The S&P 600 Small Cap Index bounced off rock-solid support at the 820 level late last week, and over the last few sessions has migrated back to its 50-day moving average line at around 837.
This means were right back to the middle of the index’s 2017 trading range. And it also means small caps are unchanged year-to-date. That lackluster performance has small caps dragging behind large caps by 8% in 2017, and underperforming in every sector except health care.
Of course, we already know that this recent underperformance is due to the dramatic outperformance that small caps posted after the election, when they rallied 18%, much more than large caps. Small is still leading large by 3% since the election, but the sector breakdown shows a mixed bag. Our greatest exposure lies in information technology and healthcare, where small is still leading by 10%.
One of the factors acting like a chain around the leg of small cap indices is energy—it’s just been brutal for small cap energy, which is why we’re avoiding the area even though there might be some deep value plays.
I mentioned recently how there appears to be some bifurcation in the market. Companies that report well are being handsomely rewarded, while those that don’t are getting slaughtered. Thankfully, we’ve been the beneficiary of several great reports this quarter. But we’ve also suffered through a few trips to the woodshed too, most notably with Aqua Metals (AQMS), Marrone Bio (MBII) and just recently, Ooma (OOMA).
Still, on balance, our portfolio continues to outperform the small cap index. Including the performance of Aqua Metals (which was sold) and this week’s drop in Ooma (currently rated Hold), our stocks are beating the Russell 2000 by an average of over 10% over the same holding time (to calculate, I track the return of the Russell from the date of coverage of each stock, measure the difference and take a simple average).
The takeaway message is that, as always, diversification and stock selection are important. Not only between asset classes, geographies, sectors and over time, but within asset classes as well.
We should still proceed cautiously now that earnings season is wrapping up and we’re entering the summer trading season when we typically see periods of erratic trading. Valuations are high, and a significant pullback would not come as a surprise. With that in mind I take one of our outperforming positions down to Hold today.
Have a great holiday weekend!
Updates
Airgain (AIRG) The company remains unknown and shares keep moving sideways. I think that will change, eventually. A recently-posted article on Seeking Alpha might help raise the company’s profile just a hair among retail investors. But ultimately, we need the stock to move higher to help pull big investors off the sidelines. Then some real momentum would start to build. Be patient. BUY.
Aqua Metals (AQMS) No update. SOLD.
Asure Software (ASUR) As expected, Asure opened its wallet and just announced two more acquisitions. One surprise was how large one of the deals is. I’ll cover the small one first. Asure bought Compass HRM, a Southeast focused (mainly Florida) provider of HR solutions. Compass is one of around 13 remaining resellers of Asure’s HCM solution, and as I’ve been saying we expect the company to buy up these companies since they already use Asure’s software and represent relatively easy integrations. Asure buys them, can add incremental revenue (maybe around 10% to what the acquired company already has, in the first year), and can immediately increase EBITDA profit margin from around 10% to 50% due to synergies. Asure paid $6 million for Compass. I haven’t seen Compass’ annual revenues disclosed in any SEC filings yet, but I suspect it’s right around $3 million, assuming a multiple of two-times sales.
The much larger deal was iSystems, based in my college town of Burlington, VT. The company is a national provider of HCM software for service bureaus, including independent payroll processors, banks and accountants. This company is more similar to Mangrove (which Asure bought in March of last year and which got the stock moving). It has its own software platform (called Evolution HCM, which covers payroll, tax, HR management, time, labor and business analytics) and its own network of over 100 service bureaus, collectively processing payroll for around 75,000 small businesses. So now the teaser line is that the potential number of service bureaus goes up from 12 to 112 (after acquiring Compass).
This is a large deal for Asure. It paid $55 million, which makes it five-times larger than the Mangrove acquisition. Asure also appears to be paying a premium. iSystems is expected to generate $14 million in sales this year. That means Asure is paying just about 3.9-times current year sales; by comparison, its own stock is trading at 2.7-times current year sales! (Asure paid about 1.5-times trailing sales for Mangrove.) I should double check these numbers, and every purchase isn’t exactly an apples-to-apples comparison, but it appears that Asure is willing to pay up for the additional growth potential of iSystems, especially since it adds roughly 30% revenue growth (on an annual basis) right off the bat. To help fund these acquisitions, Asure has increased its credit facility by $43 million (to $75 million) and its 8-K filing proposed a secondary offering of roughly 1.5 million shares at $12, to raise $18 million. That offer price represents an 18% discount to yesterday’s close, so it will be very interesting to see how the actual offer price comes in, and how shares react to the news today.
Given these acquisitions, management has increased guidance for 2017 and 2018. Previous consensus for 2017 was revenue growth of 31% to $46.6 million and EPS growth of 180% to $0.67. Management is now calling for revenue of $53 - $56 million (growth of 50% - 58%) and EPS of $0.50 - $0.59 (remember this includes just six months of contribution from these two new companies). For 2018, expected revenue growth of 13% to $52.6 million and EPS of $0.79 goes up to as high as $100 million (which would represent 82% growth) and EPS goes up to a range of $0.74 - $0.96. So basically, a year and a half from now these acquisitions have helped Asure double revenue. And EPS, after accounting for dilution, should be at least as high as it would have been without the acquisitions, and primed to grow much faster after 2018.
Asure says it wants to complete multiple tuck-in acquisitions of around $2 million in revenue for a purchase price of roughly two-times revenue to help get revenue over the $100 million mark. Simple math suggests it will need to acquire around $25 million more in sales to get there. Paying a two-times multiple suggests it needs $50 million in capital to get the job done. I’ll have to evaluate financing options once I have more time to pour over the details.
We don’t yet know if any of the management team from iSystems will come over to Asure, but I assume some will. A lot of these details will probably be discussed on a conference call related to the acquisitions being held at 11:00 AM ET today. This is a developing story and we’ll be talking about it more. I expect the stock could be volatile today. But ultimately, it would seem that, despite the steep price for iSystems and discounted proposed share offer price, this is all good news. The growth strategy for Asure requires acquisitions, and iSystems seems to fill up the pipeline for years to come. Let’s hold through this news and see what happens. HOLD.
BioTelemetry (BEAT) The stock is still moving sideways in the 27 – 30 range. Nothing to add since Wednesday’s Special Bulletin note, which said, “The company has had to up its offer price for LifeWatch by 4% ($10.2 million) to $275 million to pull in the 12% of shares owned by Aevis Victoria and Antoine Hubert, who had previously made an unsuccessful bid for LifeWatch. The offer period has also been extended to end on June 8 rather than May 31. The additional acceptance period now runs from June 15 to June 28, if needed. I still expect it to be successful”. BUY.
Everbridge (EVBG) The trend is strong with this one. No fundamental updates. Keep holding. HOLD.
LogMeIn (LOGM) Shares have been a little erratic and are back to the 110-level, which served as resistance in November and January. As before, we’d like to see the stock hold here. Management will attend the Bank of America Merrill Lynch conference on June 6, and a conference hosted by Baird on June 8. HOLD HALF.
Marrone Bio (MBII) I moved our most speculative position to hold last week given its prolonged weakness. We’re looking for some sort of catalyst here to reenergize the stock. Keep holding. HOLD HALF.
MindBody (MB) I discussed the company’s proposed secondary offering in Wednesday’s Special Bulletin, saying, “MindBody announced a secondary stock offering of 4.4 million shares, which represents roughly 11% dilution. The stock took a small hit initially and then bounced back. Why? Because this offering is almost certainly being done to help fund acquisitions, and somewhat sizeable ones at that. The company ended the last quarter with $88 million in cash (it adds a couple of million a quarter) and zero debt. At around a $28 offer price, 4.4 million shares should net over $130 million. Why would it need a total of almost $220 million in cash? No reason, other than to buy something.” Yesterday an offer price of $27.95 was announced. Given that most secondary offerings are completed at a decent discount I’d say there is considerable demand for this stock. I see it going up, and I expect we’ll hear about an acquisition within a few months. Check out the volume yesterday. Keep holding. HOLD.
Ooma (OOMA) I went over Ooma’s disappointing earnings report in Wednesday’s Special Bulletin so don’t have anything fundamental to add today. Suffice to say this was a huge setback for the company and the stock. I thought we had another winner here that could attract a buyout offer at a big premium. Now, I think big shareholders would take around $14 - $16 (I’m purely speculating here, not basing this on any rumors or anything). That would still be great for us. And it’s one of the main reasons to hold on, since I think the company’s core platform and customer base are valuable assets that would be cheaper for an acquirer to buy than to build. Bottom line: we’re still sitting back and digesting the stock’s fall from grace. It enjoyed a small bounce yesterday. It feels like the sell-off was a little overdone, so let’s keep watching. Management spoke at the B. Riley Conference in California yesterday, and will do so again at the William Blair Growth Stock Conference on June 13 in Chicago. HOLD.
Primo Water (PRMW) The stock has begun to move higher over the past week (finally!!), and enjoyed a 6% rally yesterday. It feels cheap here, so keeping at buy. BUY.
Q2 Holdings (QTWO) Our new darling is showing inspiring stability. I like this action a lot more given the comparatively volatile share price action that persisted after I first started covering it just over a year ago. That said, we’re now up almost 70% and I suspect you probably have a position, if you’ve wanted one. It feels like we’re within a couple points of the stock taking a breather, so I’m pulling back to hold. HOLD.
U.S. Concrete (USCR) Since the last quarterly report the stock has been holding up fairly well, even while a number of construction-related names have pulled back. As I said last week, we’ll need some more fundamental developments—like news about a new regional expansion—to help push the stock through resistance in the 71 – 72 zone. Keeping at buy. BUY.
