Dec 24, 2014

ALJ Regional – A Mini BRK In The Making?

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Background

ALJ Regional holdings is a micro-cap holding company. The company’s largest shareholder, Jess M. Ravich owns 47% of the outstanding shares and is also the Chairman. Mr. Ravich has had a long career as an investment banker, and thus far it seems he is putting that experience to good use in assembling the holdings of ALJ. It is also perhaps worth noting that, according to this article, he is a longtime friend of legendary investor Seth Klarman.

In 2013, the ALJ used the proceeds from the sale of its primary asset, a steel mill, to purchase Faneuil, Inc for $53 million. It then purchased a stake in Floors-N-More, a retailer of carpet in the Las Vegas area. The most interesting aspect of both these transactions is that ALJ allowed the managers of each subsidiary to participate in the upside of the business through meaningful equity participation.

Fanueli, by far the larger of the two subsidiaries, provides enterprise consumer facing services (think call centers) to municipalities and businesses. Mainly these consist of toll collection, customer relationship management, healthcare exchange support and medical device tracking services. The business has exhibited strong profitability since its acquisition. I estimate return on tangible assets to be ~ 30%, return on assets to be 12% and return on equity ~ 20%. As mentioned previously, ALJ also incentivized the management of Faneuil by allowing Ms. Anna Van Buren (the CEO) to purchase 3.75% of the company, along with options for an additional 1% stake and a bonus of 10% over any EBITDA greater than $5 million.

In the spring of 2014, AJL acquired substantially all of the equity interest in Floors-N-More (Carpets) for $5.25 million. Carpets has five locations in the Las Vegas area. Roughly annualizing the results provided in the quarterly report ended June 30, 2014, indicates that Carpets earns a 12% return on assets and a ~18 return on equity. Of course, this estimate was derived from a very small sample but it is nevertheless encouraging. Also, similar to the Faneuli transaction, the CEO of the Carpets subsidiary has been granted incentive compensation in the form of 40,000 equity award units, which vest equally over a four-year period and represent ~6% of the Carpets subsidiary.

Other Assets

In addition to its two operating subsidiaries ALJ holds approximately $180 million in Net Operating Losses. These losses were accrued during its ownership of the steel plant, which was sold in 2013. Now that the company has subsidiaries producing taxable income, these should produce value for the shareholders going forward.

(Digression – Bellator Investments)

While looking over the financials of ALJ the name Bellator caught my eye. Bellator is a company that promotes, markets and develops Mix Martial Arts content. The most well known company in this space is the Ultimate Fighting Championships (UFC). In 2014, Forbes valued the UFC at $1.5 billion. In the most recent quarterly ALJ reports an investment in Bellator of $102 thousand under Other Assets. Digging a little deeper, it appears that ALJ made an investment of $212 thousand in Bellator Sport Worldwide in September of 2009. Since then the ALJ has invested a few more small sums into Bellator. Viacom paid $50 million for a majority stake in Bellator in 2011. Despite this, the ALJ has actually amortized its investment in Bellator down to the $102 thousand as of the last quarterly statement.

The company gives almost no details on the transaction, so it is difficult to say what has transpired to reduce the value of the investment ALJ made in 2009. And certainly anything is possible (dilution?), but it seems very strange that the investment should be impaired since the company was only formed in 2008, and so an investment in September of 2009 should theoretically have been for a much smaller valuation than what Viacom paid in 2011. In any case, the investment in Bellator is most likely immaterial to the valuation of ALJ but it is an interesting artifact that I wouldn’t mind knowing more about.

Risks

As the company’s largest current asset, the majority of the operational risks lies with the performance of Faneuli. I believe this is mitigated somewhat by the CEO’s ownership stake and incentives but only marginally.

Debt, the company owes roughly $25 million in debt. The majority of which is related to a sellers note used to fund the purchase of Faneuli. ALJ has a credit line of $5 million from M&T bank that is currently undrawn. It also has $13 million of cash and equivalents and ~$24 million in accounts receivable. With operating income of ~ $10 million at the current run rate ALJ should have very little trouble covering the payments it needs to make.

Valuation

At approximately 33 million fully diluted shares outstanding and a current price of $4.00 per share the company trades at a market cap of $132 million. That is roughly 3x book value and 13x TTM assumed annualized earnings. I think if all goes well the company could earn $12 million for FY 2015 and so that would be an and 11x forward multiple. But that is assuming all goes well. No matter how you slice it the company is not terribly cheap on an earnings or asset basis, it was at $2.00 a share but now not so much.

To buy the shares at this price you have to feel very confident in Mr. Ravich’s abilities as a capital allocator and the ability of the operating subsidiaries to continue to execute on that vision. Now, this does not strike me as a totally unrealistic assumption given, 1) his small track record over the past few years, 2) his ownership stake in the company and 3) his association with one of the greatest value investors of all time. Still, this does not qualify as a substantial margin of safety. So while I’ll continue to consider taking a small position on the basis of what Jeff Bezos would call a “regret minimization framework”. I appear to have missed the boat on the great value that ALJ offered only six months previous.

Before I sign off on this one, I would just like to mention that I think this may be one of the great examples of how a company trading at a relatively high / fair current multiple could end up being one of the great bargains in the stock market. Granted, as I mentioned before, you have to feel very confident about your assumptions of Mr. Ravich’s capital allocation abilities to make such a call but you would have also had to say the same thing about buying BRK during most of its operating history. Unfortunately, Mr. Ravich is not a young man who just finished working for Benjamin Graham but even the opportunity to invest with a middle-aged skilled capital allocator at this (small) level of assets could be a great thing.

As always, please do your own due diligence and thanks for reading.

Disclosure: No Position

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