GenCorp - Rocket Science

I’ve repositioned the chess pieces in order to raise cash and better balance the portfolio’s exposure to exogenous variables while keeping expected returns constant. I have, in the last month, bought the common stock of GenCorp, Arcos Dorados and Rain Industries, and I’ve sold my equity stake in Hawaiian Holdings. I’ve also bought some January 2015 call options in Procter and Gamble. 

I’ll start with GenCorp because it has been written up several times.

GenCorp is Aerojet and Rocketdyne and some land. The land is either a free option or a red herring, and I therefore won’t say much more about it.  These are the principal merits of the investment case:

1. Aerojet and Rocketdyne are both in the niche, highly-regulated rocket propulsion business and together account for a large (70% to 90%) share of the market in rocket systems for defense and space applications. Niche + highly-regulated + monopolistic market share of course means pricing power and that’s what these two businesses exhibit.
2. Both Aerojet and Rocketdyne are beneficiaries of long-term sole-source contracts and rocket technology is expected to grow both absolutely and as a share of the otherwise declining defense budget. This means that they have revenue and profit streams that are predictable and growing over any but the shortest time frames.
3. Pricing power, large deferred revenue accounts, and healthy growth suggests that free cash flow should grow at a rate of 10% or greater for quite some time.  
4. GenCorp’s financial statements are burdened with GAAP costs and liabilities that overstate actual future cash claims on the company: some 85% or so of the pension costs (and liabilities) and environmental remediation costs (and reserves) will be borne by the federal government.

So, pulling these threads together and using what I think are conservative parameters – a discount rate of 10%, no synergies to be retained by the company, revenue growth rates between 5% and 10% – it seems to me clear that GenCorp is a bargain.

That its fundamentals are uncorrelated with macro currents makes it an attractive addition to my portfolio. The suggestion that GenCorp’s management, in residence since 2010, will be more communicative in the first half of this year holds out some potential that its intrinsic value will be recognized sooner rather than later.

Other write-ups:

Seeking Alpha

ValueInvestors Club

Disclosure: I am long GenCorp

Enterprise Group Inc - Energy & Infrastructure Services

Enterprise Group Inc. (traded in Toronto under the ticker “E”) is roll up of service and equipment leasing businesses serving the energy, utility and construction sectors in (mostly) western Canada.

As it stands today, it consists of five businesses - TC Backhoe,  Calgary Tunnelling & Horizontal Auguring, E-One, Arctic Therm and Hart Oilfield Rentals.

This is an opportunity that reminds me a little of XPO Logistics and, as I did in that case, I'll let Enterprise's  management narrate the investment case. This is the VP:

“We are a “growth by acquisition” company, but our target acquisitions – the absolutely critical makeup of an acquisition – has [sic] to be a company that is unique, that is in a competitive landscape that is not highly populated. So the uniqueness contributes to the fact that the competitive landscape is thinly populated. 

For example, the acquisition we made in September of 2012, flameless heating operations, (Arctic Therm) – they are the developers and patent holders on the large units. There is no other company like it on the planet. There is some competition out there in the availability of smaller units, but no competition in the large unit space. 

In June of this year [2013, ed.], we acquired Calgary Tunneling, which is a company that, again, very specialized, construction disciplines. There’s only five major capacity players in all of Western North America. So it’s a very lightly populated landscape for us. Margins are very good in both these businesses I have talked to you about, very good.

So those are the unique opportunities. Our strategy is to service the three segments that are important to us; that’s infrastructure, energy, and utility. Back in 2008, we were primarily oilfield focused, so when the oilfield went into a deep recession, we were completely reliant on that one segment. 

Just prior to the downturn in 2007, we acquired TC Backhoe & Directional It was part of our strategy to diversify our revenue stream, but it was a very good thing that we acquired that business going into the downturn, because their clients are mainly premier utility providers, that business made a million bucks a quarter while the other side was losing a million bucks a quarter. 

It opened our eyes to that utility segment as a much more stable environment. The reason why is - let’s be honest – these utility providers need to stand in front of a regulator when they need increases. So if they don’t spend any money, the regulators will see it on their P&L statements and they won’t give them the upgrades to increase their rates to the consumer. The utility segment maintains a fairly steady diet of construction and maintenance and we wanted to make sure that we were operating and servicing segments that weren’t just energy services, it needed to be across the infrastructure, utility, and energy services. 

Now, the new acquisition, Calgary Tunnelling and Augering, is a tremendous example of this. They service a great deal of infrastructure, utility, and energy services, and what we are really excited about is the long distance large diameter pipeline roster for construction looking forward the next three to five years is just outstanding. It has never been as rich as it has at this point looking forward.
With respect to Calgary Tunneling & Augering, and pipelines, they perform all the underground crossings for these major pipeline routes. 

For example, Kinder Morgan, I use as an example because the pipeline went through the Rocky Mountains and they did all the tunneling for that Kinder Morgan Anchor Loop, that went from Alberta, through the Jasper National Park, all the way down to the Vancouver harbour. 

At the moment they are on a three year pipeline build-out from North of Fort McMurray, all the way down South to the Enbridge liquid storage facility in Hardesty, They are tunneling all of the crossings. 

These crossings are usually roads, highways, or any other obstacle that you can’t trench through, you have to drill and basically cut a tunnel underneath the obstacle. 

So with the amount of pipeline build-outs that is in front of us, Calgary Tunneling is just terrifically positioned. 

The other example on the infrastructure side, most of the airports in Alberta, everything from Grande Prairie, Edmonton, Calgary, Fort McMurray, they are all going through massive expansions, Calgary’s airport is going to nearly triple in size. And Calgary Tunneling are doing a series of very technically difficult tunnels inside of the airport property right at this moment. The Company was also recently awarded a tunneling project at the Vancouver International Airport which should kick off in the coming quarter. 

CP & CN Rail Companies utilize their expertise as well. Much of this flooding that’s happened here in Western Canada all the way from British Columbia and into southern Alberta, all of those frontier areas where the rail lines are passing through, all of the culverts, both rail lines have to maintained and running clear.
You have to appreciate that many of these rail lines are built into an incline, on the sides of mountains, and you get lots of loose material when there’s heavy rains or melting and they clog up or damage, and sometimes completely wreck these culvert passes. So that’s the kind of work that we have been doing with the major rail companies. 

There’s an old saying in the auction business that “you make your money when you’re buying”. In other words, the key to a profitable enterprise is not paying too much for your input materials. In the case of Enterprise, management is keenly aware of that maxim and adheres to it religiously. 

“It’s important to note that we view it as absolutely necessary – it’s our discipline – that we do not pay any more than three times EBITDA for a company.”  

“You will see that our average of all our acquisitions is around 2.5 times EBITDA, we haven’t paid higher than 2.9 times EBITDA. 

And the reason why that’s important is that we believe that as we are a publicly traded company a good market may pay, and I am not convinced we are in a good market of course, but in a good market we may get 5.5-8 times EBITDA trading multiples. 

Well, if in a good market you are going to get 5.5 forward, then we have got to buy our deals under a 3 multiple. Our acquisitions are usually privately run operations. 

If you are a smaller private company operating regionally in Western Canada, there is a wholesale price and a retail price, and we feel that our shareholders require a bump. And if the vendor of the acquisition is interested in participating in a larger multiple, then that’s where we say, here’s where you need to take some of the price of the acquisition in shares of the company, so in the future you can achieve higher multiples, by the fact that there’s five other profitable divisions helping the price of Enterprise Group. 

We have been very successful in getting our targets to see it our way. You need to sell off your business between two or three times EBITDA, and you know what, you can get — for a portion of your proceeds you can get that 5.5-8 times EBITDA in a good market if you take some shares. We have been very successful at it. Calgary Tunneling was done just over two times EBITDA. 

“We have three targets at the moment [May 2013, ed]; two of them are at a certain level of dialogue. We would expect that one of them may close inside of this calendar year. 

Obviously growth is what we’re after, and again, the profile of a target company that we look at, it must have the market ability to be able to double in size within a short period of time, preferably in two or three years. If it lacks the potential to double in size in a short period of time, it’s not worth our opportunity.
Calgary Tunneling is a typical example. The proprietor who has ran this company, was very selective about which projects to complete. He was just taking enough work to match how busy he wanted to be, a lifestyle match if you will.
There was a meaningful amount of business that he could have gone after. He was quite risk adverse. 

So now that we have completed the acquisition there are several drivers that will increase the revenue here. We are going to look at those projects that are $3 million to $5 million because we have no problem bonding them. We already have bonding levels that are at these levels. So we will take on that business going forward. 

Every company we have bought, management signs on for five years. Not only had the manager/owner sign on for five years, but because his operations are so specialized, we had six key employees that were essential expertise also signed five year employment contracts."

Missing from the above monologue is Hart Oilfield Services, an acquisition that was closed at 3x EBITDA a week or ten days ago.

This is what the numbers look like to me:

If management is successful in continuing in this fashion, and if they can get 5.5x EBITDA in a sale at the end of 2015 (implying a 12% FCF yield to the buyer), this is what the valuation scenarios may look like:

Management presents its own calculations here.

There are newly issued exchange traded warrants ("e.wt") for the purchase of the common stock at a price of $1 at any time before the end of 2015. They were trading at 7 cents when issued and are at 15 cents now. After some dithering between the the common and the warrants, I've settled on the latter.

There are some things not to like about this opportunity. For one thing, other than Artic Therm, the acquired businesses are not so special. For another, this is the sort of opportunity that has all the appearance of message board bait, which I don't like. And, these fellas, as far as I can tell, have never done a roll up before whereas Bradley Jacobs was an old pro.

On the other hand, it seems to me that the downside risk is low and, if management can acquire another reasonably okay business at 3x and if the western Canadian pipeline construction, urban development and oil sands activity don't all come to a simultaneous halt, things should work out okay and in a timely fashion.

Useful supplemental resource

Disclosure: I am long the warrants  

The Year in Review

In the end, 2013 looked like this (I have scaled the numbers to a beginning net asset value of US$100,000):

Security	Value	Gain	Return	Days held
Precia	6,819	1,609	23.6%	202
XPO Logistics	15,063	(183)	-1.2%	38
Northgate Plc	9,013	540	6.0%	120
Hawaiian Holdings (equity)	24,530	11,104	45.3%	364
GEA	12,020	1,063	8.8%	13
Northgate	14,636	11,992	81.9%	337
Cybergun	3,290	(1,086)	-33.0%	343
Lamprell	13,695	2,767	20.2%	213
Conrad	6,195	2,604	42.0%	177
Cybergun 8% bonds	14,007	18,075	129.0%	45
Hawaiian Holdings (equity)	10,018	1,374	13.7%	114
Consciencefood	7,521	69	0.9%	132
Epicentre Holding	9,001	(222)	-2.5%	201
Emeco	5,065	675	13.3%	104
Emeco	4,174	2,969	71.1%	62
Emeco	14,777	1,613	10.9%	124
Unitek Global Services	2,897	602	20.8%	13
Axia Net Media	11,052	1,103	10.0%	6
Hawaiian Holdings (calls)*	6,561	8,103	123.5%	134
Alaska Comm Sys	8,515	(1,282)	-15.1%	104
Republic Airways Holdings	5,143	303	5.9%	22
The Dolan Company	5,773	110	1.9%	72
Mayur Uniquoters	13,483	9,986	74.1%	104
Zytronic Plc	7,117	1,416	19.9%	21
Lombard Risk Management	9,040	616	6.8%	65
Republic Airways Holdings	11,697	303	2.6%	54
"Reserved"	15,038	1,666	11.1%	22
Lamprell	11,112	681	6.1%	4
		78,573
Tax Liability		(15,189)
After-tax Gain		63,384	63.4%
Average Cash		22,589	16.3%
S&P 500			31.9%
Performance relative to S&P 500		+	31.5%

and was experienced in this way:

Much of the year was spent trying to undo mistakes made in the back half of 2012. My posture on January 1, 2013 was not up to the task of keeping up with a bull market and, absent some fixes, would have resulted in a disappointing performance (again, the values are scaled to a start of year net asset value of $100,000):  

	Cost ($USD)	Gain ($USD)	Return
GEA	11,376	1,415	12.4%
XPO Logistics	17,349	9,046	52.1%
Northgate Plc	17,058	11,943	70.0%
Hawaiian	26,912	12,534	46.6%
Cybergun	2,949	(1,182)	-40.1%
Precia	6,383	1,808	28.3%
		35,564
Tax Liability		(5,335)
After-Tax Gain		30,230	30.2%
Average Cash		17,973
S&P 500			31.9%
Relative Performance			-1.7%

In any case, I've shifted things around enough that I am reasonably satisfied with how I am currently positioned:

The best laid schemes of mice and men / often go awry. Still, I suspect that there's enough wiggle room in there to see me through to a doubling of NAV within two years. Being explicit about the risks, catalysts and price targets of the portfolio-as-a-whole is a useful exercise that I should have engaged in this time last year but didn't.

And I'm still holding too many names but I hope to reduce the number down to four or five within a few months.

Happy New Year.

EDIT (January 3): It has been suggested to me that the "tracking portfolio" page is not particularly illuminating, not least since it doesn't correspond to calendar years. I agree & I've adjusted it accordingly. Also, I've taken the opportunity to reduce the number of holdings by selling out of Republic and Alaska Comm Systems. 

UK Portfolio 2014

The Premise

This is what I tell myself:

If, in the medium- to long-term, the prices of financial assets gravitate toward their underlying values it is because active investors identify mis-priced securities and buy them. Stock-pickers, in other words, are the invisible hand. 

And, within the set of stock-pickers, private investors enjoy important advantages over professional fund managers: (1) we have a wider range of equities to choose from; (2) we have the option to concentrate on our best ideas and to exclude our worst ideas; (3) we can refrain from buying stocks that we simply don't understand; (4) we can weight the components of the portfolio on a risk/reward basis (with special attention to risk) rather than on a volatility (or tracking error) basis; and (5) we can choose a time horizon of our liking without fear of the sack if we under-perform in the short-run; (6) we can invest according to any so-called "style" -- asset based, GARP, distressed, arbitrage, etc. And, most importantly, (7) we can't afford to blow up whereas, in many cases, they can.

If the above differences are indeed advantages, it follows that the success in investing comes from exploiting them to the extent that one can:  Don't blow up, ever (rule #1). Look everywhere, size-wise and geographically. Don't be a prisoner of a particular "style" of investing if you don't have to. Concentrate on your best ideas and weight them according to safety first (see rule #1) and potential reward second. Don't buy anything whose downside you haven't fully grasped. Choose an investing horizon that suits you and ignore volatility and tracking error in the interim. 

Grasping the whole story and the extent of the downside is, I think, a matter of practice and of effort, the rest is a matter of acting responsibly. 

Review of 2013

In line with the reasoning above, last December I constructed a model UK portfolio that I thought would outperform the FTSE 350 by at least 20% over this past year -- ~20% outperformance being, I think, reasonable compensation for exploiting the advantages listed above.

This was the outcome of the experiment in its first year:

There are a couple of errors of judgment in those picks and, if I had to do it over again, I would leave out the cyclicals (Dewhurst and Creston) and stick with the five "either-way" picks. (Or, if I were to include cyclicals I should have gone all the way --i.e. very cyclical and levered, like the construction companies.)

2014

In this the second season of the great British bake-off, I've constructed a model portfolio that looks like this:


Again, I hope for (and expect!) year ahead returns that are at least 20% higher than the performance of the FTSE 350 and, to repeat what I soothsayed last year,  two-year returns that comfortably exceed that of any statistical strategy tracked by Stockopedia. 

I have previously written about Lombard Risk, Howden Joinery and Lamprell. I was introduced to Quarto by Lewis and to International Greetings by Richard. Senior is a wonderful business (moat, return on capital, long term secular growth, visibility, safety) that is obviously undervalued at 16x trailing earnings. And Creston is (still) in the portfolio because I'm being stubborn. 

They're all mis-priced in one way or another. One way of looking at Quarto, for example, is as follows:

And from that perspective, a market cap of £33 million may be too low for what is, after all, a stable, profitable and growing business. And, if you believe that Quarto has begun a serious effort to de-lever its balance sheet then you may be able to envisage £10 million in annual reductions in debt plus $2.5 million in dividends that, together, return ~38% to Quarto's shareholders each year, without a re-rating of the multiple.   

Please remember to do your own research and use your own judgment. It is entirely possible that I have no idea what I'm doing.

Disclosure: I own shares of Lombard Risk and I have sold out of Northgate

Judges Scientific II

I wrote about Judges Scientific last year.  The stock is up quite a bit, yes, but is still a bit misunderestimated

It is trading at ~13x its underlying earnings even though the company has been reinvesting most its retained earnings at  37% rates of return.



The acquisition of Scientifica doesn't show up in the last interim financials. That could be why.

Disclosure: No position

Republic Airways Holdings - Contract Airline

There are few mysteries to this idea. RJET was once an entity operating two different businesses, (1) a nascent, branded low-cost airline, and (2) a contract carrier. The branded airline ("Frontier") was bleeding cash, has since healed, and is in any case to be sold in this quarter.  The price has more or less been agreed and, after all is said and done, the sale will add ~$75 million in net cash to the parent's balance sheet.

What will remain of RJET - the "Republic" segment - transports passengers on behalf of the legacies under contracts that see it compensated by departure. Fuel is a pass-through cost and Republic gets paid the same irrespective of how empty or full the flight.

The Republic segment's profile looks like this:

  
There are a couple of uncertainties: the American/USair merger may decrease demand (i.e. departures) slightly as the number of hubs is reduced, and the outcome of the labor agreement negotiations with its pilots may knock two percentage points off current run-rate EBIT.

So, at the low end, one might reasonably expect run-rate EBIT of ~$180 million less interest expense of $110 million for earnings of $70 million on a market cap of $500 million. (There are a billion dollars or so of useable NOLs, so RJET won't be paying taxes for a while).

The company will also have ~$270 million in cash at the end of the year, after the sale of Frontier and, given the strong cash flow generation from the business, it seems to me not unlikely that, say, $50m to $100m of that is paid out in the form of dividends.

Disclosure: I'm long RJET

Mayur Uniquoters - Artificial Leather

Mayur Uniquoters (“Mayur”) is an Indian manufacturer of (PU and PVC) synthetic leather.

Belts, shoes, wallets, jackets, handbags, sofas, motorcycle seats, steering wheel covers – leather and its substitutes have a long list of applications. 

Leather itself, however, is expensive, in short supply, pollutive, and in any case subject to some ambivalence in a majority Hindu country. If one has been to India, however, one knows that there’s nevertheless plenty of leather about. It is only recently that synthetic (polyurethane) leather has been able to mimic the real thing well enough to have gained acceptance as a substitute for it in the range of consumer products listed above.

The synthetic leather industry in India is, as one would expect, largely fragmented. The so-called “informal” sector accounts for half the market and the “formal” sector consists principally of Jasch Industries, Fenoplast, Manish Vinyl, V.K. Polycoats, HR Polycoats, Polynova Industries, and Mayur itself.  Jasch and Fenoplast are listed; V.K, HR, and Polynova are private, and Mayur is by some distance the largest of them all.

This is how the listed companies compare:

It is not hard to see, then, why Mayur has done well over the years. It makes more synthetic leather, faster and cheaper than its competitors. It can undercut them on price and it can deliver in greater quantities. It has the broadest client vase, the lowest cost of capital, and the cleanest balance sheet, and is therefore positioned as the most reliable supplier to the major consumer goods manufacturers up the value chain. 

Big orders mean greater capacity utilization, lower average cost, a larger and more diversified customer base, faster lead times, bigger orders, even faster asset turns, even lower costs and so on -- the classic hallmarks of scale economies. 

Once Mayur had reached a tipping point (in 2008-2009 as it happens), it was always going to take yet more market share. 

No wonder, then, that Mayur’s last ten years of performance look like this.

Figures are in 2003 Rupees, i.e. adjusted for inflation

Its share price is up 30-fold since 2009. (Nobody wanted it then, even at a dividend yield of 25%).

Figures are in nominal rupees.

As it stands today, half of Mayur’s revenues are attributable to footwear. The Indian footwear industry is the world’s second largest and the Indian footwear market is the world’s third largest. The “formal” sector accounts for nearly 25% of the domestic market and consists of a handful of large players – Bata India, Relaxo Footwears, Liberty Shoes, Action, Paragon Footwear, and the VKC Group (all of which are Mayur customers and the first three of which are listed). 

Let's focus on Bata because it is the largest, because its production is entirely directed toward domestic consumption, and because it sources 75% of its synthetic leather from Mayur. 

This is Bata:

Figures are in 2003 Rupees, i.e. adjusted for inflation

Bata India trades at 35x earnings on the sensible assumptions that (a) the formal footwear industry will increasingly displace the informal manufacturing sector; (b) India's economic growth rate over the next twenty years will exceed that of the mature economies; and (3) Bata's competitive position (branding, experience, distribution network) will see it share in this bounty.

Auto

Motor vehicles of one kind or another -- scooters, passenger cars, SUVs, tractors -- contributed to 35% of Mayur's 2013 revenue. It is the number #1 (and very occasionally #2) supplier of artificial leather to each of the above. It is likely that there will be more motor vehicles in India ten years from now and that Mayur will profitably capture a healthy share of that growth. This year and next it will add GM, Mercedes and BMW to its roster of significant customers, thereby venturing further into the global market.

The last two years has seen Mayur investing in capacity to address this future demand. It has increased its production capacity, of course, but it has also taken steps toward backward integration, allowing it to control the availability of good quality knitten fabric (from which artificial leather is manufactured), thereby reducing the rejections rate and increasing gross margins. 

Mayur pays out every rupee of earnings not reinvested for growth, and its growth investments are repaid within two years. It is 75% family- and insider-owned and has always treated minority shareholders fairly.

One doesn't have to rely on the consensus projections of 20% per year growth in Indian artificial leather demand to suspect that Mayur is good value at a 10% enterprise yield.

This is a high conviction, long-term position and I've sized it accordingly.

Disclosure: I own this one.

(November 17th 2013. Note: I started drafting this at the end of August. The share price has advanced a little since then. It wouldn't be out of the question that the taper, whenever it comes, could provide a (perhaps much) more attractive entry point. The headache is in setting up a brokerage account in India and how to do that is googleable).

An Update on Emeco Holdings

Some news from Emeco this evening/morning:

"Emeco Holdings Limited (ASX: EHL) ('Emeco' or 'the Company') today announced the amendment of two financial covenants under the A$450m Senior Debt Facility, (the "Bank Debt Facility").

Emeco remains in full compliance with its current covenants. Amendments to the Gearing Ratio (Gross Debt: EBITDA) and Interest Cover Ratio (EBITDA: Net Interest) covenants were sought to provide the Company with additional flexibility and headroom and to provide balance sheet certainty while it pursues the debt reduction strategy in FY14.

Amendments will apply for the period to 30 June 2014 at which point the covenants will revert to current levels under the Bank Debt Facility. As previously announced to market, Emeco will not pay dividends or pursue other capital management initiatives prior to 30 June 2014, and has extended this commitment to providers of the Bank Debt Facility during the period to 30 June 2014.

Current and amended ratios are as follows:

	Current Covenants	Amended Covenants3
Gearing (Gross Debt : EBITDA1)	<3.0x	<3.5x
Interest Cover (EBITDA : Net Interest Expense2)	>4.0x	>3.5x

1 - Rolling 12 month trailing Operating EBITDA

2 - Rolling 12 month trailing Net Interest Expense

3 - Amended Covenants apply to the USPP Notes

Other key terms of the Bank Debt Facility, including pricing, remain unchanged and Emeco retains full access to the Bank Debt Facility. Emeco did not incur any fees or charges from providers of the Bank Debt Facility in connection with the amendment.

Emeco is focused on reducing debt and continues to generate strong cash flow with net debt reducing by
$25m in the first quarter from $415m at 30 June 2013 to $390m at quarter end. Through the combination
of further cash flow generation, working capital release, asset disposals and lower capex, Emeco will deliver further reductions in debt through FY14.

Stephen Gobby, Chief Financial Officer, said "We have been pleased with the cash flow performance of the business this year despite the tough operating environment. Our focus remains on maintaining strong cash flow over the balance of FY14 in order to further reduce debt and ensure that the balance sheet of the Company remains robust."

-----

This is a cash flow story: a bad business environment means Emeco sells off its inventory to generate cash flows; a good business environment means it rents out its inventory to generate cash flows. Emeco's rental fleet is best understood as inventory, which means that Emeco is, among other things, a "net-net".

Addendum November 20th:

An update and clarification of sorts. There's a post on this name at Alpha Vulture and the company has very recently guided between $90 and $105 million in EBITDA for FY 2014. Given that Chile and Canada account for $45 to $50 million of EBITDA, $90m in consolidated EBITDA means that Australian utilization rates have fallen off a cliff, to a third of 2012's figures and a sixth of 2011 figures. 

Alright, so this is where margin of safety comes in to play. 
--> Emeco needs to keep debt below 3.5x trailing consolidated EBITDA.
--> 90 million in EBITDA implies 40% to 45% utilization of its 813 machines
--> which means that it can sell off some of those machines 
--> so the question is, at what discount to book it will offload them.

Here's a sensitivity table relating cash flows from operations, net disposals, and discounts to carrying value on the one hand, to Debt/EBITDA ratios on the other:

Projected DEBT/EBITDA Ratios:

assumptions: operating cash flows = $90m EBITDA minus $30m capex mins $29m interest.

Can Emeco sell 2 machines a week at 40% discount to book? I think it can. And if it can, then you may consider that at the end of 2014 liquidation value will look like this:

That's why I'm long the stock. This is not Caterpillar. I should say that I'm a true believer at this point and I suspect that the conversation at Alpha Vulture would be more nuanced than anything I have to add.

Disclosure: I own shares in Emeco

The Dolan Company - Law Services

It turns out that The Dolan Co. has been written up a number of times since I bought it so there's likely no reason to repeat what has been said here and here.

In brief, Dolan's a cross between The Daily Journal and Epiq Systems, but levered. It has mostly disposed of its unattractive operating units and is now in a position to generate somewhere between $23 and $25 million in free cash flow. There are covenant issues and management is in the process of negotiating these with its lenders.

Disclosure: I own a piece of DM

Update: November 8, 2013

I'm out of DM. This development adds an element of risk that I'm not comfortable with. (I no longer feel as though I have grasped the entirety of the narrative; that's the worst kind of risk to take on). There are other, clearer opportunities with similar upsides. Next week's quarterly conference call should provide clarity on the company's plans for raising the $50m.

Lombard Risk Management - Enterprise Software

Lombard Risk Management (“LRM”) develops risk management and regulatory compliance software and licenses this software to financial institutions. 

Risk Management

The risk management business is long established and consists mainly of COLLINE, a collateral management product, and OBERON, an institutional trading software product. 

When banks and businesses lend to each other some kind of collateral is often required in order to reduce counter-party risk exposure. The types and varieties of collateral have become ever more complex over time. “COLLINE”, Lombard Risk’s 10 year old collateral management product, helps lenders keep track of these. COLLINE is licensed to about 50 financial institutions – including Northern Trust and Société Générale – and is probably the leading product in its niche. 

OBERON is software for processing, valuation and risk management of trades involving interest rate and inflation derivatives, currencies, and money market and fixed income securities. Its pedigree is longer than COLLINE's and dates back to 1996, is accordingly well-established. Mature enterprise software products tend to be characterized by stable revenue streams and high margins, and management reports that OBERON enjoys just that.

In any case, the Risk Management segment looks like this:

Regulatory Compliance

Regulatory Compliance is the segment that presents LRM with strong, sustained growth opportunities as the regulatory directives such as COREP & FINREP, Dodd-Frank, EMIR, Basel III's CRD IV and CRR, and so on, take hold in the immediate and medium terms. 

Needless to say, reporting requirements are about to become a great deal more complex and comprehensive than they were, and Excel and scratch paper will no longer cut it.

COREP: 10x times the data

LRM, already the leading provider of compliance and regulatory reporting software in the United Kingdom (and among foreign banks in the US), stands to benefit. 

That it stood to benefit was not so obvious in years past, at least to me: the very complexity of the reporting requirements may have led one to reasonably suspect that financial institutions would call in the Accentures and the Moody's Analytics of this world who would then sell their partners' or their own software solutions, leaving LRM out in the cold. It hasn't turned out that way: LRM is taking share and is signing up new clients at a fast clip. 

This is what the Compliance segment looks like:

Looks measly doesn't it? That's where the opportunity comes from.

LRM (along with most enterprise software companies) reports revenue on a percentage of completion basis and the finalization of the COREP/FINREP regulations was delayed by 9 months to January 1st 2014. Lombard Risk's fiscal year runs from March to March, so the revenue recognition from the clients won thus far will be mostly recognized in the second half of the year. 

The Big Picture

There is, at the same time, a great deal of operating leverage at work: ~75% of the company's current costs are fixed meaning that incremental revenue above, say, 9.5 to 10 million largely drops to the bottom line. This is what the operating leverage looks like on a consolidated basis: 

and this is what the consolidated income statement should more or less look like:

We know that the company is more than half way through its major software development program, so we can deduce that capitalized development expenditure will look like this:

and free cash flow will look something like this:

Management

It is clear that LRM's sweet spot is at the junction of risk and compliance and management is therefore in a tricky, game-theoretic spot. It would like to see itself as a consolidator in that specialty and is evidently averse to debt. It would therefore like a strong share price as  currency for so-called "tuck-in" acquisitions and it is perhaps this that has led them to talk up the value of the company -- not quite to the point of vulgarity but not far from it, either. 

In any case, I don't doubt that, in the final analysis, they could sell the company for two or three times its current valuation if they chose. (IDOX, after all, was spun out from LRM; they are no strangers to the M&A market). 

Value

LRM is worth more than its current market cap. Given its growth profile, 5 year contracts, and 95% client retention rate, 10x 2016 EBIT is probably at the low end of fair value, giving the shares a reasonable 100% to 150% upside.

Disclosure: I own some shares in LRM