Tuesday, August 5, 2014

ALJ Regional Holdings Annual Meeting Notes

A few weekends ago, I embarked to New York for the ALJ Regional Holdings Annual Meeting of Shareholders. While there were fewer than 20 shareholders in the meeting room, there were more than a few proficient hedge fund managers in attendance: Jeremy Deal of JDP Capital Management, Thomas Braziel of BE Capital Management, Steven Kiel of Arquitos Capital Management, and several others. Whopper Investments would have been there if not for scheduling conflicts. Any company with this type of shareholder base deserves to be studied.

Jess Ravich and the company's board of directors, as well as the heads of Carpets n' More- Steve Chesin and Faneuil- Anna Van Buren, were on one side of a large conference table, with shareholders on the other. The business part of the meeting started a few minutes after 10AM and concluded in fewer than 5 minutes. After which, an hour long discussion about the company’s state of affairs took place. Something that stuck out to me, even a few weeks later, is how competent the management teams at both Faneuil and Carpet’s n’ More Seemed. This can not be overstated enough, as they now have free reign to think for the long term health of the organization (which they stated) and are also compensated well when they preform.

The first topic brought up was how ALJ (and more specifically, Ravich) found Faneuil as an acquisition. Houlihan Lokey had shopped the company to ALJ, which, as it turns out, was not the highest bidder for the company- the seller really liked ALJ, and in turn got 9% of the company, plus board representation (Michael Borofsky). As so much of the ALJ's cash is tied up at the moment, they are not actively looking for deals, though, would buy if the company had the right one come along- think in terms of the Carpet's n' More acquisition, which involved a small amount of debt and share issuance at prices that reflect an attractive purchase.

Since the acquisition, Faneuil's growth has outperformed the company's internal expectations, with the company looking to further present contracts, and expand it's tolling operations of state highways, which the present administration supports. They are also looking to move into federal and foreign contracts, as well as more back office support, in addition to the 3 health contracts that the company recently landed.

Moving along, a shareholder asked if the company was able to quantify the amount of money that it could save the various municipal governments that it serves, or could potentially serve. Interestingly, the company is generally not the lowest bidder on most contracts, but is very competitive, especially when considering the amount of customization that they can offer clients. As such, they can generally show clients how much they can save provided the products are alike. It seemed that Van Buren felt Faneuil had an advantage over it's 2 main competitors- Xerox and Maximus, as they are so large that it is hard for them to veer off of a standard platform that they are accustomed to operating with.

The next question was the one that seems to be on everybody's mind: seasonality of the business...

Originally, there would have been some due to the nature of the healthcare business, though, they planned for this and moved into Medicaid support which "flattened revenues." There were many state exchanges that are looking to turn over to the federal government- that said, Washington state's exchange, which the company is involved in, is very successful. The company is looking to do more back office work, with states such as Tennessee. Ravich stated "there is not seasonality like retail... but we don't forecast..."

There was discussion of how there will, over time be a decline in electronic tolling for roadways, and that states generally have better success with doing manual tolling, due to there being problems with tracking down the people that don't pay. As an example of a contract, Florida's Sun Pass was one that had been held since 2005/6. Due to governance changes in Florida, the company bid for all the agencies in Florida, but ultimately lost to Xerox. With ALJ scoring higher, they decided to appeal the loss and will know the verdict in the next 60 days. The contracts end in 2015 and 2016. The company is committed to replacing and growing any revenues that are lost. While the company wouldn't talk about the bids that it is currently in the middle of, they again stated that the company is looking to win federal contracts. As part of this, they plan to partner with small minority businesses to grow. They have also been looking for new revenue streams outside of the US.

When asked as to how they are able to compete with Xerox, the company does niche work, in the sense that they can custom´service, and will often have members of the organization in management meetings to ensure that things run smoothly. Furthermore, while the company is more expensive than Xerox, they aren't so lofty with their pricing that they are out of the ballpark. In my view, this is a neat niche that has barriers in the sense that Xerox is so big, that they can't change what they do very well, as they are a juggernaut in the industry. Smaller competitors will have  tough time, as this is a niche market, that Faneuil seems uniquely suited for. Management also discussed that over 85% of their growth came from adding services to existing contracts- which to me indicates that the company is pleasing it's customers.

The only point of (albeit, mild) contention in the meeting was when a shareholder expressed that the company should at some point become SEC filing and listed on a major exchange. Certainly, the benefits are numerous- institutional ownership (especially with the recently increased market cap) as well as liquidity, higher pricing of the security, which would aid in issuing stock for acquisitions, and the like. Ravich addressed this by stating that they do keep this on their mind, and at the time, it doesn't make sense to do. Jess was sure to state that given his ownership stake in the company, that he views the company as he would his own.

In terms of deal flow, the company gets roughly 2 calls a month for potential deals, which is less than before it’s recent acquisitions, considering that people know Ravich and team don’t have the cash they did. However, the company is continuing to look, as there are still creative ways to acquire (as was highlighted by the debt and stock issuance for the Carpet's acquisition). Ravich said that if they couldn't generate returns in excess of its shareholders, cash would be returned to the owners of the company, however, he didn't see that happening soon, because the company is in a unique situation where it doesn't have to pay taxes due to it's substantial net operating losses. The company is looking for deals in the $5-$70mm dollar purchase range, as they want to use all of their NOLs, sooner rather than later. Through the meeting, Ravich was very specific in saying that ALJ is trying to be opportunistic buyers and sellers of businesses (which makes a world of sense with the NOLS, and the KES purchase and sale). He also noted that while he generally has a distaste for debt, that the company was paying too much interest in this environment for the Carpets transaction. Given that the company does have some debt which it pays double digit interest rates on, Ravich stated that "it should be paid off" and that it was on the agenda for the board meeting that immediately followed the annual meeting. Personally, he has no debt, even though he sold a lot of it when working at Drexel. It seems that if the amount of debt that the company has is reasonable, they are willing to issue it in an reasonable manner. As an example, he stated that presently, the company more or less has debt that is equal to roughly 1x its annualized cash flow, and that the majority of it is cheap- bearing interest of 5% (emphasis mine).

With this, the devil is in the details: as a thought exercise, this makes sense: if the company has net debt of ~$15mm by year end, which when using Whopper Investment’s analysis, is roughly what using the last 6 months EBITDA numbers would tell you when modestly adjusting for capex. As Whopper points out, these numbers are likely low, especially when you throw a run rate on last quarter, which during the meeting management implied that you could more or less do.

When ALJ’s stake in Bellator was came up for discussion it came out that company views it as sort of a call option. As the number 2 MMA organization in the world, with Viacom now being the majority owner, it's future could be quite bright. Management said that Viacom made UFC into what it is today, and that with Bellator now being on SPIKE! TV, that interesting things could happen.

Steve Chesin was one of the last insiders to speak at the meeting, addressing the subsidiary of ALJ that he manages: Carpets n' More. As a premier provider of carpets, window treatments, and cabinets, the company is in a unique spot, as they serve both commercial, home builders, and homeowners in the Las Vegas area. The housing downturn had taken a toll on their competition and they feel in good position to take advantage of the turning real estate market. One of the unique aspects of the business, is how they market. If a homeowner comes in as a referral from their builder, and buys a lot of one item, they can market based on that (if a new owner doesn't buy rugs, but they bought a lot of hardwood flooring...). The company has exclusive contracts with some homebuilders, which should help them scale out, and is even a preferred vendor for Caesars- recently providing the gambling operator with the tile and stone for a new casino. In the next quarter, this part of the company will still be hard to dissect, but should clear up in the future. They noted that the company was purchased by ALJ for ~1/10th the price that it was valued at, at the peak of the housing bubble- when coupled with the fact that building permits in Las Vegas are up 25-30%, year over year, and there is less competition out there, it seems apparent that ALJ got a heck of a deal on Carpets...

The meeting concluded around 11AM, with Chairman Ravich saying that they look forward to reporting back next year with the progress and as everyone was getting up from the table he said "hopefully, there will good things to come..." then, almost under his breath "which there will be".

I certainly believe that: the previously mentioned discussion and various valuations of the company contend that the company is cheap, even with no growth. I think that there is significant upside, even with the recently bid up share price. ALJ is a company with very manageable debt that can quickly be paid off from cash flow, the company seems to have incredible deal making ability, and a great management team. With the results that I feel are more than reasonable to expect, the company is trading for less than 6x cash flow, which, due to the tax assets and nature of the business, are pretty close to what shareholders will earn for the foreseeable future.

Additionally, the company has a recently acquired business, that seems to be getting better credit conditions, will be profitably expanding, and is guided by a manager that is now incentivized to think for the long term, and as such, could reasonably be (I would say, conservatively) valued at nearly 1/3 the present market cap of ALJ in the next few years. Throw in a call option for Bellator, the potential for growth at Faneuil, and yet another acquisition(s) that would speed up the monetization of the NOLs, giving them more present value, and I think that you have a compelling case for this company still being too cheaply valued by a significant amount.

Disclosure/Disclaimer: I own and represent shares of ALJJ and reserve the right to change that at any time. This is my opinion and not investment advice. Always do a ton of your own research in regard to anything that I say, do, write, or so much as even think about.