The Rational Cloning: Weekly Ideas #24
Voss Capital Q4 2021 Letter; LRT Capital January 2022 Update; Clark Street Value on Bally's Corp, Armstrong Flooring, and ALJ Regional Holdings
Welcome to the 24th edition of the Rational Cloning Newsletter (Weekly Ideas Series).
Helping you discover the best ideas of others.
Happy cloning.
Weekly Investment Ideas
(1) Voss Capital Q4 '21 Letter
Our portfolio as of the date of this letter reflects this extreme pessimism and, in our estimation, has never been cheaper on a historical basis.
28% of our long book is under 6.5x earnings
28% is in between 6.5x-10.0x earnings
33% is at all-time low valuations (on the relevant metrics) including March 2009 and March 2020
> 40% have at least a 10% FCF yield, with many exceeding 20% yields despite limited-to-no leverage
Median/Average revenue growth rate of 11% forecasted for 2022
a. Avaya Holdings Corp. – AVYA
Avaya is an American multinational technology company headquartered in Durham, North Carolina, that specializes in cloud communications and workstream collaboration solutions. Avaya is a “legacy” tech player undergoing a material business model transition from perpetual license and maintenance to a cloud and subscription model. The company has amassed a giant enterprise customer base in their Telephony (100 million seats) and Contact Center (6 million seats, ~40% global market share) businesses. Avaya is working to rapidly convert these customers to a subscription model while also moving as many as possible to public and private cloud infrastructures.
Our thesis is that the company's inflection toward rising overall revenue growth and rising free cash flow margins simultaneously (what we refer to as “Voss Sauce”) will begin to kick in during the back half of 2022 and accelerate into 2023.
AVYA currently trades at 1.2x sales, 5x EBITDA, and 4.5x earnings. By the end of the year, they will be trading at 4x their subscription base, growing 70%+, with zero value ascribed to the remaining $2 billion in revenue. We have a $30 price target (134% upside) based on fiscal year 2024 numbers, which assume 10x FCF, 7.5x EBITDA, and 3x subscription revenues (<2x overall revenues). We hope this target will prove to be quite conservative as Avaya’s narrative changes from that of a market share losing legacy dinosaur to one of the growing, niche-dominating SaaS leaders.
b. Olin Corp. – OLN
Olin is a multi-segment business, with two segments in the chemicals industry (chlorine, caustic soda, and epoxy production) and a small segment in the ammunition industry. Unlike many chemical companies, we believe Olin has a few idiosyncratic catalysts that can potentially make the stock a core-sized position for us.
We believe these catalysts over the next 2-3 years, along with a smoother earnings trajectory and massive share buybacks/deleveraging, will result in a rerating of the stock closer to the 8x EBITDA multiple CEO Scott Sutton’s previous company Celanese (CE) now enjoys. Olin currently trades at under 5x NTM FCF and has guided towards a 20% FCF yield for the next five years with over 40% of FCF going towards share buybacks. Our price target of $100 is based on 10x 2022-2025 earnings.
c. Asbury Automotive Group, Inc. – ABG
Asbury Automotive is an auto dealer that we purchased recently at ~5x earnings and free cash flow. We believe the stock’s value has been partly obscured by their recent acquisitions along with auto dealers having derated significantly over the last few months due to perceived fears of "over earning" in 2021 and 2022, as average profit per car has shot up due to supply constraints. We have constructed a framework of "normalized earnings" for 2023 and concluded that ABG trades at ~7x earnings versus a historical range of 7-15x, or around 11x on average. We thus believe the stock can rerate to 11x normalized earnings, or around 40-50% higher from our purchase price of ~$160. Downside should be limited given the company's very depressed multiples, although we will be watching for an acceleration of rates raising which could whack what is currently pent-up demand for vehicles.
d. ArcelorMittal – MT
ArcelorMittal is a global integrated steel producer trading at around 2x EBITDA which will likely generate over 50% of their market cap in free cash flow in the next 8-10 quarters. This is after a period of substantial deleveraging which now allows the company to use FCF primarily towards share buybacks. We also believe the company’s numerous joint ventures have an underappreciated $10+ billion of value. When accounting for this, we believe MT is even cheaper on a price/tangible book basis (~0.4x).
If the company can simply maintain its multiple while returning most, if not all, that FCF to shareholders in the form of buybacks, we believe 50%+ upside is conservative. Given the company's deleveraged balance sheet, even if steel pricing and profitability decline materially, we believe the downside will be limited as historically MT trades in a range of 5-7x EBITDA versus the current 2x.
e. US Home Repair & Remodeling (R&R) Related Stocks
We believe our portfolio remains positioned to capitalize on robust R&R trends. Many of the related securities are at or near all-time low valuations, such as building products distributor BlueLinx (BXC), which continues to regularly exceed earnings expectations by upwards of 100% and trades for less than 2.5x our 2022 EPS estimates. The vast majority of the company’s earnings are coming from its more stable and higher margin Specialty Products segment. We believe the housing market’s fundamentals and supply/demand picture have rarely been stronger in all of modern history, underpinned by a historic lack of inventory and record low vacancy rates across both single-family homes and multi-family.
We believe housing-related securities such as BXC are poised to continue seeing upwards earnings revisions and multiple re-rating higher from distress levels, as they scale a gargantuan wall of worry. Assuming BXC’s commoditized lumber segment, Structural Products, sees a sharp revenue drop and reverts to 8% gross margins (from the 20%+ guided to for Q1), and the company trades at an extremely discounted multiple of only 8x earnings, we believe the stock still has ~140% upside.
(2) LRT Januray 2022 Update
a. HXL: Lightweight Materials for Modern Applications
Hexcel is the world’s leading manufacturer of advanced composite materials.7 The company produces lightweight materials, and engineered products for a wide range of applications across several industries. These industries include aerospace, automotive, recreation, industrial, and clean energy.
The largest industry by measures of revenues for Hexcel is the aerospace industry. Hexcel creates lightweight materials for commercial aircrafts, military aerospace, and spacecraft applications including structural components, lightweight wing components, turbofan engine blades, and much more. In fact, Hexcel’s two largest customers by revenues are Airbus and Boeing.
Hexcel is a wide moat business, with a fortified position in the aerospace and defense sector. The business benefits from barriers to entry stemming from regulatory hurdles such as FAA55 certifications for their products. These certifications are difficult, and very time consuming to obtain.
Hexcel is one of the few COVID “reopening” stocks that is still trading meaningfully below its pre-Covid peak. We believe that the market does not fully appreciate how fast Hexcel’s business can improve once aircraft production rates improve. Given the company’s operating leverage, profits are likely to improve dramatically over the next few quarters, as the aerospace OEMs continue to ramp production back up. Airbus continues to be Hexcel’s largest customer and the company has recently announced increased production rates for its most popular planes.
Top ten positions:
Domino's Pizza, Inc. (DPZ)
Marriott International, Inc. (MAR)
Repligen Corporation (RGEN)
Extra Space Storage Inc. (EXR)
Hexcel Corp. (HXL)
Watsco Inc. (WSO)
Texas Pacific Land Trust (TPL)
Asbury Automotive Group, Inc. (ABG)
Progressive Corp. (PGR)
Colliers International Group Inc. (CIGI)
(3) Clark Street Value
a. Bally's Corp: Standard General Go-Private Offer
Bally's Corporation (BALY) is the old Twin River Worldwide Holdings (old ticker, TRWH) that began with two casinos in Rhode Island, then really starting in 2019 through an aggressive series of complicated acquisitions created a sprawling omni-channel gaming company that appears well positioned to benefit from the long term growth in iCasino and online sports betting. The architect of this transformation is Soo Kim of Standard General, he is the Chairman of the Board and his investment firm owns more than 20% of the shares. On 1/25/22, Standard General submitted a non-binding offer to buy Bally's for $38 per share (shares trade for $35-$36).
If we back out the corporate expense on the above for an apples to apples with the Q3 numbers, we get $317MM versus the $359MM (post rent) done in Q3, for simplicity, let's just say normalized is somewhere in between there, an average would be $343MM. Add Gamesys (pretty consistent grower over time) and subtract the corporate expense gets us $633 of EBITDA against a $5.9B EV (using 68 million shares, $3.445B of debt excluding capitalized leases) for an 9.4x EBITDA multiple (or a 14% levered FCF yield using management's estimate) that gives no value to the mobile app opportunity in the U.S. (currently loss making). Again, there are a lot of moving parts, I could be wrong, please double check, but I think that's a pretty reasonable price to pay for a company that is potentially in play and/or at an inflection point in their business model.
b. Armstrong Flooring: Distressed Situation, Pursuing a Forced Sale
This is potentially a horrible idea, it is only a teeny tiny tracker position, it could go to zero, but I wanted to throw this out there in case others know more about situation and are kind enough to share.
Armstrong Flooring (AFI), the 2016 spin from Armstrong World Industries (AWI), designs and manufactures resilient flooring products and sells through distributors or you might walk by their vinyl tile displays in big box home stores like Home Depot. Armstrong is a recognizable name but they're much smaller than market leaders Mohawk (MHK) and Shaw (owned by BRK), since the spin they've had a challenging time and now due to covid supply chain disruptions and resulting inflation (some of their raw material costs are up 100%), find themselves on life support.
The company has tried to implement price increases to offset inflation but seem to be a step behind resulting in gross margins being squeezed to near zero and the company burning cash. Their term loan lender, Pathlight Capital, recently extended Armstrong Flooring another $35MM to repay their ABL facility and shore up the near term balance sheet. A stipulation of the term loan amendment was the company has to try to sell itself ASAP.
While the company is bleeding cash, the balance sheet doesn't look terrible, they own almost of their real estate and manufacturing facilities. Last March, they sold one of their production and warehouse facilities in South Gate, CA for $76.7MM (likely the one with the most significant value) which they partially used to pay down debt and then burned through the rest. I read a comment somewhere that this company is great at selling assets, but not running the company, back in 2018 they sold their wood flooring segment for $90MM or 7.2x segment EBITDA at the time. They went on to use most of the proceeds to do a Dutch tender offer at $11.10/share, the stock trades below $1.50/share today.
c. ALJ Regional Holdings: Partial Liquidation Below Proforma NCAV
ALJ Regional Holdings (ALJJ) is likely a familiar name to many readers (and thanks to those that pointed it out to me), it was an NOL shell that Jess Ravish (former Drexel, Jefferies and TCW executive) used as a holding company to buy and sell several various unrelated businesses over the last 10-15 years to soak up the tax assets. The vast majority of the NOLs expire in 2022. It has functioned as Ravich's mini-PE fund, he owns ~47% of the stock (management owns 56% as a group). As of 9/30/21, ALJ had two operating businesses: 1) Faneuil, a business processing outsource provider and; 2) Phoenix Color, a specialty book printer that manufactures education materials, heavily illustrated books, etc.
The main reason the stock is cheap is Jess Ravich, the market doesn't trust him, one good example is he participated in a financing round during covid and got convertible debt at a $0.54 conversion price that PIKed for a year (further diluting minority shareholders) before it was amended. Another is he's also been facing legal trouble over the last few years regarding his time at TCW. Now that the NOLs are burned off and/or expiring, maybe he no longer wants to deal with public shareholders and uses the cash proceeds to take out the minority shareholders. There is precedent, he did a large cash tender back in 2012 following the sale of a business, the Alpha Vulture blog covered it well back then.
Full disclosure, my cost basis is closer to $2.10, the stock ran up last week and I didn't have time to write it up but still think the shares are pretty cheap.
Tweets That Make You Go… Hmm 🤔
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