Following Up on Enzon (ENZN)

Enzon published their annual 10-K filing after the close on Friday. Royalty revenue has been drying up much faster than management anticipated in their 2015 filing. They expected $9m in revenue for 2016, and received closer to $8m. They had forecast $29m in revenue at the start of 2016 (or $20m from 2017 thru 2021), and as of 2017 they now expect to receive $10m, implying that they reduced their 2017-2021 forecast by half from $20m to $10m in revenue. Additionally, Merck notified ENZN that they had overpaid and will be reducing future payments to account.

The Nektar court case is still moving along, so there is still upside revenue potential there. Additionally, Shire is in Phase III with its calaspargase pegol development (referred to as SC Oncaspar by Enzon). So the upside potential still exists for one-time milestone payments of roughly $15 million triggered by European and U.S. FDA approvals.

My guess is the stock will trade down closer to $.20-0.25 in the near-term. I closed out of my position at -20%. Thankfully was never very big to begin with and the accelerating decline in royalties seems much faster than anticipated. The company still likely has $15-25 million in royalties, but expenses remain high, and as less than a 1% position, it’s not worth the hassle.

From a learning standpoint it was helpful to learn more about liquidating trusts and the associated taxation of distributions.



Norsat International Acquisition Likely But For How Much?

Last Monday I purchased shares in Norsat International, and so far I’m up 22%. The story is evolving faster than I had anticipated…

NSAT is a small Canadian manufacturer of satellite components, and yet another stock which was trading at very cheap multiples (6x EV/EBITDA,  1.3x Price/Sales, 1.2x Price Book, very little debt)  due to negative investor sentiment towards the satellite industry in general. Norsat specializes in custom, rugged, portable satellite equipment. I have some (small) experience using satellite equipment myself from the military. Compared to cell phones or landlines, satellite is far from perfect in implementation, but also far better than nothing at all.

Viasat’s aggressive new Ka band satellite launches have been turning up the heat on an already precarious industry. Bankruptcies and mergers still loom for satellite providers due to a lot of satellite oversupply coming onto the market. More competition between Ka and Ku band providers should result in lower costs of renting satellite bandwidth, which is a good thing for satellite customers, and ultimately, the manufacturers making the equipment to connect to the satellites. Consequently, NSAT is showing solid EBITDA and margin growth as they roll out Ka band equipment alongside their existing Ku gear.

Norsat had suffered from poor management and lack of profitability about a decade ago before bringing on CEO Aimee Chan, who has cut costs and swung the company back to the black. About 6 months ago the firm published a press release stating that it had received multiple buyout offers, including one from Privet Fund LP for $8.00. I was surprised to see a company which had such good upside optionality only trading at $8. Privet had taken a 17.6% stake in the common shares, which perhaps convinced investors that this was a done deal, but it is often the case that companies receiving buyout offers trade through the initial offer price. The valuation multiples I mentioned above along with the emphasis on the phrase “multiple offers” piqued my interest further. I made this a mid-sized position at $8.

The stock shot up on Friday after Privet Fund raised its initial offer from $8/share to $10.25/share. Given the aggressive interest from Privet I am a bit puzzled about why the stock is only trading at $9.80 as of the end of close Friday. At 8x EV/EBITDA NSAT is no longer what I would define as cheap, but it isn’t rich either. I plan to keep holding for now.

Oh also, please note the following news about Duke basketball.

Rock Chalk!

After Running Up 69%in 4 Months, Selling WLDN

We must all suffer one of two things: the pain of discipline or the pain of regret or disappointment. – Jim Rohn

Be fearful when others are greedy. Be greedy when others are fearful. – Warren Buffett

My best performer for the past 4 months, Willdan (Ticker: WLDN) might also end up being my biggest regret for two reasons:

  1. My initial position was in too small a size, about 0.05% of my portfolio.
  2. Momentum could carry it further.

I bought in November soon after the election when it became clear that infrastructure was going to be an actual priority. WLDN had been growing a lot and wasn’t expensive for the growth at the time. So I took a small position around $19/share and sold after last week’s earnings report at $33. The earnings results themselves were fine and the company sounded solid, but the multiples have blown up on this name.

My initial decision to research WLDN came from this write up. I didn’t know much about the company going in, but similar to my other small bets (VG, RSYS, TSL, and RDCM), my intention was to start small and add to the winners. This one got away from me, and at a TTM EBITDA of 20x, a Forward P/E of 25x and no defensible moat that I can see, I can’t justify holding on. I have to obey the iron law of valuation, even/especially when it’s tempting to say “but this time is different”. So I’ll choose the pain of discipline – look for other stocks with more attractive intrinsic valuations, and size my initial position appropriately.

In the short-term I think WLDN may go higher still, and if I had a larger position to begin with I could have trimmed rather than exiting. Lately I’ve been working harder to start every position with no less than a 3% position, which should help me to avoid having to bail from another runner like Willdan earlier than I would like.


Trina Solar (TSL) Deal Closing – Up 18% in 3 Months

Bank of New York Mellon which handles the ADR shares of Trina Solar appears to be finalizing the all-cash TSL self-buyout of the U.S. based shares. I am up 18% in the 3 months I have owned it compared to a 5% gain for the S&P 500.

This investment worked in part because the valuation was so cheap that I was never sweating getting stuck with the TSL shares if the deal fell-through. The price was well-supported by a valuation floor, which poses a sharp contrast to my Rite Aide debacle. Trina Solar ADR shares were trading at single digit valuation multiples as recently as a month ago. I felt confident that Chinese regulators were not going to block the Chinese founder of his company from buying back his own US-based ADR shares. So when the stock was selling off due to vague macro fears of a Chinese capital outflow clampdown,  I bought. Disgusted and exhausted U.S.-based investors had discounted the likelihood of the deal closing.

It is interesting to see Berkshire Hathaway now doing the same style investment in Monsanto, a stock founded on low valuation but which includes 12.1% of upside M&A optionality if the deal closes. To me this lends credence to my initial thoughts about M&A investment back in the fall. Many of the regular risk-arb M&A firms chose to sit on the sidelines rather than take on some of the riskier M&A deals available without considering the cheap-to-fair valuations of the pursued companies.

My portfolio is getting more manageable at 25 stocks. For anyone interested in M&A arbitrage spread ideas, two great resources here:



1Q17 Portfolio Update – Sizing Up While Slimming Down

Doubt is not a pleasant condition, but certainty is absurd. – Voltaire

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so. – Mark Twain

I generally don’t like to measure performance by quarter as it leads to short-termism, but this quarter has been a good one. Facebook, WLDN, Dell, Charter, and CSAL/UNIT have all had strong 3 month rallies of >15%, but I’ve still had too much cash sitting on the sidelines, between 5-15%. So, I’ve decided to ignore the macro for the most part, and focus on deeply undervalued names. This portfolio is meant to compose of my most compelling investments. It’s not supposed to have a macro view and I can always pull more cash from savings into the account if a real market crisis/opportunity emerges. This doesn’t mean I won’t hold cash, but from here on out, I plan to keep it within the 3-5% range. While valuations *could* be high right now, I find little certainty in macro opinions.


Slowly rotating from passive to active has been a challenge. Owning part of a going concern entails hours of research, but I’m getting more comfortable with the names I own. As I started researching new stocks initially, I spread my bets with several small positions in names like LVLT, TSL, RAD, RDCM, GSAT, Dish, ESOA, T-Mobile, Dell, and RSYS. Some panned out (LVLT, ESOA, DVMT) and some have not (RAD, GSAT, VG). Thankfully, by keeping my riskiest allocations small, and selling after being down 10-20%, I’ve generally been able to limit losses, while sizing up the names I am more comfortable with like AOBC, HUM, CSAL/UNIT, DISH, and TMUS. My one big mistake recently was Rite Aid, a reminder that valuation is everything.

This activity has entailed a lot more trading than I can sustain over the long-term, and I’ve been focused on buying fewer small positions and getting more buy and hold value names into the portfolio.

As such, I recently added SBFG and CKFC, two community banks with low loan-to-asset ratios and price to tangible book values which should help them benefit in the event that interest rates rise. My hope is that I won’t really have to touch them for the next year.

I also added a shipping spin-off, INSW which appears to be at least 20% undervalued on a NAV basis (thesis here), and the ADR tracker for Actelion in the hopes of receiving shares in a biotech R&D spin-off for free (good summary here). Shipping in general I find to be a pretty “meh” industry. Biotech and pharma I do not fully understand, but I am seeing a lot of names pop up in my screens, and it seems like there are a lot of babies being thrown out with the bath water.

My goal is to run a portfolio of no more than 20-25 names at a time, which should enable me to stay focused and to avoid tracking the market.


ESOA- Buying More After Strong 1Q Results

  • ESOA posted solid year over year revenue growth, margin expansion, and EBITDA.
  • Management reached out to allay a few concerns some investors have noted about the stock.
  • At under 3x EV/EBITDA, 3x EV/OI, and > 10% EV/FCF yield run-rate, the company is undervalued.
  • The stock is worth at least $3, a 70-100% return from the current trading range.

Shares in ESOA have rallied 10% since my initial investment in January. The CEO was also kind enough to reach out to help rectify a few errors in my initial analysis. We recently circled back to discuss 1Q results and I have incorporated some of his comments with my own thoughts. Overall results were strong, and the stock is still very attractive relative to the market and to peers.

Operating Fundamentals Solid Across the Board

ESOA posted a very strong 1Q, in part due to contract timing, but also reflecting solid improvements in operating metrics.

Revenue of $37.5m vs $34.3m in the prior year.

Gross, EBITDA, and Net Margins all expanded by 100-300 basis points.

EBITDA grew 54% YoY to $3.2m with margins expanding from 6% to 8.4%.

Cash from Operations more than doubled, again partly due to the time of contracts, but definitely a strong start compared to prior years. The backlog of $81.2m was a bit lower than prior year’s backlog of $91.1m. Management believes that this is because there is less a sense of urgency than early 2016. Prospects look good for 2017 and beyond.

Infrastructure Thesis Intact

From my research it looks like at least 2 of the projects circulated by the current administration, and listed here could benefit ESOA. While I am worried about the protectionist bent of wording, such as insisting on American-made steel pipes, I think less regulation in general around pipeline and electrical infrastructure should be bullish for Energy Services of America. Management has also confirmed that some of these projects will run through areas which ESOA services. ESOA’s peers have traded up.

Four Details I Missed

  1. MRO =/= MPC. I mistakenly researched Marathon Oil, rather than Marathon Petroleum as a customer in my initial analysis. The linguist in me took those two words to be interchangeable. MPC is an oil pipeline focused company and in less danger than MRO of paying its bills. MPC recently announced plans to expand production in the Marcellus shale, which could be a good thing for ESOA’s backlog.
  2. A captive insurance company keeps insurance costs low, but also includes some tail risk which is hard to quantify here. To-date the captive insurer has consistently returned a small dividend (a few hundred thousand dollars) to ESOA.
  3. ESOA does not have a fiduciary responsibility for any of the several multicompany pensions to which it contributes, which lowers the risk from any sort of pension fund blowup significantly. I do not believe that ESOA would be on the hook for a significant sum of money.
  4. ESOA has a large dilution overhang which partly explains the lackadaisical share performance. A helpful Seeking Alpha user, Fijas, posted the following:

I think it should be mentioned that there are (dilutive) Series A Preferred units out. Per the December 2016 10-K, there are 206 preferred units out, which in total convert to 3,433,333 shares (16,666 shares per Series A unit). Page 9 states that they issued 56 of these units for debt forgiveness of $1.4mm, which implies a conversion price of $1.4mm / (16,666 * 56) = $1.50.For share prices above $1.50, the Series A pref should be considered dilutive. Given there are 14.8mm ESOA shares outstanding as of December 2016, you’re looking at 3.43 / 14.8 = 23% dilution above $1.50. Seems we can’t treat the preferred as debt, because most were issued to company insiders (they own 63% – see 2016 10-K page 35) and there doesn’t seem to be a liquid market for the preferred (therefore no obvious way for the company to buy them back). Also, the company is paying $309K per annum on the preferred (page F-3), which by my calculations is something like a 6% yield ($309K / (3.4mm underlying shares x $1.50 per share)).All told, this isn’t bad – the company had to make some deals to get out of forbearance, and 6% “convertible debt” in the form of Series A Preferred sold to insiders at least keeps management aligned with shareholders. Just thought it should be mentioned since the stock is hovering around $1.50 and 23% dilution is pretty material.

I think the biggest concern is #4. After speaking with the CEO, I believe that management is aware of investor concerns and will either redeem the Preferred Series A shares for cash or institute a share repurchase plan in the event of pending dilution.The calculation below should capture the full dilution. An important takeaway from our conversation was that the preferred shares are in fact, redeemable.


Even with full 24% dilution and no share buybacks my new valuation numbers are close to the old numbers. When something is this ridiculously cheap it takes a LOT of share dilution to make it significantly more expensive, and at 1.3x tangible book value, it starts looking pretty reasonable for the board of a company like ESOA to either redeem the preferred shares or repurchase common stock.

Why So Cheap?

Setting aside the dilution highlighted above, virtually no ESOA shares (<2%) are held by institutions currently, which may partly explain the low valuation. The company is “uninvestable” for many institutional investors simply because of its low market capitalization, OTC listing, and low share price. Management could lever up, buy-back shares, and/or make a few acquisitions to boost the company past the $50m market cap threshold, which would then begin to make it “investable” to smaller institutional small cap investors. Willbros Group (Ticker:WG) is an example of a slightly larger small cap stock at a $190m market cap which is >60% owned by institutional investors currently, and which incidentally has worse operating performance than ESOA. WG trades on the NYSE. ESOA trades over the counter currently. Over-the-counter stocks tend to trade at discounts due to illiquidity and an often unfounded investor bias that OTC companies are lower quality. So the game plan for management would seem to be either to buyback shares, do some M&A, and/or keep organically growing past the $50m mark, then re-list on a more “prestigious” stock exchange, which should engender more institutional investor interest. I am not saying one of these things will happen, but the potential exist for any combination, any of which should be good for the share price.

Another risk could be M&A. Acquisitions can be messy and often lead to the destruction of shareholder capital, so I don’t want to downplay the risk of M&A, however I feel pretty comfortable knowing that the Chairman in particular has a long and successful track record of wheeling and dealing businesses.

Factoring in Dilution, Stock is Worth 2x the Present Value

I am still learning the energy services industry, but I am a big believer that when a stock is so glaringly “stupid cheap” from a valuation perspective, good things will come. Many options exist for shareholder returns, and management interests seem to be aligned with common shareholders. The issues holding the stock back appear to be simply dumb market forces which haven’t caught up to the changing industry outlook, under-levered balance sheet, and strong company fundamentals due to the small size of the company.

Even after including the 24% share overhang this is a very attractive stock. Looking at comps like MasTec and Quanta, which trade at 10-13x EV/EBITDA currently, ESOA shares should be worth more than $3 after dilution.

Let’s disregard the stellar current quarter results, and assume a more conservative $10m EBITDA run-rate (only slightly better than 2016’s $9.4m. This is still well below the growth rate for the past 4 years since Doug Reynolds first took the reins. Using a $10m EBITDA estimate for 2017, the firm is currently trading at a post-dilution multiple of 3x EV/EBITDA. This is just blatantly undervalued to comps like PWR, MTZ, PRIM, and WG which are all trading between 11-13x. I should also mention that the run-rate EV/FCF yield is >10%, and that the TTM dividend yield was 3%. I also expect that management will continue some form of capital return to shareholders this year similar to the prior year.

I always hate getting the price down to a decimal point (false precision), so consider this more illustrative of my thinking than an actual estimate of the fair price.

Over the past 6 months peers have rallied 40%  vs ~8% for ESOA. Even discounting Energy Services of America a bit for being small, the stock should be trading at roughly twice the current price of $1.66, which would put it around a more reasonable 6x EV/EBITDA ratio, a 5% EV/FCF yield, and a dividend yield closer to peers at 1.5%.

Management does not sound interested in selling the company anytime within the next several years. I could be wrong here, but that is my perspective. I generally prefer companies that are willing to be sold rather than acquisitive companies, but I haven’t found much else that is this cheap in the present market. Given the strong growth prospects and rock-bottom valuation, I believe ESOA is a good buy and hold prospect with several options that should eventually yield strong shareholder returns in the years ahead.

I bought more shares over the past week, and made this a medium size position.


Closing out EarthLink in favor of CSAL. Exiting PayPal.

Every month or so I take a hard-look at my portfolio. In addition to exiting RAD, last week I closed out of EarthLink(Ticker: ELNK) and PayPal (Ticker: PYPL).

ELNK-WIN is Less Attractive than CSAL At Current Spread

EarthLink had appreciated a bit since my initial purchase, and while I still believe it is cheap, I prefer to play Windstream via Communications Sales & Leasing. With the deal spread between ELNK-WIN having narrowed significantly to <2%, I saw no reason to keep holding. I took my gains and exited. I prefer CSAL because it weirdly still pays a higher dividend than WIN, yet sits higher in the capital structure than Windstream stock.

These are the kinds of spin-out situations which Joel Greenblatt loves. Not only did WIN spin-out an entirely different investment industry classification (telecom -> REIT), but in doing so it went from being a mid-cap stock to a small-cap. This resulted in both stocks being undervalued significantly post-spin as investors hit the Nope button, likely due to size/sector fund investment limitations.

CSAL pays a 9% dividend currently vs triple-net REIT peers at 5-7%. WIN pays a 7.8% dividend currently.. despite sitting lower in the cap structure. This. Makes. No. Sense. I don’t know of any other REIT-Customer dividend spread quite like it. CSAL is also significantly exposed to WIN revenue, but if WIN were to go bankrupt, CSAL would still own the copper/fiber assets and should still be collecting lease payments throughout any bankruptcy process. Bond investors in Windstream do not appear to believe that bankruptcy is on the horizon currently.

A lot has happened in the REIT space with the REITS now designated as a separate sector within Financials. As REIT-focused funds get more comfortable with CSAL we should eventually see solid share price appreciation, offset by some potential interest rate hike headwinds. I consider CSAL to be relatively macro safe. If the economy turns South, people will still need internet and telephone service. They are much more likely to stop buying new clothes and computers than to stop what is effectively a utility these days.

With interest rate rises lurking in the horizon, and CSAL being a very unique REIT I think it could be another 1-2 years before the stock achieves a fair value. To the extend that CSAL can minimize WIN exposure through further deals, that should be good for the stock, but management has been cagey there. I’m willing to sit back and collect the 9% dividend in the meantime. It is currently one of my largest positions.

PayPal Operating Momentum is Slowing, Deals with Credit Card Holders is Meh

PYPL operating momentum appears to have slowed a bit year-over-year, and having gained 23%, I am happy to exit. I think the deals last year with Visa and MasterCard were only so-so, and while recent AMZN news could be good, I suspect Amazon will drive a hard-bargain.

I appreciate the potential of Venmo (how many times have you heard the term “I’ll just Venmo you.”?)  I don’t know how or when PYPL monetizes it without losing customers. So I’ve chosen to move to the sidelines for now. From a valuation perspective the stock is not cheap at 1.4x PEG and >18x EV/EBITDA. I like PayPal/Venmo as brands but I’m just not excited about the fundamentals or the general business direction currently.

Maybe I’m missing something here?

New Buys

OK I’ll bite on the community banks thesis which others have described. I’m looking hard at a few now and will write more about that later. I also bought some INSW – an undervalued spin-out from OSG. More to follow.