Company Profiles – Mesaba Range Value

Microwave Filter Company (MFCO): Trading at 25% of Liquidation Value

The company’s name is pretty self explanatory, MFCO manufactures radio frequency (RF) filters and related components for eliminating interference and facilitating signal processing for the following markets: Cable Television, Broadcast, Commercial and Military Communications, Avionics, Radar, Navigation and Defense. The 10-K offers as much information as you would expect from a ~$1.2mm market cap company that is attempting to go dark (more on that later). The radio frequency market, from what I can tell, is very competitive. It seems like there are a number of Mom and Pop type manufacturers and one large competitor of note is owned by Dover Corporation (DOV). Long story short, the company doesn’t benefit from a huge moat, but from what I can tell they have built up a solid reputation of being able to deliver custom applications to customers quickly. When you search for the term ‘Competition’ in the 10-K, the following is the only result,

“The principal competitive factors facing both MFC are price, technical performance, service and the ability to produce in quantity to specific delivery schedules. Based on these factors, the Company believes it competes favorably in its markets.”

To be able to produce in such quantity and customization you would need a state of the art facility one would think? Talk about burying the lead, now we are to the whole point of the article. The company owns its 40,000 square foot office and manufacturing facility in East Syracuse, NY and the 3.7 acre lot it sits on. Based on precedent transactions in East Syracuse it seems $75-100/sqft is close to fair value. That’s at least $3mm for the value of the building compared to $1.2mm market cap. Let’s jump into quick approximation of what liquidation value would be.

Liquidation Value Estimate (values as of 6/30/19)

Net Working Capital: $1,097,856

Given the company’s backlog of ~$740k, I didn’t make any adjustment to inventory.

Long Term Liability: $(179,178)

This is actually a mortgage against the property with KeyBank. From what I could gather I think proceeds were used for working capital and to shore up the balance sheet after a special dividend in 2012/2013. Original principal was $500,000, taken out in July 2013 with a 10-year term.

PP&E: $4,925,341

$3,500,000 for the value of the 40,000 square feet of manufacturing and office space. This assumes a price of $87.50/sqft, approximately what a light industrial building sold for in September of 2019.
$259,200 of Land. MFCO is not utilizing all of the 3.7 acres, only about 1 acre at the stated square footage. I’m assigning what I think is a very conservative estimate of $96,000/acre. Why $96k? There was a half acre lot that sold for double that amount per acre in June in East Syracuse.
$1,166,141 for Machinery & Equipment. The estimate is 1/3 of what is listed in the 10-K, again to be conservative. As stated above, the facility needs to be state of the art to compete and deliver in the quantity and speed necessary for customers. From the December 2018 10-K:

“Efficient computer simulation, design and analysis software enhanced by proprietary MFC developed software, allow rapid and accurate filter development at reasonable cost…Other in-house testing facilities include environmental chambers capable of testing products for temperatures of -40 to 200 degrees Celsius and humidity up to 100 percent. Several high power amplifiers are available for power tests. We have 2500 watt capability from 88-108Mhz with 200 watt capability up to 2200 Mhz. Facilities are also available for salt spray, sand and dust, shock and vibration, RFI leakage and altitude testing.”

Total Liquidation Value Estimate = $5,844,019
Shares outstanding (as of 8/1/19) = 2,579,238
Liquidation Value per Share = $2.26
Closing price as of 11/18/19 = $0.51
Potential return = 443%

I know I know, there are many reasons to shoot this down. I will try to answer some of them below and you can ask any I miss in the comments.

Isn’t the business just a melting ice cube?

Not exactly. While the business is volatile, they jump back and forth between positive EBITDA and should do between $0.2-0.3mm of EBITDA in Fiscal 2019 which ended 9/30/19. The biggest risk I see is their reliance on a couple large customers. Two customers usually take up 30-50% of total revenue. This explains the volatility as different capital spending programs are undertaken. The business, while not great, could be a lot worse.

So the company is going dark?

Well trying to, in May they filed an 8-K with the following:

“On May 2, 2019, the Board of Directors of Microwave Filter Company, Inc. (“MFCO” or the “Company”) unanimously approved the filing of Form 15 which is a voluntary filing with the Securities and Exchange Commission, also known as the Certification and Notice of Termination of Registration.

The Company’s Board of Directors considered the costs associated with the preparation and filing of reports, management time spent on the documents and the costs of outside legal and accounting resources. The Company will continue to put their financial statements on its
website (www.microwavefilter.com).”

15 days later they filed a 15-12G showing they have 459 holders of record, quite a ways from the less than 299 needed to go dark. The company has been buying back shares over the last few years, a couple hundred of dollars at a time, so my guess is they have been trying to work this down. I don’t see going dark as a negative really, as long as they are still making financials available to us. The part that would worry me about them going dark is the next piece.

Insiders Own Very Little

Now this isn’t always bad but combined with going Dark, it’s harder to feel like management has your back if they don’t have a material investment in the company. The 10 person Director and Executive Officer group as a whole own 6.9% of the company. Normally that would be an average amount but given the market cap is $1.2mm, 6.9% is very little compared to any members net worth, I’m guessing at least.

Other Investors Involved

Zeff Capital had offered to purchase the company in January of 2018 for $0.72/share. At the time he had owned 8.6% of outstanding shares. In the original letter he references the company’s willingness to go Dark. Zeff withdrew the offer in June of 2018. He also sold down his stake below 5% recently in 2019 so he no longer has to disclose his holdings.

Conclusion

I think I’ve laid out how unique of a situation this is at MFCO with the company currently trading for less than 25% of my estimate of liquidation value. At the very least the stock should reflect the value of the office building they own and the net working capital which would give us a even more conservative liquidation value of $1.71/share, 335% greater than the close on 11/18/19.

TableTrac (TBTC): Impressive growth story with a long runway ahead

At a market cap <$15mm, TableTrac (TBTC) is small enough to fall off the radar of most investors but definitely deserves a look for those of us that traffic in the under the radar world. I originally came across this name in Avram Fisher’s 3Q18 letter to investors (http://www.longcastadvisers.com/letters). As an aside, I would definitely recommending Fisher’s letters to anyone interested in small and microcap companies, it’s always one I look forward to every quarter.

TBTC’s business model is simple enough. Their main product, Casino Trac, helps casinos track and manage table games, loyalty programs, as well as cash management and accounting/audit. The company initially sells the hardware and then also collects service and maintenance revenue once the system is installed. The split between Hardware and Service revenue is roughly 65%/35%, respectively. Despite its size, TBTC has been able to carve out a nice little niche catering to smaller casino operators in 14 states (MD, TX, OK, CO, NE, IA, MN, WI, ND, SD, MT, WA, NV, CA), Central and South America, the Caribbean, Australia, and Japan.

Why do I like the stock?

Growth Potential: TBTC has admirably executed on its growth plan thus far. Results tend to not increase in a straight line given the lumpiness of contract wins but the last three years have seen revenues grow at a 10% CAGR due to a significant pickup in installation momentum as the company has successfully expanded its footprint in the U.S. and with suppliers in Australia and Japan. 2011-2014 averaged about 8 installations per year with 2015-2018 registering an average of 14 per year. In the first half of 2019, the company installed 5 systems and has another 4 in backlog. I don’t expect this momentum to stop either. The company is only in 14 states and has proven they can enter foreign markets through distribution agreements most notably in Australia and Japan. Their exclusive Australian supplier installed another 11 systems in 1H2019 and in early July, TBTC announced an exclusive distribution agreement with a Japanese company, with $1.2mm of contract deliverables expected to be recognized in Q3 2019.
Valuation: On the surface at an EV/EBIT of ~20x, the average passerby probably isn’t going to think TBTC is a steal of deal. However, I think this would be ignoring the company’s growth prospects and the fact that the current level of SG&A spend is artificially high as the company is focused on growing installations (operating Income has still grown at a 50% CAGR over the last 3 years despite high levels of growth spending). Over time I’d also expect gross margins to improve from the already impressive high-60% area as service and maintenance revenue continues to increase as a percentage of total revenue. The supplier agreements in Australia and Japan will also continue to deliver higher margin revenues and I would expect this to be replicated in more markets. (I’m planning on attending the Annual Meeting at the end of the month and this is something I’m going to ask more about.)

Aligned Incentives: Founder/CEO Chad Hoehne owns ~26% of the company. Hoehne had stepped down as CEO in 2011, maintaining a board seat and President role, but retook the CEO role in 2017. I have no idea the circumstances surrounding these role changes, but I would imagine it wasn’t his plan to retake the day-to-day operations. As with any owner/operator, one of the most likely exits is through a sale and I think TBTC has definitely proven they own their niche of the market, and could prove valuable to a larger strategic competitor.

I don’t own shares because I think the company might be purchased at a premium any time soon. I own shares because I think you get a high quality business, with an impressive growth runway that is not reflected in today’s valuation. Please comment with any comments, criticism, corrections, etc.

Thank you for reading.

Pico Holdings (PICO) – Collection of Scarce Assets Worth 2x Current Market Price

I think there’s a reasonable argument to make that PICO Holdings (PICO) is conservatively worth 100% more than its price in the market today. The company has simplified its operations to focus solely on its portfolio of water rights located in Nevada and Arizona. I’ll describe the value driver of the rights in each state soon, but overall the water rights are a scarce asset that have and will only increase in value due to drought conditions as well as above average population growth.

PICO is focused on monetizing the water assets and using the proceeds to return capital to shareholders. This process has already begun as the company has simplified. In 2017 PICO sold their last non-water related asset, a stake in homebuilder UCP, for $115mm using the proceeds to pay a special dividend to shareholders. After a successful ramp of activity in the sale of water credits in 2017 and 2018, PICO repurchased 10.6% of outstanding shares in 2018. In 1Q19 the company repurchased $4.2mm of shares.

The sales in 2017/18 and other disclosures give us a good idea of where the market is currently valuing these assets. As I stated above, my conservative estimate is that the total value of the company today is 100% higher than today’s value. I’ll break down my view of the value of these assets below.

Nevada

In Nevada, the value driver of water rights is the above average population and employment growth, which have combined to create a housing shortage.

Screen Shot 2019-05-01 at 10.40.56 PM.png

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Screen Shot 2019-05-01 at 10.41.51 PM.png

Each house needs about 0.5 Acre-Feet of water and as developers bring new houses onto the market, they must secure water rights that can be pledged to the area’s water utility for service. PICO has two main groups of assets in Nevada: Fish Springs Ranch and Carson/Lyon.

Fish Springs Ranch (FSR):

PICO owns a 51% stake in FSR, located 40 miles north of Reno. The water rights total 12,907 Acre-Feet (AF). Of this, 7,907 AF is available to be sold. The other 5,000 AF has received the necessary approvals from the the Nevada State Engineer, but federal rights of way would need to be updated before they could be monetized.

So what is this worth?

In 2018 PICO sold 77 AF to a developer for $2.7mm or $35,000/AF.
In 1Q19 86 AF were sold to a developer for $35,000/AF.

As the majority owner and managing partner of FSR, PICO has funded all of the operational and development costs. These costs accumulate as Preferred Capital, which accrues interest at LIBOR + 450bps. As of 12/31/18 the Preferred Capital balance stood at $181.7mm and was growing at >7%. As sales are made, the Preferred Capital will be paid out first. Applying the $35,000/AF value to the 7,907 AF available for sale, while paying out 100% of Preferred Capital first, you get the following value of the FSR assets:

Screen Shot 2019-05-01 at 6.08.30 PM.png

I think this is a conservative estimate since it doesn’t include the additional 5,000 AF the company owns. I’m confident these additional 5,000 AF hold value, but given the uncertainty around development timing I’ll omit them for now.

Carson/Lyon:

A little more straightforward here, the company owns 3,500 AF along the Dayton corridor, east of Carson City and Lake Tahoe. In 2018 PICO sold 511 AF for $10.3mm or $25,000/AF.

3,500 AF @ $25,000/AF = $87.5mm in value.

Kane Springs:

PICO has an option agreement with a developer to sell the remaining 500 AF of water rights in this area at $6,358/AF, escalated at 7.5%/year from September 2017. The agreement expires in September 2019 with a cost to exercise of approximately $3.5 million. To date, the developer has made all required annual option payments ($60k/year).

Kane Springs Value = $3.5mm

Arizona

The value driver of the Arizona assets is a little different than Nevada. What PICO owns in Arizona is Long Term Storage Credits (LTSC). They are similar to the Nevada water rights as they are Acre-Feet of water that can be purchased by municipal or industrial users to satisfy water requirements. The driver here is the strain on the entire water supply due to the ongoing drought in the area and the effect it has on the Colorado River Basin and Lake Mead, where Arizona derives about 40% of its water.

If Lake Mead is expected to drop below 1,075ft, a Tier 1 shortage is declared. At Tier 1 (<1,075ft) Arizona would see their annual allocation from Lake Mead drop 320,000 AF. A Tier 3 shortage would push this to 480,000 AF annually. The states that share the reservoir (Arizona, California, Nevada, and Mexico) are doing everything they can to ensure shortages like this are avoided. On and off over the last 8 years they have been working towards something called the Lower Basin Drought Contingency Plan (DCP). The DCP would require additional water be held behind Hoover Dam in Lake Mead requiring a reduction in the volume of water that Arizona, Nevada, and California could use each year. So far, nothing has been agreed to. In a worst case scenario the Secretary of the Interior could use his/her power to determine what the shortage would be for each state.

In conjunction with the DCP group meetings, the Bureau of Reclamation presented its view on the likelihood of shortages. Without a DCP agreement, they see a 50% chance of a Tier 1 shortage in 2020 and between a 60-65% chance of a Tier 1 shortage in 2021-2026.

PICO’s assets in Arizona are perfectly positioned to benefit from either outcome here. Either the states take voluntary cuts under the DCP or they risk being subject to cuts when shortages are declared based on Lake Mead’s elevation (you can see the elevation levels of Lake Mead here http://mead.uslakes.info/level.asp). In either situation Arizona will need to replace hundreds of thousands of Acre Feet of water.

How much are the Arizona assets worth? There were three sales of LTSCs in 2017.

In February 2017 PICO sold 100,000 LTSCs total to two parties (AZ Water Bank Authority and Central AZ Groundwater Replenishment District) for $25mm ($250/LTSC).
In December 2017 PICO reached an agreement to sell up to 15,000 LTSCs to the Roosevelt Water Conservation District(RWCD) for a base price of $350/LTSC. The LTSCs may be purchased by RWCD at any time over the term of the agreement, which expires on December 31, 2019. Any purchases prior to December 31, 2017 will be at the base price of $350 per LTSC and any purchases of LTSCs under this agreement beginning January 1, 2018 will be at a price that is increased from the base price at 10% per annum.
The company also currently has 1,150 LTSC under contract with Apache Sun Golf: 1,150 LTSC at prices ranging from $306.26-$375.18/LTSC, terminates 9/30/21

Given the escalator in the agreement from 12/31/17, the current market value would be $423.50/LTSC if RWCD exercises this agreement. I used a few possible prices and you can see the corresponding value break down below.

Conclusion

As stated in the opener, I think there’s a reasonable argument that PICO is at least 50% undervalued by the market.

Fish Springs Ranch $229.2mm

Carson/Lyon $87.5mm

Kane Springs $3.5mm

Arizona Base Case $116.3mm

Cash $12.6mm

Total Value $449.1mm

I intentionally was conservative in the estimation of value: not ascribing any value to some assets that are further from monetization and smaller in nature (including the Dodge Flat asset sale that closed in 1Q19 for $8.9mm of total proceeds). There is an argument to make that the supply/demand imbalance will push prices above levels that have been recorded in previous transactions. From what I’ve read, PICO’s water rights and constructed pipeline are the only source of water for developers in the Northern Nevada area.

While timing is uncertain I think the data points towards a short term need for water credits in both Nevada and Arizona. Monetization won’t be in a predictable straight line over the next 3-5 years. As part of the simplification of the business, PICO cut overhead costs in half, now expecting them to be $5.5mm going forward. This will free up more cash to be returned to shareholders as water rights sales are realized as well as help ease the lumpiness of any sales.

Overall, I think PICO offers investors a unique collection of assets that have a definite scarcity value and a nice margin of safety built in at current market prices.

I currently own shares of Pico Holdings (PICO). This article is not a recommendation to buy or sell.

Tandy Leather Factory: Adding More Gas to this FCF Machine

New CEO Janet Carr got a proper chance to address investors on the 4Q18 earnings call on March 7th. A key theme throughout the call is that FCF, instead of top line growth, will be a priority driving decisions going forward. Consistent with this focus, the retail stores will be operated to maximize cash flow, likely leading to 4-6 store closures in 2019 in addition to the 3 closures announced in February. No store openings are planned so Capex will likely be at a lower level than we have seen in recent years ($1mm ’18, ~$1.7mm in both ’17 and ’16). Tighter Inventory management continues to be a priority. Even after falling $3.5mm throughout 2018, we are still looking at ~$34mm of Inventory. It was loosely mentioned on the call that 3.0x Inventory Turnover is an aspiration, given 2018 sales that would imply a further $7mm improvement in Inventory.

Outside of the FCF focus, TLF is also re-focusing on Commercial Wholesale customers. This is really a no-brainer, and will be a good growth component in a time when the retail segment is being right sized. Tandy’s main benefit is how large they are in their niche of leather crafting. Given this, they have the ability to compete most effectively in what is a more commoditized segment of the business.

The focus on FCF should be music to investors’ ears. FCF yield was >10% in 2018, a year full of one-off expenses. Now we look to 2019 and despite it being a reset year, I expect the focus on FCF to drive a year over year improvement. The company continues to buy back shares: 243,387 in 2018 for $1.6mm. Subsequent to year end, the company fully repaid the $9mm outstanding on the revolver while also having repurchased 53,626 additional shares for $300k. 853,780 shares remain on the current buyback authorization that expires in August. At today’s (3/18/19) closing price, to complete the authorization would cost $5.5mm for a company that has ~$15mm on the balance sheet and no debt.

I had initiated a small position in February and will be adding to it in the coming weeks. I really am encouraged by management’s focus on cash flow over top-line growth and as I stated above the focus on the Wholesale business is a no-brainer. TLF remains a Cash Flow machine, and sooner than later the rest of the market will take notice.

I own shares of Tandy Leather Factory (TLF). This article is opinion only and not a recommendation to buy or sell.

Tandy Leather Factory (TLF): A 2018 Buffet business at a 1960s Buffet price

Tandy Leather Factory is a niche brick and mortar retai…..wait guys! Stop! Why are you running away so fast!

Tandy is the dominant market leader selling leather and leather crafting items to retail and wholesale customers in North America (115 stores) and Internationally (1 location in both UK and Spain). In some ways 2018 was rocky: 1) CEO and President (both with long tenures at TLF) abruptly resigned in October. 2) This caused 2020 financial targets to be withdrawn ($87-90mm annual sales and >10% operating profit margin) to be withdrawn. 3) In the past week TLF pre-released 4Q 2018 sales numbers which included notes on 2 U.S. store closures, the closure of the 1 Australian location, and that 2018 operating profit would negatively affected by these and other one-time events. But 2018 wasn’t all bad: 1) The company will end up recording its first positive annual sales growth (+0.9%) since 2015. 2) With the announcement last week, TLF also disclosed their cash balance as of 12/31/18 was $24.1mm, +$5.8mm YoY.

Currently the market is punishing TLF for the negatives of 2018 while ignoring the company’s strong competitive position and arguably very wide moat. Before we dive more into how cheap TLF currently is, take a look at the following link. This report was very informative and helped me get a better idea of TLF’s world and how they have come to dominate it. I feel no shame in linking to another great piece of work as I feel it would be a waste of time to reinvent the wheel. The report was completed in 2015 so some of the ways the company classifies its segments and store count have changed but the main points remain the same:

The company sees potential for 150 stores in North America (115 today)
Absent new stores, focus on relocating to larger stores in nicer areas
Have identified 20 countries outside of NA that could support a TLF store
Growth in the U.S. has been constrained by the difficulty in finding and retaining key talent (store managers mostly) as its a tough argument to get someone to uproot their life for a $36,000 salary (raised 40% in Dec. 2016) and 25% of store EBIT as compensation
About 40% of sales are leather and 60% leather crafting accessories; the leather sales are commodity-like and lower margin

After reading more on TLF’s competitive position I think it should be easy to see that this in not a cigar butt by any means. The market is offering us a high-quality business, with a sustainable moat, for not too much more than liquidation value. As of 9/30/18, Net Current Asset Value was $44.3mm vs. a market cap of $52.6mm (2/1/19). And despite the noise in 2018, TLF will still likely report ~$5.5mm of FCF for the year.

Despite the removal of the 2020 financial targets I think it is safe to assume a 10% operating margin is a level the company will continue to strive towards. At current EBIT levels, TLF is valued at less than 6.5x EV/EBIT. If you assume they can get to 10% EBIT margin, this drops a full turn, assuming no top line growth.

Concerning the excess cash that’s building on the balance sheet, TLF has an outstanding share repurchase authorization of ~1mm shares, about 11% of outstanding. The company has $8mm of debt outstanding on a $15mm line of credit that is expressly for the use of share buybacks. (It will be converted to a 4-year term loan once the authorization is completed). The buyback has already been extended by one-year as the illiquidity of TLF stock makes it tough to complete buybacks.

The abrupt departure of the former CEO and President is a definite negative, but it doesn’t do too much to shake my confidence in the company or how shareholders will be treated going forward. A main reason for this confidence can be attributed to Chairman, and 30% owner, investor Jeff Gramm. Gramm joined the board in 2014 and has been an advocate for creating shareholder value; he even wrote a book on the history of shareholder activism all the way back to Ben Graham titled, Dear Chairman. Gramm’s involvement leads to me believe that the path forward will include narrowing the gap between intrinsic value and market value while also growing intrinsic value over time.

In summary we have the following:

High quality business with a large moat trading for around 6.5x EBIT
Current market price near Net Current Asset Value
A share repurchase authorization to repurchase 11% of outstanding shares
A major shareholder and chairman who is strong advocate for shareholders and narrowing the gap between intrinsic value and market value

Whether it’s the executive departures or just the fact this is an illiquid micro cap in a very niche end market, I think the market is completely undervaluing TLF today. It may not happen in 2019, but I am confident that the 4 bullet points above will combine to create value for shareholders going forward.

I own shares of Tandy Leather Factory (TLF). This article is not a recommendation to buy or sell.

Parks! America (PRKA) Gets A Letter In Its Christmas Stocking

On Friday PRKA released their FY18 earnings, which were a very welcome positive after the first 3 quarters disappointed on what management described as “higher precipitation levels, as well as unplanned park closures due to several significant weather events”. I tweeted this on Friday:

https://twitter.com/MesabaValue/status/1073703750542471168

I debated writing a post on PRKA on Friday, but I figured there were enough good blogs covering the background and story so no point to recreate the wheel. Check them out here: hiddenvalueblog and otc adventures.

I had accumulated a small position in late summer as I thought this could be an interesting situation given the strong operating track record, cash generation (>10% FCF yield), and the debt refinancing/partial repayment that was disclosed in the 3Q18 10-Q. I was waiting for an indication that the first 3 quarters of 2018 were indeed a weather related event before increasing the position size.

Enter Marlton LLC, who has accumulated a 5% stake and released a letter to the PRKA board after market close on 12/17. Marlton PRKA Letter

The letter raises some valid points around capital allocation and succession issues. I have two takeaways:

1) This comes from information in one of the blogs listed above. ‘An interesting quirk in the capital structure is the large number of “zombie shareholders.” The company came to market via a reverse IPO, where a former mining company was turned into a shell corporation which subsequently acquired the assets of the Georgia site. This has resulted in 3,000 shareholders in PRKA, which cannot be located. I believe this has been a key impediment to capital allocation policies as the management team does not want to “pay dividends to nobody.”’ This can be easily(?) fixed through a reverse split, to ensure all cash is going into interested shareholders pockets.

2) I don’t think this should be seen as an indictment on current management. Not only have they proven themselves excellent operators but they also don’t draw outrageous salaries and are properly aligned with shareholders; insiders hold ~52% of outstanding shares. Both a more transparent capital allocation policy and clarity around CEO succesion will favor all shareholders (including management) while ensuring smooth operations for PRKA going forward.

What’s Next?

The fact that the company is incorporated in Nevada (favors incumbent management) and that insiders own 52% makes it tough to believe this goes to a proxy battle. At the end of the day, the demands/suggestions aren’t outrageous at all. The dividend/tender offer proposed would leave PRKA still with $0 net debt while the company generates >$1mm of FCF annually. PRKA has been searching for another deal since 2008 the rights right deal and/or price hasn’t appeared. If you need a reminder of the execution risk ANY deal will bring just check out the performance of the Missouri park compared to the Georgia park.

Valuation

As my tweet inferred last Friday, I thought PRKA’s valuation looked attractive. Fast forward to Monday, December 17th and we have a possible catalyst. If nothing else, more eyeballs will be on the company and stock, making it more likely the gap between market valuation and intrinsic value is narrowed. At ~6.0x operating earnings, ~10% FCF yield, and net cash on the balance sheet equal to almost 10% of market cap, I really like how 2019 is setting up for PRKA.

I own shares of PRKA. This is not a recommendation to buy or sell.

Update Following 3Q19 Earnings Call (MMMB)

I don’t think quarterly updates are particularly useful. The thesis remains intact from the previous article, but I figured I’d briefly touch on what I found interesting from the release and earnings call:

1) 2Q Weakness One-Off Blip- If there was any skepticism around managements explanation of a weak 2Q19, this quarter proved it was truly transitory.

2) Operating Leverage- Sales grew at a 12% clip but this drove a 50% growth in EBIT to $536k. Stock is trading close to 10x EBIT going forward, assuming no future growth.

3) Strategic Alternative In 1Q18- Company expects to give update on review underway early in the company’s 1Q2020, which begins 2/1/19.

Investors continue to be in a good position. If the company is purchased as a result of the strategic initiatives, I think it comes at a price about 100% higher than today. If the company remains independent, there is a solid growth runway to a $50-60mm annual sales level.

I hold a position in MMMB. Any article is only opinion and not a recommendation to buy or sell.

MamaMancini’s Holdings (MMMB)

I’m going to sound like every value investing blog or quarterly letter when I say the more boring an idea, the better. MamaMancini’s (MMMB) fits this perfectly. Selling branded meatballs and other Italian dishes, MMMB is taking advantage of a trio of trends in consumer packaged foods that are actually driving growth: 1) Natural and Organic 2) Freshly prepared foods 3) Frozen foods. The company successfully grew the top-line at 43% in Fiscal 2017 and 53% in Fiscal 2018, leading to a profitable and FCF positive 2018. This growth came as MMMB was able to increase their product placement to 43,300 SKUs in 12,500 locations as of 7/31/18 from 32,000 SKUs at 10,100 locations as of 1/31/16.

The stock has been a laggard over the last year, exacerbated by a weak Fiscal 2Q 2019 (7/31/18) as changes in multiple purchasing offices of MMMB’s customers caused sales to drop vs. 2Q18. Despite this, the stock is offering investors a great deal as growth is likely to continue in the coming quarters as MMMB management has laid a solid base for the company with catalysts upcoming for significant stock price appreciation.

Catalysts:

$40mm annual run rate of sales by end of fiscal year: management expects SKUs to increase by 7-10k placements to 50-53k total. A $40mm annual run rate would mean a resumption of ~25% growth by Fiscal 4Q19 (1/31/19)
Continued growth in Fiscal 2020: MMMB indicated a major national retailer has strongly indicated a start date for selling our products next spring. As you can see below the company still has only entered about 32% of available locations.

Screen Shot 2018-11-26 at 9.10.54 PM

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Strategic Alternatives Initiative: MMMB retained Akin Bay Company in partnership with Kernick Advisory Group to investigate strategic options for MMMB shareholders “Given the current strong U.S. economic environment, management and the Company’s Board of Directors believe that this is an appropriate time to evaluate the Company’s market position and prospects and investigate if there are alternatives where shareholder value can be substantially enhanced. Potential options could include, but not be limited to, strategic acquisitions, a merger with, or purchase by a larger strategic food company or investors or recapitalization of the Company. There is no guarantee that any transaction will occur. However, given the positive fundamentals of the economy and MamaMancini’s, we believe that our shareholders deserve a comprehensive review of our options. We intend to further comment on this process when appropriate.” Current CEO and the largest shareholder (21%) of MMMB, Carl Wolf, has extensive experience building and selling consumer branded products, from the most recent 10-K, “ Wolf was the founder, majority shareholder, Chairman of the Board, and CEO of Alpine Lace Brands, Inc., a NASDAQ-listed public company with over $125 million in wholesale sales. He also founded, managed, and sold MCT Dairies, Inc., a $60 million international dairy component resource company. Other experience in the food industry includes his role as Co-chairman of Saratoga Beverage Company, a publicly traded (formerly NASDAQ: TOGA) bottled water and fresh juice company prior to its successful sale to a private equity firm.”
If nothing comes of the strategic review uplisting to Nasdaq will increase liquidity and visibility for the company and stock

Valuation:

MMMB recently completed a plant expansion, following the acquisition of its supplier Joseph Epstein Foods, that will allow for $50-60mm of annual sales at current production plans. A great benefit of this company is the operational leverage, which has been evident throughout the growth period beginning in Fiscal 2016.

At a $60mm sales level, 40% gross margin, 0.5% of sales to R&D, and SG&A of $12mm, the company produces EBIT of $11.7mm. Compare that to the fully diluted market cap, as of 11/26/18, of $32.3mm. This is a longer-term target so let’s look at something that could be achieved in Fiscal 2020. Let’s assume a $40mm annual sales target, which is conservative given that this run rate is expected to be achieved by 4Q19. Assuming this level of sales with 40% gross margin, 0.5% of sales to R&D, and SG&A of $10mm, the company produces EBIT of $5.8mm. Currently you’re paying 5.5 times operating income for a high growth company, with a runway for continued growth, and a number of catalysts that could uncover value for shareholders.

Along with the CEO Wolf, insiders own close to 50% of outstanding shares. This is a unique, and almost boring, opportunity where investors can invest alongside a leader in the industry who has a demonstrated track record of success. If the company continues to execute on its growth plan I think the stock could double from current levels. A sale of the company would likely limit this upside potential, but would make sense given the investment necessary to surpass the current $50-60mm sales capacity the company currently has.

Full disclosure, I currently own shares of MMMB. This is simply an opinion and not a recommendation to buy.

Turtle Beach Corporation (HEAR)

After pausing my nascent investing blog career in early 2017, I’m back for hopefully regularly scheduled programming. At first glance I may be setting myself up for some easy article ideas and an eventual “What I got wrong on HEAR” article by picking a company that has already been a 10 bagger this year. Despite the successes, I think the market has it wrong currently on Turtle Beach (HEAR).

My thesis is that even with unbelievable success driven by the battle royale boom in gaming (Fortnite and PUBG being the most famous), this isn’t a one-time blip. The stellar 2018 has allowed HEAR to completely turn around their balance sheet; setting the stage for continued growth in PC gaming headsets (targeting 10-20% market share in the next few years), untapped markets (China), and other gaming hardware items (mice, keyboards, etc.).

At current levels the market is pricing in a greater than 50% drop in FCF and net income next year. I feel the boom in sales in 2018 has simply increased a user base that on average refreshes products every 2 years. HEAR will continue to lead this market and with a brand new capital structure that has nearly eliminated all debt, HEAR will have optionality to invest in their identified growth markets and/or return capital to shareholders. Irrational expectations and very high short interest has created a great margin of safety and an attractive value proposition for investors.

Turtle Beach (HEAR)

The company sells gaming headsets compatible with the popular gaming consoles: PlayStation 4 (PS4) and Xbox One. HEAR is the market leader in the console headset market and it really isn’t close. They currently have 6 of the top 10 selling console headsets. This includes the #1 selling console headset for PS4 and Xbox One, #1 and #2 Xbox One wireless headset, #1 PS4 wireless headset, and #1 chat headset for Xbox One and PS4. They currently have a 45% market share in the U.S. and Canada and a 51% market share in the U.K. The PC market was mentioned above as a growth platform going forward, but if you combine the PC and Console market share currently, HEAR is at 34% in the U.S. That is larger than the share of the next three competitors, combined.

What has happened in 2018?

On a macro level:

The gaming world has received a huge jolt from battle royale style games. Battle royale games are a multiplayer, online format where the winner is the last man/woman standing. The most popular of these are Fortnite and PlayerUnknowns Battleground (PUBG). The headsets are key for these games as they help the player pick up on audio cues, which is imperative for competitiveness in the format. Prior to the battle royale games, about 25% of gamers used a headset; 80% of battle royale gamers use a headset. This has led to an increase in total units sold, YTD through September, of 51.3%. Capitalizing on this trend, HEAR’s projected FY2018 revenues are expected to come in 81% higher than 2017.

The popularity of the Battle Royale format hasn’t been lost on the industry as a number of companies are delivering games with Battle Royale formats:

Call of Duty: Black Ops 4 has a Battle Royale mode, Blackout
Red Dead Redemption 2 launched on October 26^th and achieved $720mm of sales in its first 3 days, scoring the highest rating of any game in the past decade, and HEAR mgmt. mentioned on the 3Q18 call that there are rumors of a battle royale mode in 2019.
Battlefield V launches on November 20^th and features 8 multiplayer modes, one of them being a battle royale mode

The maker of Fortnite, Epic Games, has also attracted interest as it completed a $1.25bn financing round, which will likely bring new seasons and games looking to capitalize on the 80 million players per month that Fortnite currently draws.

An amazing stat from a HEAR earnings call, “There are 148 million eSports enthusiasts around the globe, and 22% of American male millennials watch eSports, putting it virtually equal with baseball and hockey in terms of viewership among that demographic.” HEAR has partnerships with a number of eSports teams.

On a micro level:

The battle royale boom has allowed HEAR to totally repair its balance sheet, positioning the company to take advantage of attractive growth opportunities.

As of 12/31/17, this is what the HEAR cap structure looked like:

$38.5mm Revolving Credit Facility
$10.9mm Term Loans
$21.9mm Subordinated Notes
$18.9mm Series B Preferred Stock at an 8% interest rate

The capital structure is 180 degrees different today thanks to an exchange of shares and warrants to retire the preferred stock and allocation of Free Cash Flow ($41mm YTD 9/30/18) towards debt reduction. Today the capital structure looks like this:

$3.5mm Revolving Credit Facility
$12.5mm Term Loans
$10.4mm Subordinated Notes (Will be paid off by end of 1Q19)

On the 3Q18 call, management said they will have the cash available to repay ALL remaining debt if they choose to do so in 1Q19.

The company has continually beat and raised guidance. Going into 4Q 2018, the company is guiding to 4Q Revenue of $94mm and Net Income of $16.7mm, both +18% YoY. This will bring FY2018 Revenue of $270mm, +81% YoY, and EPS of $2.55 (as of 11/14/18 the stock closed at $13.66).

Why is the market wrong?

As I mentioned above, currently the market is valuing HEAR as if sales will completely revert back to pre-battle royale levels. This is just not going to happen. While we are not going to see an 80% top-line growth number in 2019, and may even see a modest decline, HEAR is positioned with a clean balance sheet to drive profitable growth beyond 2020. Management has identified adjacent growth initiatives and now has the balance sheet to pursue these. Additionally, the battle royale trend is here to stay. HEAR’s customers, on average, refresh their headsets every 23 months so we simply have a much higher base that will be re-entering the market every two years. Along with this, it is likely that new customers entered at low price points and will trade up and sooner: from surveys, the company has observed that Fortnite players (80mm monthly) that play greater than 3 hours per week replace at a faster rate than the average gamer.

What’s it worth?

In HEAR we have a market leader/giant with a clean balance sheet, identified growth plans in adjacent markets, and secular tailwinds that are likely to continue. The market is currently valuing HEAR as if earnings and revenue are likely to fall off a cliff. At a current market cap (fully diluted) of $222mm, the company is trading at a 23% FCF yield on projected FY18 numbers.

After a normalization year in 2019, with revenue off slightly from 2018, I would expect HEAR to deliver continued growth as it continues to dominate the console headset market while building market share in the PC headset market. The PC market increases HEAR’s addressable market by about 50% and the company will begin targeting a 10-20% market share in the next couple years. The company has already secured shelf space with retailers for this and initial reviews are very positive. Below is the Turtle Beach Atlas Elite review from PCMag.

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Over time HEAR will look to expand the addressable market by another 50% by entering PC headset markets outside of core markets, specifically China. Finally, add another $1bn of addressable market share through non-headset gaming products like keyboards, mice, and others.

Conclusion

The market is dismissing HEAR as a one-hit wonder when in fact it has a good margin of safety built into the story given current valuations. FCF and EBITDA could both fall 50% and HEAR would be trading around a 10% FCF yield and less than 10.0x EV/EBITDA. Another factor to consider is that a large number of shares are sold short, >75%, which has caused a lot of volatility in the name, likely cherry picked by speculators who only see the 1,000% return YTD. I’m not going to give an absolute value for the company, but I love the margin of safety currently at a >20% FCF yield to FY18 projections.

Thank you for reading!

Disclaimer: I currently own shares of Turtle Beach (HEAR). This is article is opinion only and not a recommendation to buy.

The Wheels on the Bus, Blue Bird Corporation (BLBD) (BLBDW)

One of my favorite books I’ve read in the past few years is Mohnish Pabrai’s The Dhando Investor. Since reading this I’ve devoured all of the great articles and YouTube videos that are out there outlining Mohnish’s value philosophy (I posted links to some of my favorites at the bottom)*.

This article is due in part to Mohnish. One of his larger holdings is in GM and not directly through the common stock but through the company’s 2019 warrants. The warrants trade under the ticker GM/B and give the right to buy GM common stock at $18.33 per share. In essence it is a levered bet, so instead of buying 27 shares with $1000 you can control 54 shares with the same amount of capital. I really liked this idea and it follows Mohnish’s saying of “Heads I win, Tails I don’t lose much.” I’ve never gotten myself around to buying the GM warrants, although I’ve been very close many times. This did, however, inspire me to purchase the company I’ll be writing about today.

Blue Bird Corporation (BLBD) manufactures and designs school buses. The North American Type C and D bus market is controlled by three players: Blue Bird, Thomas Built Buses, and IC Bus. Blue Bird the only independent company of the three. Thomas Built Buses is owned by Daimler and IC Bus is owned by Navistar. In 2016 the market share was divided as such: Thomas Built Buses 35%, IC Bus 34%, and Blue Bird 31%. I think it is safe to say that the North American Type C and D bus market has a fairly deep moat around it. Schools have trusted Blue Bird since the 1920s and its dealership networks are very entrenched (leading to 90% of sales). Not only do I think the company has a pretty deep moat around it, I also love the warrants available under the ticker BLBDW. Each warrant gives the right to purchase 0.5 shares for $5.75, (2 warrants for 1 share at $11.50).

As of market close on 1/27/17, the underlying common stock was at $16.95, implying a market cap of $383mm. The warrants were trading at $2.75.

The bus industry hit a trough in 2011, as there were only 23,821 Type C/D registrations, significantly below the mean since 1985 of 30,500 annual registrations. As the industry has recovered, Blue Bird has consistently gained market share. In 2010, Blue Bird had a 23% market share, rising to 31% in FY2016. This has been driven by the company’s significant dealer network within the U.S. as well as leadership in the alternative fuels space, offering propane, gas, and CNG buses. In FY2016 Blue Bird’s sales of propone vehicles increased 33%. I think Blue Bird’s leadership in alternative fuels will help drive outperformance for the company going forward.

It is important to note that Blue Bird has a large majority shareholder, private equity firm American Securities. They own 53% of the common stock and it is worth mentioning that they attempted to purchase the other 47% in the summer of 2016. American Securities had offered to pay $12.80-13.10/share for the remaining shares it didn’t own, an offer that was rejected by a special committee formed by the Board of Directors.

Blue Bird is projecting 2017 sales to rise 6% to $980-1,010mm, EBITDA to rise to $72-76mm and FCF to rise to $38-42mm. At an EV/EBITDA of 6.5x, a FCF Yield of ~10%, and a forward P/E less than 12x, the stock and warrants seem very attractive. Given Blue Bird’s position in an industry that has a deep moat and multiple avenues for future growth (alternative fuel buses, sales to the commercial market, potential for development of an electric vehicle) I feel that shares and warrants present a great value at current prices.

https://www.youtube.com/watch?v=IOoaNYQHaYY (Mohnish Pabrai at lecture BC)