Synergetics CVR expires worthless

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Earlier this year I wrote happily how the Casa Ley CVR that was issued in 2015 in connection with the Safeway merger was going to pay out. Another CVR that I acquired in the same year, when Synergetics USA was bought by Valeant Pharmaceuticals (now know as Bausch Health Companies), didn’t have a happy ending. The CVR had some milestones related to product sales from the effective date of the merger till 30 June, 2018, and apparently those weren’t met. I didn’t see a SEC filing or press release about it, but only noticed the disappearance of the CVRs in my brokerage account. Of course, a bit of a disappointing outcome, but not really surprising considering how Valeant imploded almost directly after finishing the acquisition.

Disclosure

No positions anymore

XPEL: anything but your classic value stock

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Some stocks are well known in value investing circles, even though they are anything but a classic value stock. XPEL, Inc. (CVE:DAP.U), a company specializing in paint protection films for cars, has been written up twice on VIC, once in 2013 and again in 2015. There is a long thread about it on CoBF, people write about it on Twitter and there are plenty of articles on SA as well. With a market cap of ~$185 million XPEL is a tiny company, but it is remarkable well-known in certain circles. But with the stock trading at a 37x P/E and 10x P/B-ratio while it’s up almost 400% this year it sounds like an unlikely candidate for me to investigate.

Share price: $6.54
Shares outstanding: 27,612,597
Market cap: $180.6 million
Enterprise value: $180.9 million
P/E (ttm): 37.1
EV/EBITDA (ttm): 20.8
P/B (mrq): 10.0

Financials

Based on these simple metrics above XPEL is anything but cheap, but what this doesn’t show is the extremely impressive growth the company has been experiencing. The company had revenues of $6.0 million in 2011 while revenues for the last three months alone were a whopping $28.9 million. That’s a compounded annual growth rate of more than 50% for six and a half years straight! Even more impressive is that all this growth was accomplished with almost no increase in share count, minimal debt levels, and while fighting a lawsuit against 3M (settled last year). An overview of the historical income statement is shown below:

While these numbers are pretty impressive, the last two quarters have been even better: revenue grew in the first half of 2018 with more than 80% compared to the first half of 2017, while realizing a 3 percentage points higher gross margin. And too be honest, that was about time. Because despite the impressive growth the past years, the operating profit of the company was a bit disappointing. In 2013 the company earned about $2 million on $18 million in revenue, and 4 years later it was still earning $2 million on $68 million in revenue. Growing revenue is great, but in the end it’s about earning money. But once you have a lot of revenue, increasing your margins a little bit does wonders for your profitability.

Valuation

Valuing a growth company is never easy, but in my experience they are usually so expensive that no matter what kind of model I produce, I have a very hard time justifying the current share price. So I (almost) never end up buying anything that can be classified as a growth stock. But with XPEL it’s remarkable easy. We don’t have to make a fancy model that projects (high) growth rates a decade forward. Really all that is needed is to assume that the company can grow revenues by 35% for two years in a row while maintaining its current gross margin. Considering the historic growth I think that’s a pretty low hurdle to jump over. I have no idea how far growth can continue, but if you can grow for 6.5 half years at more than 50%, while growing at 80% in the last half year, I’m sure there must be quite a bit of runway left.

Asumme at the same time that there is a bit of operating leverage in the “Selling, general and administrative costs” and that these will grow a bit slower than revenues at 25% and the following picture is painted:

With the stock currently trading at $6.54 that means that you can buy this rapidly growing company at just 10.8 times its earnings in two years time.

Insiders

What I like about XPEL is that insiders own a decent chunk of the company. The CEO owns 5% of the outstanding shares while various members of the board of directors own another 35%. Surprisingly enough, the company doesn’t pay its executive officers with options. The number of outstanding shares increased with 7% since 2012, from 25.8 million to 27.6 million, but not from options or other share based compensation. The reason for the increased share count was a private placement in 2017 at $1.43/share (then the current share price). Most of the shares in the private placement were issued to certain directors and officers of the company, and in hindsight these were for sure issued at an opportunistic time, just before the settlement with 3M. It leaves a bit of a bad taste in my mouth because there didn’t seems to be a pressing need to raise cash at the time. At the same time, I wouldn’t be complaining if the company would have paid twice the amount in share based compensation throughout the years…

Conclusion

Some people think that as a value investor you have to buy stuff like net-nets and stocks trading at a single digit P/E-ratio. While I often like companies like that, the only thing that matters is whether or not something is cheap. Sometimes a stock trading at a single digit P/E-ratio is expensive if for example bankruptcy is around the corner, and sometimes a stock trading at an almost 40x P/E ratio is cheap if revenues are expected to grow explosively. I think XPEL is one of those stocks. How fast it is growing is really amazing, yet the stock is surprisingly affordable.

Of course, it’s not without risks. There are all the “normal” risks like growth slowing because of higher market penetration or a downturn in the economic cycle and people stop buying cars. But I think the biggest risk is basically that this is more or less a one product company. They are growing fast because they have a great product (their ultimate paint protection film was introduced in 2011). I don’t have a car, so I don’t really know how useful it is, but the numbers speak for themselves. But what happens if some company, lets say 3M, creates a superior product? Can they still thrive, or would business slowly deteriorate until nothing is left? That’s the big question. If you pay a high price you not only need XPEL to grow the coming years, it also needs to be a good business 10 years and probably 20 years from now. A lot can happen in such a timeframe.

That said, I couldn’t resist picking up some shares. I don’t think XPEL is a sure thing (it never is), but at the same time it’s just too cheap to ignore considering the absolute fantastic growth.

Disclosure

Long XPEL

Comtrex Systems merger completed

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Last Friday, the merger between Comtrex Systems (OTCMKTS:COMX) and Zonal Hospitality Systems closed. When I wrote about the  company the stock was trading at $9.40/share while the merger consideration, according the press release, was GBP 7.46/share (after a bit of a negative FX movements currently worth ~US$9.70/share), but subject to certain adjustments. My guess was that these adjustments were most likely some kind of price adjustment based on the net working capital balance at the time of the merger closing. While that proved to be true, the specific implementation in this case was not very favorable for shareholders.

When the proxy statement was released it became clear that the adjustment could only be made downwards, not upwards, and a large part of the consideration will be held in escrow for two years. Of the total payment of GBP 12,300,000 a hefty sum of GBP 2,000,000 will be held in escrow for two years while GBP 150,000 is earmarked to fund costs of the stockholder representative. The initial payment is going to be $8.02/share while another $1.58 might be coming in two years time, and it’s probably going to be a safe bet that the money earmarked for the stockholder representative will never be paid out. We will have to wait a long time before knowing how this deal will work out exactly, but we can unfortunately be pretty sure that it’s not going to be great. Even if the full escrow is released, and that is a pretty big if, we would be looking at a mediocre internal rate of return because of the long escrow period.

Disclosure

Author is technically still long COMX

Half-year portfolio review, 2018 edition

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With June behind us it’s once again time to see how my portfolio has been performing so far this year. It’s getting repetitive, but there is little I can complain about given the double digit return and the solid outperformance compared to the MSCI ACWI. With global equity markets going up year after year, I started investing at a very favorable moment, and I absolutely don’t expect that I’ll be able to keep generating performance numbers like this in the future. At some point some negative return numbers are probably going to be mixed in the list, and that would evaporate a (potentially large) part of the current compound annual growth rate.

Year Return* Benchmark** Difference
2012 18.53% 14.34% 4.19%
2013 53.04% 17.49% 35.55%
2014 27.72% 18.61% 9.11%
2015 20.23% 8.76% 11.47%
2016 43.58% 11.09% 32.49%
2017 30.12% 8.89% 21.23%
2018-H1 12.06% 2.40% 9.66%
Cumulative 483.20% 114.66% 368.54%
CAGR 31.16% 12.47% 18.69%

* Return in euro’s after transaction costs, dividend withholding taxes and other expenses
** Benchmark is the MSCI ACWI (All Country World Index) net total return index in euro’s

As you can see in the performance attribution graph below, a large part of the return can be explained by just a couple of positions. Especially HemaCare has been a driving force behind my portfolio thanks to a 155% gain in share price. Conduril and Viemed Healthcare also contributed nicely, but the rest of the positions were a mixed bag with small losers and winners.

The contribution to the portfolio of the special situations with 259bps doesn’t look bad, but is actually a bit disappointing. In the first half of the year I had a couple of nice situations play out such as the Casa Ley CVRs (contributing 59bps), a BINDQ liquidation payment (contributing 67bps) and the Tejoori liquidation (contributing 86bps). Unfortunately lots of the gains inside the special situations bucket were offset by a couple of deals that went sideways. The biggest one was the Rosetta Genomics merger that failed spectacularly, causing a 207bps loss. Another (undisclosed) merger subtracted 87bps from the performance while some other deals also generated small losses. Hopefully things will turn around a bit in the second half of the year.

The composition of my portfolio doesn’t contain any big surprises. It’s a fairly standard (for me) split between long-term value stocks and special situations. The observant followers of this blog will notice that there are in the overview above a couple of positions I haven’t blogged about previously. One of them is Scheid Vineyards, a name you might have heard before. I used to own a single share just to keep track of the company, but after reading the latest letter to shareholders my interest was piqued again.

This year the company managed to rezone about 130 acres of farmland bordering the city of Greenfield into commercial and residential land. They are planning to sell this the coming years, and will probably realize a handsome profit on it. They also got their vineyards and winery appraised earlier this year for $190.5 million while the company has a market cap of just $80.4 million. There is a lot of debt that needs to be taken into account as well, but there are also other assets such as the 130 acres mentioned earlier, and a large wine inventory. All-in-all I believe that the intrinsic value of the company is more than twice the current price, which makes it a pretty sweet deal in my book.

Disclosure

Author is long everything in the portfolio overview

Exited Deswell Industries after six years

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Deswell Industries is one of my longest held stocks. I bought my first shares more than six years ago on March 6, 2012 and sold my position last week after reviewing the latest annual results. The company isn’t exactly expensive, but it’s not longer a net-net since NCAV is $3.13/share while the current price is $3.25/share. If we take the value of all non-operating assets, and slap a 8x multiple on last years operating earnings we get a very similar value of $3.18/share. So right now Deswell isn’t expensive, but probably fairly valued, and after more than six years I think it’s time to move on to something else. I have always been a bit hesitant to sell this stock because of the years of continues insider buying which at some point in time will probably culminate in a going private transaction. But I don’t have unlimited patience…

Deswell Industries went up 53% in the more than six years that I held the position, and while that is not bad, you would expect a mediocre annualized return. But thanks to all the dividends ($1.04/share in total!) that the company paid in the meantime the internal rate of return was actually a pretty satisfactory 15.10%. Better than I expected before I did the math for this post.

Disclosure

No position in Deswell Industries anymore