, 73% and 36%, respectively. In particular, NRS’ growth of 151% was incredibly impressive. NRS deployed 1,300 billable POS terminals during the quarter, increasing its network to 13,700 terminals, and had 3,800 active payment processing merchant accounts at January 31, 2021. IDT believes that the market for NRS’ point of sale terminals is 100,000. On a sum-of-the-parts basis (which I think is the right way to view this name given IDT’s propensity to sell and spinoff its assets), the stock is worth 34. Original Write-up. Buy under 23.50.
Liberated Syndication (LSYN) Last week Libsyn filed an 8-K disclosing the extent of the restatement of their financials. In it they also disclosed that the CFO, Richard Heyse, resigned. The restatement is a little messier than I had initially expected, but I don’t think it’s material. The CFO resigning was the big negative to me. While it is said that Heyse had no disagreements with LSYN’s Management, directors, or outside auditors, it’s certainly not something you want to see, especially because he was buying stock in the open market recently. The CFO has also agreed to act as a consultant for the company to assist in the preparation of the 2018 and 2019 restated financial statements. Perhaps I’m being optimistic, but maybe he just realized that it’s going to be a lot of work and would rather move on, or rather didn’t want to commit himself to the process. I continue to have conviction in the stock. Original Write-up. Buy under 5.00.
MamaMancini’s Holdings (MMMB) recently reported earnings and the stock popped. While revenue in the quarter only increased by 1.4%, net income increased 500% to $0.05 as the company continues to leverage its fixed cost base. For the full year, MamaMancini’s generated EPS of $0.12 (+200% y/y) on revenue growth of 20.8%. Growth in 2021 (fiscal 2022) should continue driven by improved penetration of the company’s products in grocery stores nationwide as well as by bolt-on acquisitions. My 12-month price target is 3.80, which is driven by an estimated price to earnings multiple of 20x on expected fiscal 2021 earnings of $0.19. Original Write-up. Buy under 2.50.
Medexus Pharma (MEDXF) has been a little weak, but it remains our highest conviction idea. I expect Medexus to announce that it will be uplisted to the Nasdaq very soon and this could be a nice catalyst to see the stock continue its upward march. Medexus remains my highest conviction idea and largest personal holding. Management believes its current drug portfolio (including recently licensed Treosulfan) has peak sales potential of $350MM to $400MM CAD. Assuming the company can trade at 3x this revenue estimate (the company will execute additional licensing deals so I expect revenue to ultimately grow even higher) in line with slower-growing peers, MEDXF would trade at ~24 per share, implying significant upside from here. Original Write-up. Buy under 8.00.
NamSys Inc. (NMYSF) recently released Q1 ’21 results. Revenue grew 9%, which was solid but a slight deceleration from last year’s growth. The Canadian dollar was strong relative to the USD and as a result was a headwind for the company in the first quarter. Otherwise, macro trends remain supportive of continued strong growth in 2021 and beyond. The stock continues to look attractive trading at only 15.0x free cash flow. It has a pristine balance sheet with significant cash and no debt, and insiders own more than 40% of the company, ensuring strong alignment. Original Write-up. Buy under 0.80.
P10 Holdings (PIOE) recently released its Q1 ’21 letter and everything looks good. A couple highlights: Assets under management are expected to increase by 30% this year. This will drive revenue, earnings and cash flow high in 2021. The company has a full pipeline of M&A opportunities. Insiders own 73% of shares outstanding. If we assume the company can achieve $16.0BN in assets under management by the end of the year (its goal), it is trading at 10.0x free cash flow and 13x EBITDA. Those are very reasonable valuations considering its closest (albeit larger) peer is Hamilton Lane (HLNE), which trades at 31.9x EBITDA and 21.3x free cash flow. My official rating is Hold Half, but I may eventually switch my rating back to Buy given how well the business is positioned. Original Write-up. Hold Half.
Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.
Disclosure: Rich Howe owns shares in BBXIA, GLGI, HPTO, LSYN, MMMB, MEDXF, PIOE, FPAY, IDT, APVO, and DS. Rich will only buy shares after he has shared his recommendation with Cabot Micro-Cap Insider members.