Description

Summary

Trade shows can make wonderful businesses.  But some of their unique qualities also make them very susceptible to sudden stops in travel or large meetings.  Alhough I have argued in the past for trade show resilience in general, and this stock appears cheap at 6-7x consensus earnings, operating leverage, financial leverage, and a turnaround challenge combine with covid-19 risks to make this currently unsafe as a long, in my opinion.

Introduction

On VIC I have written up four longs on trade show companies, including this one, and one other short.  Over the years, despite a mixed track record and sometimes well after my exit, each one of these other trade show businesses got bought out, with premium valuations paid for unique industry characteristics.  But the very qualities that work so well in most scenarios falls prey to one major risk: any event which sharply reduces appetite for travel or congregating with lots of people.

Nails4 presciently asked in January 2018 whether there was a structural short to be had in the tradeshow and events industry.  (https://valueinvestorsclub.com/idea/ASCENTIAL/9228884397#messages)  His timing was fantastic, and this stock would have been the best way to do it, subsequently down 68%. 

After last week’s developments on covid-19, nathanj asked on the EEX thread:

“Anyone care to weigh in on the impact of travel concerns due to coronavirus? 

At some point does financial or strategic buyer step in or is this too toxic an asset?”

I write up my response here as a short.  I am not short, because I rarely like concentrated shorting.  But I want to explain why, though falling knives can make good investments, I do not think this is one of them.

Risks to the short

1. 66% owned by Onex, Canadian PE.  It is hard to handicap the chances of a takeout. Onex founder is still active, and a billionaire.  

(But: Onex has failed to sell its controlling stake into a red-hot private market for trade show assets since the 2017 IPO.  The Onex fund which holds the majority of the EEX stake is 2009 vintage, so might lack the appetite to redeploy its $290 million cumulative EEX proceeds to defend its remaining stake valued at $323 million.)

2. US trade show attendees rapidly lose their fear of Covid-19.

3. Generic risks of shorting.  Leverage works both ways.   

Short thesis

1. Covid-19 fears temporarily stop some buyers and exhibitors attending US trade shows, creating operating leverage problems. 

2. Financial leverage problems. 

3. Turnaround problems.

1.  Covid-19 fears temporarily stop some buyers and exhibitors attending US trade shows, creating operating leverage problems. 

Case Study 1: Comdex, Las Vegas computer trade show, 2001.  Sheldon Adelson developed one of the world’s largest trade shows of all time in the 1980’s and 90’s, before selling out to Japan’s SoftBank (!) in 1995 and then making another fortune in Las Vegas.  Some weakness ensued, but it was 9/11 and the subsequent fear of flying that saw attendance drop 40%. Within a few years the show closed. The name was sold (comdex.com now routes to Informa’s Interop show, and a Computex is still held in Taipei), but a wonderful business went from hero to essentially zero.  Joel Greenblatt refers to this as his most disastrous investment (see appendix, below).

Case study 2: SARS, Asia 2003.  In 2003, Global Sources was preparing in Shanghai to launch its first face-to-face trade show.  SARS almost killed the tradeshow venture before it began. But the founder had developed a group that was already serving its customers online and in print, enabling the company to survive.  They then rode a post-SARS boom and built a successful portfolio of trade shows that formed a key attraction for Blackstone’s 2017 acquisition.

“But the summer before the first Shanghai show, the survival of the whole business hung in the balance. A near-pandemic outbreak of a new flu mutation was paralyzing much of Asia. In the early months of 2003, the virus known as SARS spread from Guangdong to infect 8,096 people in 37 countries. In the end, only 12 confirmed deaths from the disease were recorded, but during the spring and summer of 2003, panic and uncertainty gripped the region, implemented strict quarantines at border crossings. Travelers found with a fever faced quarantines of up to 10 days in length.

In Hong Kong, Taiwan and mainland China, hospitals and even apartment buildings with known SARS cases were completely sealed off. And throughout Asia, people on the streets wore surgical masks to keep the disease at bay.

The economic impact was immense. Tourist and business travel plunged. In late April 2003, economists at Morgan Stanley estimated China’s economy was shrinking at an annual rate of 2 percent in the second quarter.

Global Sources took a strong, pro- active stance. Unable to travel easily, buyers around the world made heavy use of Global Sources Online, with RFIs on the site spiking by up to 50 percent more than usual in the month of April. In early May, Spenser Au sent a series of emails to exporters throughout Asia offering a US$500 rebate on Global Sources advertising packages to encourage their active online promotion. A few weeks later, other B2B online services followed suit with various special offers.

By late summer, the SARS outbreak began to subside. Merle remembers: “The biggest challenge during the SARS epidemic was managing the fear and uncertainty of suppliers, buyers and team members. The virus emphasized the importance of online and print channels as an alternative, but the value of face- to-face negotiation was also underlined by its absence.”  The pent-up demand for face-to-face meetings may have contributed to the enthusiastic buyer attendance at the first China Sourcing Fair in Shanghai that fall.”

http://www.corporate.globalsources.com/METRICS/40YRS.PDF pages 140-142

(N.B. the quoted SARS death count seems lower than current records).

Why operating leverage is especially acute in the tradeshow industry

a) Temporary breaks can kill a trade show business.  Exhibitors (typically the paying customers, in a two-sided model) re-book after a successful show.  Hence the predictability and wonderful economics of deferred revenue. But if a show does not happen one time, even if the crowd survives, it will often congregate in future at a different place.  Turns out Americans did fly again after 2001. And the crowd still meets face to face, at very valuable shows like CES, SaaStr, or dreamforce. But not at Comdex.

b) Trade shows are capital-light: a major advantage as an investment.  But once the crowd is gone, salvageable value is close to zero.

c) Concentration of event risk.  The biggest crowd is the most profitable, but right now, potentially the biggest health problem.  So although Emerald organizes 142 separate events, their Top 5 account for 30% of sales and an even higher proportion of profits.  If one big show flops, it matters.

2.  Financial leverage problems

On Dec 31, 2019, net debt was $531 million, bigger than current market cap.  Leverage was already 4.2x (net debt/adjusted EBITDA), up 0.8 turns during the year as adj. EBITDA declined 21% during 2019. A new CFO was hired January 16, 2020. He seems well qualified, but I don't think he has trade show experience. In his first earnings call February 13, although he claimed that there was not much risk at this level, he made clear that he would prefer it to be lower, and hoped to get there by year end.

Ajdusted EBITA fell $35 million in 2019, to $128 million. A decline this year of $31 million, if net debt remains constant, would get leverage to the 5.5x covenant.

The new CFO chose to not give any full year guidance at his first Q1 2020 call. But he did acknowledge a question that leverage might go up in the next few quarters. We already know from Dec 31, 2019 deferred revenues (exhibitors’ fees are collected between 1 year and 1 months prior to most shows), that 2020 sales should decline by $5.1 million (2.7% decline in deferred revenues).   

Cash collections were also deteriorating in Q4 2019, declining $3.2 million (the proportion of deferred revenue included in accounts receivable increased from $49.8 to 53.0 million).

This month’s US travel ban on all Chinese exhibitors will have some impact: up to a decline of $11 million as explained by the new CFO this month:

“Our revenue in 2019, for the full year, from exhibitors from China was between 2% and 3% of our total revenue. Not a lot, but not inconsequential, right? That's real money. And last year, as the company talked about throughout the year on their earnings calls, there was pressure on Chinese exhibitors because of the trade war and the tariffs. And so 2019 was down from 2018 because of that issue. So there was a higher number in 2018 modestly than what I said. It was a little north of 3% as opposed to between 2% and 3%. And -- but in terms of year-over-year risk, we're looking at the 2019 metric. And we're looking at it in total. I would say that not 100% of that revenue is at risk because some shows have already traded, but as we sit right now, there's a travel ban. People can't come from China here. And so they are not going to come to our shows as long as that travel ban is in place. When it comes to the insurance, if somebody has already contracted to be an exhibitor and has to cancel because of the travel ban, which they can't control and we can't control. We believe that there is recoverability from our insurance. We're working through that. There's no guarantee of that. And that will play out over the coming weeks, I would expect. And what insurance would not cover is the theoretical person who never signs up and come to our show. And so there's likely to be some impact during the year. With or without insurance because of that dynamic, that's really hard to quantify. But the totality, as I said, of all our revenue over the course of the full year last year from Chinese exhibitors was between 2% and 3%.”

So financial leverage was deteriorating before the most recent covid-19 developments: the material risk that US participants develop a fear of attending trade shows. 

My last comment on financial leverage does not conform to conventionally held wisdom on deferred revenues.  Most bankers and their happy corporate customers choose to ignore deferred revenues when calculating financial leverage.  I think that is wrong, or at least not conservative. Customers who pay up front for a service or product are basically lending you money, which you will need to repay in the form of that service or product.  If you have used that cash for dividends, buybacks, acquisitions, or anything other than its original use (like almost all these publicly traded companies have), then I think it adds to financial leverage. In this case, that would add $187 million of leverage, or an additional 1.5x turns.  Most people don’t seem to agree with me. But even in a good scenario, the company would only get to keep 20% of this as its post-tax margin, so I have always considered it reckless to ignore this aspect of financial leverage.

3.  Turnaround problems

There have been three CEOs since the April 2017 IPO, with one of the resignations unfortunately due to ill health. After David Loechner, 35 year veteran, retired in November 2018, free cash flow has dropped by a third to December 2019.   This despite spending cumulatively $150 million of the $159 million IPO proceeds on acquisition.

In hindsight I did not appreciate how poorly positioned the core business was at IPO.  As of two years ago, 85% of the retailers that came to their shows had less than 4 brick-and-mortar stores.  Still today, four of their Top 5 shows serve these mom and pop retailers: a structurally challenged crowd.

The good news for 2020 is that two of the Top 5 (Kitchen & Bath Industry and Future Market NY Now) plus the smaller Outdoor & Snow Show have already completed.  KBIS is growing, and 85% of next year’s floor space has already been booked.

But ASD Marketweek will be held March 22-25 in Las Vegas.  This is a struggling show that, due to its seasonal repeat in the fall, accounts for two of Emerald’s Top 5.

Seasonality does not help.  Two thirds of annual EBITDA has traditionally been earned in the first two quarters of the year.  But this increased to 79% in 2019 as earnings declined.

So in addition to financial leverage, the business was also facing turnaround challenges before recent covid-19 developments. What happens if you combine these with negative operating leverage?

Globally, many big trade shows have already been cancelled, prompted either by government decree or a critical mass of exhibitors pulling out.  Trade shows’ value proposition: face-to-face contact and handshakes with multiple strangers in confined spaces, could temporarily be a major weakness. 

Emerald so far has not had to cancel any event due to covid-19, and only operates in the US.  They did issue the following warning for attendees at its recent Outdoor retailer show: https://www.outdoorretailer.com/2020/01/28/coronavirus-update/

End Note: I wish everyone good health; and would take neither pleasure nor profit from this business suffering as result of any health crisis.  

Appendix

Joel Greenblatt, interviewed by Howard Marks in 2015

Joel Greenblatt: “I wouldn’t call it my worst investment but I'd say my most disastrous investment. I don't know.  Anyway, I've had a bunch. My partner Rob Goldstein who joined in 1989 always jokes that you know, if we worked for someone else over the last 15 years they would have fired us about eight times, you know, so you have you have to be willing to, I guess, make mistakes and you can't really avoid it.

And so our worst one was probably we actually bought through a spin-off a company that actually owned Comdex, which used to be a computer trade show.  And it was the biggest one. We were actually able to create it before the spin off for about $3 a share; and it was going to sell some new shares at $6; and that had been announced, but yet we could create it by buying the parent and shorting another piece and creating what was left for about $3.

So all good, so far.  But we actually fell in love with the business.   What I loved about the business was that they ran this trade show in Las Vegas and you could rent all the trade space you wanted in Las Vegas at the time, and it was available about $2 a square foot and they could re-rent it at $62 a square foot.

So whenever the trade show grew, they would spend another two dollars and get a $62 contribution. And so we fell in love with the operating dynamics of this business and the stock actually went from $3, they sold some more stock at $6, and the stock actually went to $12.   And we had a really large position at $3. The reason for that is that we thought we could get out right away at $6. We did not get out right away at $6 because we fell in love with the business. It went to $12. So it sounds good so far! But then unfortunately shortly after September 9th 2001 the company bought another trade show and borrowed a lot of money.  Then, after September 11th, no one wanted to travel at all and both trade shows really went downhill.

Everyone knows about financial leverage. Meaning, you know, hey, you borrow a lot of money, you pay your money you take your chances.  You put up a dollar you borrow nine, you know that's a risky investment! 

So this is how I learned about operating leverage, which is when you lay out another $2 and collect $62, when the sales go down, right, when you lose $62 in revenue, $60 of your profits just evaporated and it drops immediately to the bottom line, that's called operating leverage.  So that was my lesson in operating leverage the stock. I think I got out at a little over $1 or so…

You know, things happen.  It's a lesson in concentration.  It's a lesson in operating leverage.  I learned a lot of things, and I can still safely say I'm always learning.  I'm always making a new mistake. I'm trying not to make the same ones. But the same ones usually have a little different face on them; you are really making the same one but, you know, it presented in a little different way and you didn't notice it.  And you go make that mistake again and so I guess advice would be: “Don't be shy about making mistakes, because you will anyway.”   

Skip Howard Mark’s reply if you don’t need any encouragement at a time like this:

Howard Marks: “I think that's very important what Joel just said, and I want everybody in the audience to take cognizance of it. I wrote a memo in April called dare to be great.  And basically it said if you want to be exceptional as an investor, you have to dare to be great. Everybody here is willing to be great.

But to be great you have to be different because if you think the same as everybody else, you'll make the same actions.  If you take the same actions you'll have the same performance. You certainly can't be exceptional if you follow the common course.  So to be exceptional you have to be different.

You also have to dare to be wrong. And nobody bats a thousand.  The best baseball history hitter in history got four hits every ten times to the plate, right?   Some investors can do a little better than that. But nobody bats a thousand. You know Joel mentions that he could have been fired eight times.  And I had lunch today with a guy who works for Berkshire Hathaway, and we were talking about what makes Warren successful. I said one of the things that makes him successful is he is not afraid of getting fired.

But very few people have that luxury and the question is for those of us who work in the world where we can be fired, if not by our employers then by our clients, will we still take the chance and back our ideas?  There are no sure things. Will you back the things that have a chance of being wrong? I think you have to take that chance.” 

https://www.youtube.com/watch?v=N-azmBU0yII&t=2s  (24:11 minutes onwards)

Sources & further reading

https://www.computerworld.com/article/2564412/death-to-comdex.html

https://www.exhibitionworld.co.uk/2013/09/09/big-interview-ubm-chief-executive-david-levin

https://travel.state.gov/content/travel/en/traveladvisories/traveladvisories/china-travel-advisory.html

https://www.kbis.com/show-news/kitchen-bath-industry-show-kbis-energizes-industry-for-2020

https://www.asdonline.com/

https://www.nynow.com/

Header financials are consensus. This write-up expresses opinions only.

Catalyst

Any big show that flops.