The Rational Cloning: Weekly Ideas #22
SRK Capital H2 2021, Greystone Capital Q4 2021 Letters, Alta Fox Works to Free Wizards
Welcome to the 22nd edition of the Rational Cloning Newsletter (Weekly Ideas Series).
Helping you discover the best ideas of others.
Happy cloning.
Weekly Investment Ideas
(1) SRK Capital H2 2021 Letter
The second half of the year was not kind to us. Partly due to a failure by me to capitalize on stretched valuations on some of our holdings during the summer months, supply chain/inflation concerns, and indiscriminate selling. Losing money never feels good, as one of the largest investors in the fund with my entire liquid net worth invested, I eat my own cooking.
a. Harrow Health Inc. (HROW)
Harrow Health was introduced in our previous letter. Harrow is underfollowed, misunderstood, and has been the victim of indiscriminate selling recently (Harrow was added to the Nasdaq Biotechnology Index which is down about 20% over the past few months; Harrow is far from a biotech company).
The company’s subsidiary, ImprimisRx, is the leading compounding pharmacy in the ophthalmology industry. Their top products are combination eye drop solutions for pre and postoperative cataract surgery. ImprimisRx’s solutions provide a win-win outcome for the practitioner and the patient…
Currently, 1 out of every 5 cataract surgeries in the US use ImprimsRx’s products and I believe the company is on a path to increase their penetration through highly accretive acquisitions and partnerships that will be plugged into their distribution network on top of double-digit organic growth. In the most recent quarter, Harrow Health grew revenue 30% year over year. On a two-year basis they have increased revenue by 47%. Yet, as of recently shares can be had for the same price as two years ago.
Harrow Health is profitable and has high amounts of operating leverage. I believe the business is trading for about 10x free cash flow.
b. Tile Shop Holdings Inc. (TTSH)
The Tile Shop reported its best third quarter in company history with a 13% increase in net sales to over $92 million as demand has continued to remain elevated with an incredible strong order book.
In my previous letter to you I mentioned: “What to do with the cash? If history is any indication of what Peter Kamin controlled companies do, we can speculate that there is potentially a return of capital in shareholders future.” That speculation turned out to be correct as the company declared a special dividend of $0.65 per share, close to our average purchase price in 2020. The thesis for TTSH has played out wonderfully over the past two years.
The final piece of the puzzle will be an entire sale of the company, and even though I do believe the company will eventually be sold, I have been reducing the size of our position to put the capital to use in what I believe are better risk/reward opportunities.
c. Nocopi Technologies Inc. (NNUP)
As disappointing as the quarter was, the company was still able to maintain positive cash flow and add to the cash on its balance sheet. The company’s largest licensee, Bendon Publishing, has recently introduced new products under its Imagine Ink line that includes six mini markers and 4 additional pages.
I believe the company is selling this product at a 24% price increase versus the older format, which should increase royalties to Nocopi. Despite the issues that Nocopi is facing on the shipping front, there has not been long-term impairment to the attractive economics of the business. Those attractive economics have attracted a collective of quality investors taking interest in the company.
For years I have asked the company to hold an annual meeting only to be met with another year go by without one. I have mentioned to the company that someday someone is going to come knocking and not be as patient as me. That day has come, and activists have demanded for an annual meeting to be held with a proper election of directors.
Nocopi has pulled the same card they did against me previously by promising a meeting and changing the bylaws of the company in order to entrench management. The CEO doesn’t realize that he would not be in this situation if he would have put shareholders’ interests above his own. For a company that requires minimal capital in its business with multi-year contracts, return of capital to shareholders is a value enhancing no-brainer. In fact, the company should borrow as much money as possible and return that capital to shareholders as well.
d. Mount Logan Capital (MLC.NE)
Mount Logan Capital is a new holding. The company is an alternative asset manager listed on the NEO Exchange in Canada. Over the past two years Mount Logan has transformed itself from a company that managed investments on its own balance sheet to a credit asset manager of mostly permanent capital vehicles with highly stable management fees.
The company should be 5 closing in on $3 billion of AUM, broken down into three categories of institutional, retail, and the recently acquired insurance operations. The insurance business gives Mount Logan a path to accelerate organic growth of AUM which in turn drives growth in fee related earnings (FRE).
I estimate the business is trading for a mid-single digit multiple of free cash flow; similar companies trade for double digit multiples due to the highly valued management fees. Looking forward, as cash flow from their acquisitions start to show in the financial statements, I believe the market will begin to realize how undervalued the stock is. The management team, led by Ted Goldthorpe, has a strong track record of managing assets throughout multiple credit cycles and has already shown through the Portman Ridge BDC that they can create value as a manager. I expect we will do quite well over time as shareholders of Mount Logan Capital as the company continues to grow organically and through acquisitions.
e. Reitmans Canada Limited (RET-A.V)
Reitmans is a new holding entered during the second half of the year. They are a Canadian apparel retailer that has recently exited CCAA (a pre bankruptcy process). The company successfully used the CCAA process to shed 170 stores (and lease commitments), focus its operations, and settle liabilities. They emerged with a net cash balance sheet, owned real estate worth ~$140 million, a $115 million credit facility, profitable stores, and streamlined operations.
The company currently operates 412 stores under three banners throughout Canada: Reitmans, Pennington's, and RW&Co. These banners have been steadily profitable over the past two quarters with sales and profits consistently above forecast. In the 39 weeks ended 10/30/21, the company generated $71.4 million of adjusted EBITDA. They have likely ended 2021 generating over $100 million of adjusted EBITDA.
These numbers are understandably unrealistic going forward due to the one-time nature of consumer purchases as covid restrictions were being relaxed in Canada. On a conservative analysis taking historical numbers into account, I believe the company can generate at least $40 million of adjusted EBITDA and $20 million of free cash flow going forward. This is on an enterprise value of less than $100 million when adjusted for the likelihood of an increased cash position from the holiday quarter. Therefore, it is safe to assume that the company is trading at less than 5x free cash flow.
The company is majority controlled by the Reitman family and I imagine the CCAA process has intensified their interest on maximizing the remaining value of the company through prudent returns of capital. In 2019, they repurchased 14.5 million shares for $43 million (an average price of about $3/share). I expect the company to reinstate the dividend later this year and begin share repurchases.
(2) Greystone Capital Q4 2021 Letter
a. RCI Hospitality (RICK)
The company’s Q4 2021 and FY21 earnings release reflected record results and the business continues to execute tremendously well, posting record revenues, EBITDA and free cash flow for the year. Bombshells early progress has been exceptional and is on track to $100mm in revenues over the next few years followed by operating margins in the 18-22% range.
During the year end call, management outlined the current free cash flow profile whereby the company is doing $1 million per WEEK after debt service, all of which is before their recent 11-club acquisition (which should meaningfully add to EBITDA and free cash flow) and future club M&A.
Management took an incredibly bullish stance during the Q4 conference call about their ability to continue to grow organically, reinvest cash flows and execute further M&A, while pointing to a FY22 run rate of $100mm in EBITDA. RICK’s current market cap is below $600mm.
b. 1847 Goedeker Inc. (GOED)
Following a year that was marked by inflationary concerns, raw material price surges and supply chain issues, Goedeker achieved record results as a newly combined entity between Appliances Connection and legacy 1847 Goedeker. I say record year in terms of total revenues, revenue growth, margins and profitability.
Goedeker’s scale, product offerings, logistical capabilities and SEO expertise puts them miles ahead of smaller mom and pop e-commerce operations and will provide significant revenue and margin opportunities moving forward. The current valuation remains head-scratching as none of the above is being reflected in today’s share price. Additional research can be found here.
c. PARTSiD Inc. (ID)
As disclosed to you via email during Q2, we currently hold a position in PARTSiD Inc., which is attacking head on the problems of ‘fitment’ and the friction of shopping digitally in the aftermarket auto accessories category. PARTSiD is an auto parts retailer that operates primarily via e-commerce channels and is focused on taking share from independent retailers and brick and mortar incumbents by serving what the company calls the aftermarket ‘wants’ segment of the industry… I don’t believe many of the attractive aspects of the business nor the potential future value creation are being accurately reflected in the price.
d. Houghton Mifflin Harcourt (HMHC)
During the quarter we entered into a core position in Houghton Mifflin Harcourt, a small cap education company undergoing a strategic business shift set to enhance their customer captivity, value prop and margin profile.
Moving forward, I’m confident that HMHC will be able to effectively deploy future cash flow into sales resources, product development, share repurchases and potential tuck-in M&A to further drive value. We should continue to see very strong results over the next few years, and there are multiple avenues to do very well owning our shares especially given our purchase price of what I estimate to be a single digit multiple of normalized free cash flow. I look forward to providing more detail about this investment in future letters and potentially adding to our position should the opportunity present itself.
e. IDT Corp. (IDT)
My prior comment on owner-operators is fitting, as during the quarter we entered into a core position in IDT Corp., a founder-led company with an incredibly strong history of value creation and multiple catalysts on the horizon for potential share price appreciation.
IDT is a telecommunications company with zero comps that is both misunderstood and overlooked as a confusing, slow growing secularly declining telecom business that pays no dividends and has unappealing historical financials. IDT is not for the industry specialist crowd, wouldn’t make sense for quant or momentum strategies, isn’t included in any passive indices and has a market cap below $1 billion with 70% of the voting power held by insiders.
This leaves the small group of active small cap investors as the only participants who might be interested in analyzing IDT. Throw in the fact that management participates in one investor conference per year and has done little to gain research coverage for IDT or any of their subsidiaries, and there is the potential for mispricing here. These factors along with the recent market selloff have caused IDT to appear undervalued looking a few years out, using conservative business assumptions. Until recently, I was among the group described above, as studying IDT took some getting out of my own way to appreciate.
As mentioned above, valuing IDT’s growth subsidiaries has typically required a revenue multiple approach given they are in growth mode and thus reinvesting (as they should be) while generating slight operating losses. Utilizing conservative revenue multiples below peer valuations despite the competitively advantaged aspects discussed above would yield a share price of around $60 by 2023, or 70% higher than the current price. I stress the word conservative given the lower than peer multiples, exclusion of Mobile Top Up optionality, and a low multiple of EBITDA for Traditional Communications while assuming zero growth in cash flow from today.
Adding up the 2026 valuations described above would yield a share price of $75/share or greater than 100% upside from today’s price. Keep in mind this excludes a breakout of Mobile Top Up, as well as reduces cash and investments to $20mm, setting aside $125mm for potential damages relating to IDT’s ongoing lawsuit with Straight Path Communications (touched on below).
IDT was also mentioned in Alta Fox’s letter back in Weekly Idea Issue: #20.
(3) Alta Fox (Activist Position)
a. HAS (Hasbro, Let Wizards Go.) Presentation
We believe HAS can trade to >$200/share by 2024 (base case), representing >100% upside from the current price.
(1) In our view, Hasbro’s stock trades like a slow-growth consumer toy business, but the majority of its value is in a poorly disclosed segment, WOTC, which in FY21 grew revenue 42% with 47% EBITDA margins.
In our view, this is an incredible and misunderstood asset with a long growth runway that is worthy of a premium valuation multiple.
(2) WOTC has not been given the respect it deserves from investors primarily due to a systematic lack of disclosure.
Despite growing organically from ~20% of Hasbro’s EBITDA in 2016 to ~50% in 2021, Hasbro only started reporting revenue and EBITDA for this segment in February 2021 and continues to refuse to publish important KPI’s. Moreover, we believe Hasbro has shackled WOTC by running the segment as a cash cow, limiting its internal reinvestment opportunities and diverting its cash flow to invest in margin-dilutive Hasbro-related business lines.
(3) The RemainCo (Consumer & Entertainment divisions) focused “Brand Blueprint” strategy has failed to create value for shareholders. It seems to have served as little more than a cover for “empire-building” without financial discipline, yet Hasbro’s out-of-touch Board of Directors (the “Board”) continues to double down on the strategy despite its poor performance.
Hasbro’s Board is almost exclusively composed of toy and media executives, even though over half of the company’s value is now derived from WOTC.
Board members have presided over a long period of underperformance and questionable capital allocation decisions.
(4) Alta Fox believes Hasbro should immediately pursue a tax-free spin-off of WOTC which will maximize shareholder value, lead to improvements in capital allocation at both WOTC and the remaining company, and result in 100%+ upside over the next three years.
Extensive conversations with ex-employees, gaming experts, and the broader WOTC community has made clear that there are no material synergies between WOTC and Hasbro that justify shackling this gem asset within the larger conglomerate
I’m keeping an eye on this one- could be an interesting coattail idea.
Tweets That Make You Go… Hmm 🤔
ICYMI, we published a Mosaic Musings earlier this week on the disinflation vs. inflation debate. Check it out:
Check out previous issues of Weekly Ideas👇
Weekly Ideas #20: Greenhaven, Alta Fox and Maran Capital's 2021 Q4 Letters
Weekly Ideas #19: Baron on Real Estate, Nitor Capital on VST, CF, JOE
Weekly Ideas #18: Upslope Capital & Alluvial's Q4 2021 Update, Kuppy on Oil, Pete Panda on Tin