Lessons On Investing In a Turnaround, Scott’s Liquid Gold

I have been closely following the story of Scott’s Liquid Gold (SLGD), which became profitable for the first time in a decade in the middle of 2013. The company manufactures and sells wood polish and air fresheners and they have distribution rights to dry shampoo and other products. What makes the story interesting is that the company has been profitable since Q2 2013 but it is still dirt cheap. The stock still trades slightly above book value. The sale leaseback of the companies facilities in February of 2013, which netted $9.5M, aided the come back. Detractors like to point out that SLGD is losing some of its distribution rights to the quickly growing dry shampoo business. Still further is the sordid battle between the company and activist investor Tim Stabosz. I plan on waiting a little longer before deciding whether to invest, but I will be waiting anxiously. Investing in a turn around story generally ends in one of two ways, big win or big loss. Getting in is a difficult thing to time. I recommend caution.

The Pros of SGLD

The Company’s valuation is attractive and its balance sheet is clean. SLGD has a P/E ratio of 6.8x TTM and trades slightly below 4.0x EV/EBITDA TTM. The company has no debt and $4.4M in cash. Its business segments have been improving top and bottom line. The market cap is ~$10.7M and TBV is ~$8.6M.

After freeing up cash from the sale leaseback the company was able to make some improvements. It paid down all debt and put a bigger emphasis on its products and marketing. In Q4 2013 the company introduced it’s Floor Restore product. The company also hired a new head of marketing, who has an impressive background at other major CPG companies. These moves helped to revitalize the legacy Liquid Gold brand, which saw sales decline from nearly $10 million in 1998 to under $5 million in 2012. Household products are manufactured in house and make up only 27% of sales and grew by ~18% in the last twelve months. The business operates at a loss, but margins are improving as sales grow. A complicating factor is that overhead is allocated 50-50 over both segments, which I doubt is a fair split. Household goods had a $600K operating loss. If sales improve this business could turn quickly as margins are high, ~47% and growing, by ~5% in the last 12 months.

Skin and hair care makes up 73% of the companies revenues. The company has two owned brands Alpha Hydrox and Neoteric Diabetic. Alpha Hydrox is the larger brand with products that include face creams, body lotions, and foot creams.  Like its name implies Noeteric Diabetic’s skin products are made for diabetics. Like the rest of the business these brands struggled over the past decade, but are now a main target for the company to revitalize. These products suffered mainly due to neglect and a lack of new products.

SLGD distributes Montagne Jeunesse face masques, and Batiste dry shampoo. The Company recently renewed its contract with Montagne Jeunesse through September 15, 2017. The one stipulation is that SLGD brings in at least $4.5 million in face mask sales annually, which seems doable because they are currently doing more sales than that and the business is growing. The companies distribution rights to the dry shampoo lapsed at the end of 2014 but a new deal was recently made. This is where the future becomes a question mark. SLGD retained the right to distribute Batiste to specialty retailers but lost the right to mass retailers. The deal lasts through 2016. The impact of this new deal will be what makes or breaks the company. The company does not break out sales which further clouds the picture. We do know that the dry shampoo market in the U.S. is growing, it is a relatively new product here and sales growth is up between 50-100% in the TTM. Some believe that the company can be profitable under these new terms but I think it is hard to know.

SLGD IS copy

The Products

wood copyTouch of scent copyfloor copydry copyface copy

The Cons: All That Shimmers Isn’t Gold, Says Tim Stabosz

Company management is suspect, the impact of losing part of the dry shampoo business could be worse than expected, and the company could lose further product distribution rights in years to come. If SLGD can not turn a profit you can expect for management to just let the company bleed out. Activist investor Tim Stabosz has been vocal in critiquing the company’s management, which may have scared some investors away. I agree that management has not acted in the shareholders best interests.

Stabosz wanted the CEO, who is also majority shareholder ~26%, fired and the businesses sold. He accused the board of being spineless yes men. At one point he even offered to buy out all of the boards shares at $.50 or let them have his shares for the same price. I can understand his frustration. The company could have been sold at an attractive price before Stabosz got involved. The CEO turned the offer down. He then proceeded to drive the company into the ground, with only one year of profitability over the next 14 years. The whole time he was earning ~$500K in salary. Would he have been fired if he did not own the lion share and have the board in his pocket? Absolutely!!  Stabosz has since sold his entire stake. His involvement has been pretty entertaining. My favorite quote from Stabosz is below.

  • Mr. Goldstein lives in a bubble, thriving on the high regard in which he is held by his employees and the community-at-large, and is operating the company primarily for the sake of “image” and “pride,” as a de facto not-for-profit institution, for which he is awarded a generous “sinecure.”

Read Some of Stabosz’s letters in filings on the SEC’s EDGAR website at the following two links:

http://www.sec.gov/Archives/edgar/data/88000/000116289311000004/slgd13d1.txt

http://www.sec.gov/Archives/edgar/data/88000/000116289311000004/slgdltr.txt

My other concern is that SLGD will lose all distribution rights to dry shampoo. The owners Church and Dwight are handling the mass retailers now because that is easier logistically. It would definitely make sense that they are slowly taking control of their entire business. I have seen other examples of this happening in the space before.

Recommendation:

There could be big opportunity here because the stock is so cheap, but I am going to wait. My projections of dry shampoo’s impact on net income has a wide range. It might be profitable and it might not. I do not think the company’s break-up value means anything because management will let it bleed money forever.

In a turn around or a company that just turns profitable a lot of the pop in the stock comes after the second quarter of profitability. In this case another big milestone is Q1 2015 when we see how the business reacts to losing the distribution rights. Stay tuned.

Warning: Like many of the other stocks that I write about on here this stock is illiquid.

In related news Horizon Lines, HRZL, had its first profitable quarter in a long time. It made ~$10M last quarter in net income, which is not bad for a $27M market cap company. Yes, I said only $27M market cap. Beware there is a lot of hair on this one, namely debt, lots of debt. In addition, TSRI is finally making a comeback after the recession, this one is not as messy.

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George Risk Industries Is Not Such A Big Risk After All.

Background: George Risk Industries (RSKIA) designs and manufactures, burglar alarm components and systems, pool alarms, computer keyboards, push button switches, and water sensors. Security alarm products make up ~85% of revenues and are sold through distributors. It is not an exciting business, but the company is good at what they do. They have been able to carve out a niche by taking custom orders that larger competitors shy away from. Management asserts that the company competes well on price and from my scratch the surface investigation that seems accurate. The company is 58% insider owned, with the commanding number of shares held by the mother daughter combination who serve as board member and CEO, respectively. RSKIA has a market cap of ~$39M. This is a good investment for a personal account because of the companies size and trading volume.

Thesis: Between its earnings power and the value of its assets the company deserves a higher stock price. The company remained profitable through the recession and has been growing steadily since. I see an upside of +45% with a limited downside. The stock price is supported by a +$24M cash and marketable securities balance. The rub is that management is not very shareholder friendly. They are sitting on top of a mountain of excess capital that should be returned to shareholders. Continue reading

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Growth Will Drive Past Next Year Consensus Expectations.

Summary: (Full report click here: EXA Corp Report)

  • Competitive advantages in simulation software, market leader position in auto space.
  • My consumer survey results suggest rapid company growth and high barriers to entry.
  • Fuel economy regulations will continue to spur demand for Exa Corporation products into the foreseeable future.
  • Attractive entry point, trades at 2.2x EV/Sales.

Business Description: Exa Corporation (EXA) competes in the digital simulation space, where it is a leader within fluid simulation, working with ground transportation customers (96% of 2014 Sales). Engineers use EXA’s software to simulate, for example, how changes to a car’s dimensions will impact fuel economy and interior noise. PowerFLOW is EXA’s core product. The alternative to using simulation is building physical prototypes and testing them in wind tunnels. The company earns its revenue by licensing software (~85% of Sales) and by performing consulting projects for clients (~15% of Sales). Customers of fixed cost projects are generally converted to licensed software users once they understand the technology. Customers are sticky and the business is steady and predictable. EXA showed sales growth even through the recession in 2008 and 2009.

The stock has traded down from ~$16 to $10.89 after management’s decision last year to invest a higher percentage of revenue in the necessary infrastructure for growth. The company’s stock is thinly traded, contributing to the pullback. The sales force was doubled over 18 months ago. In the six months ending July 30 versus the same period last year, R&D went from 35.1% to 36.7% of revenue, G&A from 20.6% to 22.2% of revenue, and S&M from 17.1% to 17.7% of revenue. These higher costs have pressured the bottom line. This has shaken out some near-sighted investors, but has created an attractive entry point. Continue reading

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LogMeIn is Running Out of Levers to Pull to Drive Growth

I have been following this company for awhile and I think it is time to SELL – To Read Full Report Click Here: LOGM SELL

LogMeIn, Inc. Time To Sell

 Concept:

  • LOGM growth is driven by business model changes, new products, and aggressive sales and marketing spending. This has masked that the majority of the company’s services have mature or flat growth.
  • Risks related to competition are not fully reflected in stock price. Large players have established brand names and deep pockets, and free substitutes are easy to find.
  • Customers are upset and leaving because of the abrupt forced migration, price increases, and poor customer service.
  • On a P/Sales basis, the company is trading above its average premium to mature tech companies and its peers. In addition, I predict 2015 sales coming in below consensus estimates.
  • LOGM does not deserve a similar multiple to growth software-as-a-service companies, which often trade above 5x sales. LOGM is a broken growth story and sum-of-the-parts analysis justifies a lower price.

Continue reading

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CZBS, Good Company at a Great Price.

BUSINESS DESCRIPTION: Citizens Bancshares Corporation (CZBS) is a minority owned bank headquartered in Atlanta Georgia. It has 10 branches and $407mn in assets. Board member, Herman J Russell owns 29.5% of the company and other officers and directors own another 10.6%.

INVESTMENT THESIS: CZBS is a well-capitalized bank with safe assets. It should be trading close to or above its tangible book value. Instead, the companies stock is trading at 52% of tangible common equity. It has a market cap of $18.5mn and tangible common equity of $35.5mn. This is an example of a good company at a great price. It is cheap because Atlanta was severely impacted by the credit crisis, the company is underfollowed and trades OTC, and because of stagnant loan growth. An example of the on-going problems in the area is that banks seized more homes in the Atlanta area in 2012 than in any other metro area, according to CoreLogic Incorporated. Problem loans are under control at the bank, but the stock price remains suppressed. In addition to being cheap, CZBS is a good business with positive tailwinds. It has a long history of profitability including during the credit crisis. Management has been together over ten years. The new CEO was promoted from within in 2012. In addition, because of its minority owned status the bank participates in federal agency programs that reduce credit risk and offer subsidized loans. Credit quality has been steadily improving at CZBS and lately deposits have been growing too. As bad loans run off the books earnings will continue to improve. I predict EPS of over $1 next year, giving the bank an ~8x P/E ratio with still more room to improve earnings.

Fundamentals have been improving at the bank and it is positioned well for the future. The percentage of nonperforming assets to total assets has been cut in half in the last two fiscal years, from 6.17% to 2.98%. Management accomplished this by changing the loan mix away from construction, and single-family home loans. For the six month period ended June 30, 2014, non-interest expense decreased by $647,000 or 8.2%. Owner real estate owned related expenses decreased by $380,000 to $276,000 from $656,000 for the same period last year. Also, non-interest bearing deposits, the cheapest form of funding, went from $71mn to $84mn. Declining expenses have helped the bottom line. EPS was $.51 for all of 2013 and is already $.35 in the last six months. Right now, CZBS has 1.9x the regulatory required amount of capital. This is enough to guard from losses and to grow assets when the time is right. The company’s net interest margin has been compressed by low interest rates. The catalyst for top-line growth will be when rates rise and the bank can charge more for loans.

Two important items to note are that the bank has Government/TARP money in preferred shares of ($11.8mn) and a high concentration in loans to area churches ($40.9mn) and convenience stores ($9.2mn), which would be hard to resell if foreclosed. A benefit of the TARP money is that I know the bank is heavily regulated, which ensures a level of fraud protection.

A worst-case scenario for the bank would be having to charge-off all of its nonperforming assets. In that scenario it would record a loss of ~$12.5mn, decreasing TCE from $35.5mn to $23mn, which is still 24% greater than current market cap. If CZBS could earn a profit during the latest market downturn then its equity is not at a high risk of getting eaten away by operating losses. Additionally, It’s extremely unlikely that the bank will end up with a total loss on its non-performing assets. Some of the loans will be restructured; others will become OREO and will be sold. The $6.8mn of bank owned real estate appears to be conservatively valued based on LoopNet and Zillow comps. You are basically paying a discount for the company’s assets and getting all of the future earnings for free. In the current banking environment, profitable banks with healthy deposit networks and mostly clean loan portfolios are selling for at least book value. The icing on the cake is a management team that made solid investments and strategic decisions in the past, and that is incentivized with company ownership to keep doing so.

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Reflecting and Checking In

I started this blog hoping to network with other investors and to learn more about investing. It has been a success in both of those categories. It is not possible to know everything about investing, so it is important to reflect, keep learning, and refine your approach. The blog has helped me learn from previous success and yes… even failures. I have also built up my network of bloggers, professional investors, and investing enthusiasts that I speak with on a regular basis to discuss ideas. The purpose of this post is to discuss a few of the things that I have learned but more importantly to talk about where I plan on going with the blog in the future. There are a lot of micro cap companies that I want to write about going forward.

I think that I have learned the most from reading over the blog ideas that performed the worst. I stress the importance of channel checks now when dealing with small companies because you can’t count on anyone else doing it for you. Also, I now never underestimate how quickly consumer preferences can change and how quickly a competitor can sweep in and steal share in retail. Lastly, I learned not to trust that people will behave in a rational way as soon as I would like. I now spend a lot of time searching for bargain stocks with catalysts for price appreciation.

In the future I plan on writing much more about deep value micro cap opportunities. I think that it is a very under-served part of the market. I have found many interesting opportunities that fit the bill and I would like to share that information. These days a lot of people are worried about a market correction. Micro caps have only a 66% correlation with the S&P. I think it is a great time to share more info on these companies.

As a disclaimer, my blogs are just a resource of information for readers and not always a recommendation. Many ideas going forward will be companies in my tickler as good ones to follow. My favorite ideas are generally kept for work.

Thanks for reading,

Bulldog Investor

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Valmet Corp. is an Under-Appreciated Spin-off

Company Background: After a spin-off from Metso, Valmet Corporation (VALMT) was listed on the Helsinki stock exchange on January 2, 2014. The company is a global market leader, either number 1 or 2, in paper, pulp, and bioenergy manufacturing equipment. It is also the market leader in servicing all of the aforementioned equipment. The company has three segments, servicing (39% of sales), pulp & energy (35%), and paper (26%).

Investment Thesis: Sales and margins are improving and the market will eventually give the company credit for running a great business with a clean balance sheet. Price is held down by the selling dynamics impacting spin-offs, a 2013 hiccup in earnings, and negative perceptions of the paper industry. Cost cutting measures and increased sales should return earnings to previous levels, eventually leading to margin expansion.

Since 2006, the company has returned EBITA margins between 5.5% and 8%, and increased sales steadily to a peak of €3B in 2012. In 2013 sales fell by €392mm and margins fell to 2%. Paper and energy equipment sales fell short. Lower demand for newspapers drove slow paper equipment sales, and inexpensive natural gas led to fewer bioenergy equipment sales. It appears that these business lines bottomed out and are now rebounding, driven by emerging market growth. Tissue and cardboard equipment, which are also in the paper segment, remain stable growth products. The company is putting increased focus on the higher margin services business, and on much needed cost cutting. The services business had a 7.4% CAGR between 2010 and 2012. Services then grew from 34% of company sales in 2012, to 39% in 2013. More money can be made servicing the equipment than selling it. While the company has a 50% market share of installed equipment, it only has about a 14% market share in services, which is a highly fragmented space. I expect consistent high single digit growth in this space. Sales are improving. The order backlog increased from €1.9B in Q2 2013 to €2.4B in Q2 2014.

To increase margins the company is laying people off, standardizing products, and subcontracting work to low-cost countries. Close to 2,000 workers have been let go, including white-collar employees. The company has a €100mm cost savings plan that will be completed in 2014. 2013 margins were also depressed by a one time project delay in Brazil that cost the company €30mm in profit. Just these two events alone make up half the peak 2011 EBITDA of €265mm. Management has guided towards EBITA margins of 6-9% in 2015. In just the last three quarters EBITA margins have gone from -3.7% Q4 2013 to 3.7% in Q2 2014.

The company is making strides to restore margins and increase sales, but analysts have not priced in the recovery. Management is now incentivized with VALMT stock instead of Metso stock, so they will work hard to continue to produce results.

Valuation: At the current price of €8.20 per share, the company has an EV of ~€1.2B. This is approximately 6.7x 2015 EBITDA, hitting only the bottom end of analyst estimates. Assuming an 8.5x 2015 EV/EBITDA multiple, the median of VALMT’s Nordic peer companies, VALMT could be worth €10.50. 2015 Margins could come in realistically between 5.5% and 8%, and sales could grow between 3% and 10%, creating a valuation range of €9.50 to €15.50.

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Team Health Will Not Catch The Obamacare Tailwind Investors Expect.

Team Health Holdings, Inc. Short Thesis

  • The shift from a pay-for-service to a pay-for-performance business model in the healthcare industry will decrease ER visits and hurt TMH’s business.
  • Bulls believe that Obama-care will reduce medical bad debt by improving the payer mix, but the affects will be partially offset by defaults from the middle class on high deductibles.
  • TMH price hikes and the lack of doctor patient relationships concerns many hospital executives and will slow company organic growth.
  • Having an Obama-care stock play was envogue in 2014 but will lose luster.

 

Business Description: Team Health Holdings, Inc. (TMH) outsources emergency room (ER) and other healthcare services. In addition, the company provides billing and collections. Because the volume of patients in the ER is constantly changing many hospitals use outsourcers like TMH for staffing needs. The hospital only needs to supply the facilities because TMH offers a turnkey solution. In 2013, 69% of sales were from ER services, 12% from Inpatient services, and 10% from anesthesiology. 84% of contracts are based on services rendered and are dependent on collections. Most other contracts are based on hourly rates. TMH is a rollup and has been buying up other outsourcers. It was taken public by Blackstone in 2009, and it has had 12% sales CAGR ever since. In February of 2013 Blackstone finished selling its shares.

Bull Story: TMH has become a popular play on Obama-care for three reasons. The increased number of insured through Obama-care could drive higher volumes in the ER. The newly insured are more likely to visit the ER. People without insurance usually skip preventative care and go straight to the ER when their problem is bad enough. The newly insured are accustomed to taking problems directly to the ER. Lastly, bulls are expecting better collections from patients. Since a larger percentage of patients will be insured under Obama-care there could be fewer defaults on medical debt.

The stock price has gone from $12 at IPO in 2009 to $56.18, up over 360%. 2Q 2014 EPS beat consensus estimates by over 15%, with EPS of $.61 versus consensus estimates of $.53. Last quarters positive performance is attributable to 8.6% less uninsured patients during the quarter. Sixteen analysts cover the company. Fourteen rate it a buy or strong buy, and two rate it a hold.

Why It Is A Short: TMH faces many obstacles that have been overlooked by bulls. There has been a structural change in the business environment that will reduce patient volumes, and disappoint investors who are expecting growth. The government and private insurers are now focused on patient outcomes, and not just paying hospitals for services performed. TMH’s business is not suited for the current business landscape because the new goal is to keep patients out of the ER. In addition, debt collections will be hurt by the recent FICO change, and by the growth of high deductible insurance plans. It is getting harder to win new contracts because the company has a poor reputation among hospital executives. Lastly, good acquisition targets are getting more expensive and harder to find. The company has been a roll-up for years and most of the low hanging fruit acquisitions are gone. The company is also facing increased competition for deals. Competitor Envision Healthcare raised $966mm in its August 2013 IPO.

The ER is the most expensive setting for care and will be the prime target of pay for performance initiatives aimed at reducing costs and improving patient outcomes. Government initiatives link hospital reimbursements to metrics based on adherence to certain care processes, scores on patient satisfaction surveys, and patient outcomes. Medicare advantage is one such plan that now makes up +25% of medicare plans provided. Private insurers are beginning to collaborate with hospitals. These insurers could potentially steer customers to specific hospitals that provide the best value to patients. This creates an incentive for hospitals to be efficient. Also, insurers use algorithms to track when patients are likely to go to the ER. Case managers can then call the patients to steer them towards preventative care. It is clear that all this will negatively impact TMH growth.

Because of the increased costs of insurance the number of high deductible plans is increasing. Large employers are projecting a 6.5% increase in health-care costs in 2015 and that is on top of a 7% increase in 2014. To share the burden with consumers, employers are offering high deductible plans. In a recent National Business Group on Health survey, 81% of corporations plan on offering a high deductible plan in 2015 and one-third of companies plan on only offering such plans. In addition, FICO recently made a methodology change to its credit score calculation that has not received much attention. The change will improve the credit score of the average person with late payments on medical debt by 25 points. These two factors will lead to more uncollectible accounts among low-income and even middle-income consumers.

Once a hospital decides to outsource its ER, the hospital becomes dependent on its outsourcing company. It is not easy to bring an entire ER room staff onboard at once. TMH has used this dependence to increase its prices. Hospital executives have become weary of outsourcing and TMH has earned a poor reputation. Robert McNamara, M.D., past president of AAEM, thinks that hospitals should have learned there lesson years ago when they started buying private practices and it didn’t work. “They saw drops in productivity and commitment because the doctors no longer had an ownership stake.” I predict that organic growth will slow down at TMH.

TMH trades at 16.3x ttm EV/EBITDA, which is nearly twice what an efficient hospitals multiple would be. The two multiples should be similar but with a small premium given to TMH for growth. The company will continue to grow, but I think that it will disappoint bulls expectations. The company is facing major headwinds that bulls are not factoring in. Public and private insurers are focused on bringing down the number of ER visits. The payer mix benefits that bulls are waiting for will also have negative impacts as people begin to default on deductibles. Lastly, organic growth is now harder because TMH has a poor reputation among hospital executives. I predict a 30% downside in the next 6-18 months

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Investment Results Over Last 12 Months Look Good!

I have recommended seventeen stock positions in the last year and I wanted to go over the results. It has been a successful twelve months, especially when factoring in that most of my blogs were written in the last six months. The average position has been in my portfolio for less than 5 months, with a total return on investment of 17.4%. Extrapolating these returns on a full 12 month basis would mean returns in excess of 40%. 10 recommendations have been short sales, and 6 have been longs. In my portfolio, I have never had more than 35% in short positions. It just turns out that over the last year the majority of the best investments that I found were shorts. In the last year my personal portfolio is up over 45%. I hope to keep the good ideas coming, and I will continue to post blogs. I have been thinking of closing several of my recommendations, and there are many more stocks that I have been monitoring to invest in.

To view full results click here: Results

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Parked in Cash but Will Keep Blogging Ideas.

I apologize that I have not updated the blog recently. The truth is that I am bearish right now, which is evident by recent sell posts. I do have a few long ideas that I will share soon, but right now is a good time to have money parked in cash. In addition to my job and blog, I have started writing company reports for SmallCapIR. I release reports periodically, and I will start including those on the blog as well under the category – Published Reports. These new reports will be a little bit longer 3-5 pages, and I will write them in weekend. I usually follow a stock a bit longer before blogging about it.

Updates are coming soon.

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