Description

Summary

Once a $1 billion per year revenue company, marketing firm Harte Hanks (HHS) has gone through extreme turmoil and is being priced by the market as a bankruptcy. Yet, HHS has no debt and is trading below the value of its cash and receivables. It also has a $19 million revolver available that appears to be secure. Heavy losses in some areas of the business are masking two divisions, call centers and direct mail, that may be profitable on their own. Activist investors have become involved and new management has been brought in to save the company. HHS may become cash flow positive by the end of 2019. This is a very high-risk, high-reward idea.

Profile

Harte Hanks (HHS) is a nearly 100-year old marketing firm with 21 offices in five countries and more than 3,000 employees. Harte Hanks’ services include direct mail, consulting, call centers, email marketing, data analytics, and shipping fulfillment. HHS has blue chip clients in such industries as consumer, technology, automotive, healthcare, and retail. HHS is based in San Antonio, TX.

History
Harte Hanks has its roots in the newspaper business. HHS was founded by Houston Harte and Bernard Hanks in Texas in 1923. For most of its history, HHS owned newspapers in Texas, including the San Antonio Express-News. In the 1960s, HHS began acquiring radio and TV stations as well. After completing an IPO in 1972, HHS expanded outside of Texas and eventually owned several dozen newspapers. It also developed the marketing business which is the core of HHS today. HHS was taken private by management in 1984 and began to divest its media assets to pay down debt. It focused on marketing services, a fast-growing business at the time. HHS completed a second IPO in 1993 and had sold most of its media assets by the mid-1990s.

Harte Hanks is now a shadow of its former self. In the mid-2000s, HHS exceeded $1 billion in annual revenues and was earning net income above $100 million / year. At its peak stock price of (split-adjusted) $310 in 2005, HHS had a market cap around $2.5 billion. Between 1997 and 2016, HHS returned about $1 billion to shareholders in dividends and stock buybacks. Today, HHS trades around $4 with a market cap of about $25 million. The company’s revenue has dropped below $300 million / year. Yes, HHS has lost about 99% of its value in less than 15 years. Ouch.

The Good

Harte Hanks is one of the few large independent marketing firms and has worked with many blue-chip customers. Current and former customers include Samsung, Verizon, Microsoft, Sony, Macy’s, Bank of America, IBM, Ford, BMW, Pfizer, Royal Caribbean, ADT, and Starwood Hotels. Many of these customers have long-standing relationships with HHS and want the company to succeed. Services provided by HHS include direct mail campaigns (junk mail), call center services (primarily in the Philippines), product shipping, social media marketing, and email advertising (spam). HHS has significant amounts of data which are valuable and difficult for others to replicate. There is concern among HHS’ clients about HHS’ possible failure given the large amount of customer data it has accumulated.

The Bad

Harte Hanks has experienced just about every possible business setback. It has failed to transition to our digital world as it should have. Direct marketing spending declined during the 2008-9 recession and never came back to HHS. Marketing dollars shifted to the likes of Google and Facebook. HHS has experienced customer losses and reduced spending by existing customers. HHS has tried, and failed, to find new customers to replace lost ones. Meanwhile, the company has been mismanaged. Its problems have included: customer losses, accounting problems, failed products, management turnover, value-destroying acquisitions, and disputes among shareholders. Harte Hanks has suffered revenue declines in every year since 2007 and hasn’t reported a profitable year since 2014. Still, HHS reported positive operating cash flow until 2017. Its business has deteriorated rapidly over the past several quarters as customers have shifted advertising dollars from direct mail and other traditional marketing activities to online ads. Also, some of its customers have fallen on hard times and reduced marketing (e.g. Toys ‘R’ Us, Barnes & Noble, JCPenney).

·         Accounting problems: Harte Hanks has been unable to file some of its recent 10-Q and 10-K forms on time. HHS has disclosed material accounting weaknesses in its filings. Although there was no “going concern” clause by the accounts in the 2017 10-K, I wouldn’t be surprised to see one in the 2018 10-K. Hopefully, the new management can fix some of these problems. HHS just hired a new CFO.

·         Risk of delisting: Although HHS is a nanocap stock that only trades about 20K shares / day, it still trades on the NYSE. HHS has been at risk of being delisted for the past couple of years. It completed a 1-for-10 reverse stock split on 2/1/18. In late-2018, it received another delisting notice because both its market cap and shareholders’ equity dropped below $50 million. On 1/28/19, HHS announced the NYSE had accepted its plan to get back into compliance with listing requirements. HHS intends to fix its balance sheet through expected tax refunds and financing activities. Still, HHS is at risk of being delisted at any time.

Why This is a Value Investment

Harte Hanks is being valued as a likely bankruptcy, but I think the business can be saved. HHS is trading at roughly 0.1x 2018 revenues and, possibly, less than its cash and likely receivables. At the end of the third quarter, HHS reported current assets of $87.1 million versus current liabilities of $52.9 million. Including in the current assets were $10.4 million in cash, $51.2 million in accounts receivable, and $14.1 million in prepaid taxes and income tax receivable. HHS expects to receive a $9 million tax refund by the end of 2019 due to the sale of subsidiary (discussed later). Moreover, HHS has $19.2 million available in a revolving debt facility and no debt. While HHS reported negative operating cash flow in 2017 and the first nine months of 2018, the company has stated that it expects to return to positive cash flow in the second half of 2019. Despite its problems, HHS was consistently cash flow positive until 2017. The company has been rapidly cutting costs and new management is expected to cut costs further. I believe Harte Hanks’ direct mail and call center businesses remain profitable.

Overview of Services

Harte Hanks operates call centers in the U.S., Europe, and the Philippines. This segment comprises about 25% of HHS’ revenues. Employees at these centers answer phone calls, send emails, and provide tech support and other services. A typical client of this business is Fleetcor, the fuel card company. Harte Hanks has downsized some of its U.S. call centers as its business has declined. Still, HHS continues to advertise job openings at its call centers in Austin and the Philippines. Investors and HHS’ management have said that HHS’ call center business is profitable.

Harte Hanks manages direct mail campaigns. HHS’ direct mail, logistics, and fulfillment services segment comprises about 50% of total revenue. A typical client for this business is ADT, the alarm company. HHS recently designed a direct mail campaign for ADT in which select clients were sent VR headsets in the mail. Recipients were instructed how to use the headsets with a YouTube app that simulates a house on fire. HHS does these sorts of campaigns and provides logistics and fulfillment services. Direct mail spending dropped during the 2008-9 recession and continued to decline through 2014. Industry research suggests direct mail spending has stabilized since 2015. It’s a low-growth business but, as with call centers, a potentially profitable one.

Harte Hanks provides database and software services. The company has tried to build a software-as-a-service business, but I don’t think it has been very successful. HHS has recognized multiple impairments of goodwill and software development. HHS also provides agency and digital services. Some of these services include social media marketing, search engine optimization, and email campaigns. In 2015, HHS bought a company called 3Q Digital that specialized in these areas. The deal was such a failure that it was recently sold back to management (discussed later).

Harte Hanks has experienced revenue declines in all market segments. HHS categorizes its clients in six areas: B2B, consumer brands, financial services, healthcare, retail, and transportation. None of these areas have been performing well. HHS is in cost-cutting mode, not expansion mode. It has already reduced total headcount by about 2,000 people.

Activist Involvement & New Management

Harte Hanks’ management situation has been a mess. HHS has had, by my count, five CEOs since 2008 (excluding interim CEOs). In 2013, then-Chairman / CEO Larry Franklin (serving as CEO for a second time) and then-Vice Chairman Houston H. Harte (son of the co-founder) both retired. Both had worked at HHS for decades. Houston H. Harte (now about 90 years old) and family own about 10.6% of the outstanding shares. Franklin was replaced as Chairman by Christopher Harte, nephew of Houston H. Harte. Christopher Harte had spent most of his career in the newspaper industry. Notably, in 2006, he was part of a buyout group that acquired the Star-Tribune in Minneapolis and he became publisher. The Star-Tribune, like many papers, struggled in the recession and filed for bankruptcy in early-2009. Franklin’s replacement as CEO, Robert Philpott, only lasted two years in the position. In 2015, Karen Puckett was named as his replacement. She had been an executive at cable company CenturyLink and had served on Harte Hanks’ board since 2009. Puckett did not, however, have executive experience at a marketing firm.

Shareholders and activists got involved as Harte Hanks’ fortunes declined. In 2017, a New York hedge fund called Sidus bought a stake in HHS and asked for two board seats. Sidus and the company came to an agreement and Sidus’ nominees were added to the board. Several months later, Houston H. Harte, undoubtedly alarmed by the massive collapse of his family’s fortune, filed a 13-D demanding changes to the board and the direction of the company. It was a direct (though understandable) shot at his own nephew. Harte’s 13-D was soon followed by one from activist investor Bradley Radoff of Fondren who had acquired 7.2% of HHS. Radoff also demanded changes to the board. On 3/5/18, the Harte family, joined by ex-CEO Larry Franklin, filed another 13-D that included a detailed letter that was sent to HHS’ board. The letter discussed the company’s many failures and demanded the resignations of most of the company’s board members (including Christopher Harte). In May 2018, HHS announced an agreement with the Harte / Franklin group that included the resignations of Christopher Harte and three other board members. Three new people, including an experienced marketing firm executive named Bant Breen, were nominated to HHS’ board in June 2018. One of the Sidus nominees, Alfred Tobia Jr., became Chairman. Karen Puckett was pushed out soon after the terrible Q2 results were announced in August. Initially, she was replaced by an “Office of the CEO” comprised of board members. On January 4, 2019, Bant Breen was named CEO of Harte Hanks.

Harte Hanks has entirely new management. Breen served on HHS’ board for about seven months before becoming CEO, so at least he has some experience with the company. Importantly, unlike the former CEO, he has executive experience in the marketing field. HHS also has a new CFO and president. Andrew Harrison was named president when Breen was named CEO. Harrison has worked at HHS for more than 20 years and is likely in charge of keeping some continuity and morale during these troubled times. Mark Del Priore was named CFO on January 16. He had joined HHS a couple of months earlier in the role of Chief Restructuring Officer. The prior CFO remained at HHS through February to help with the transition.

I have been told that HHS employees and managers are hopeful about the new direction of the company and management changes. I understand that Puckett tried and failed to land new big clients. I believe that there is much that can be fixed by focused management. Harrison was promoted to president because he has good relationships with managers.

Wipro Relationship

HHS has a partnership with Indian IT company Wipro (NYSE: WIT) that appears to be a failure. In January 2018, HHS announced that Wipro had purchased $9.9 million in preferred stock in HHS. The preferred stock is convertible into 16% of HHS’ shares at (split-adjusted) $9.91 per share. The stated purpose of the deal was to integrate customer tools and services of both companies, improve Wipro’s marketing business, and bring new customers to HHS. This deal is a miniscule one for Wipro, a company with more than $8 billion in annual revenue. The activist shareholders were very unhappy with the Wipro deal as it diluted other shareholders and did little to improve the company’s liquidity. They accused Puckett and the board of signing the deal for their own benefit. There was no shareholder vote on the deal. Unfortunately, more than a year later, it appears that the disgruntled shareholders were correct. I don’t think that Wipro has brought a single customer to HHS, even though HHS is likely paying fees for services. I suspect the new management will want to end the relationship, but that may be difficult given that Wipro still holds preferred stock in the company. If the Wipro deal ever amounts to anything, it will be an unexpected positive.

Asset (Fire) Sales

Harte Hanks acquired Silicon Valley-based 3Q Digital in 2015 but has already sold it back to the original owners. 3Q Digital, which had about 120 employees at the time of the acquisition, specializes in search engine optimization, social media advertising, mobile advertising, and analytics. HHS did not disclose the original cost of 3Q, but it was apparently based primarily on earn-outs. HHS allowed 3Q to operate independently and, apparently, poorly. In 2018, the managers of 3Q bought the company back from HHS for just $5 million in cash. There is also a possibility of another $5 million payment if 3Q is sold again. As part of the deal, HHS assigned a $35 million earn-out back to 3Q, thus relieving HHS of any liability. The loss on the 3Q is the reason why HHS expects to receive a tax refund in 2019 of approximately $9 million.

HHS sold a large subsidiary in 2016 to pay down debt. HHS used to own a data management software company called Trillium Software. In December, 2016, HHS sold it to a big data firm called Syncsort for $112 million ($103 million after fees). HHS, apparently, sold it to avoid tripping debt covenants as it used all the proceeds to pay down debt. The Harte / Franklin group cited the Trillium deal as evidence of mismanagement by Puckett and the board. The group claims that outside analysts valued Trillium at $150-$250 million and that HHS dumped it at a fire sale price. Moreover, HHS paid $34 million in taxes in 2017 related to the sale. Ouch.

Financials and Earnings Estimates

It is difficult to forecast earnings as the new management hasn’t even reported one quarter yet. HHS is expected to report fourth quarter results within the next two weeks. HHS does hold quarterly conference calls. Replays of past conference calls are available on its website. I suggest that any interested investors listen to the Q3 call. I hope to hear more about cost cutting and a return to cash flow generation on the Q4 call. I forecast that HHS will continue to lose money through 2019, but that losses will be reduced from 2018 levels. My hope is that the business has reached a bottom.

Income Statement ($mil.)

Balance Sheet (in $mil.)

Risks

Further accounting problems, customer losses, management turnover, bankruptcy

Final Items

Harte Hanks could be an acquisition candidate. There aren’t a lot of independent marketing firms available to be acquired. HHS, despite its problems, has a roster of big-name clients and standing in the industry. HHS wouldn’t be an expensive acquisition given its miniscule market cap. There are no shareholders large enough to block a sale.

I posted a similar idea call Support.com (SPRT) two years ago. While that stock hasn’t been anything exciting, Support.com is still alive and doing ok. Support.com is quite a bit smaller than HHS and very dependent on just one customer. HHS is a more diversified firm with many more employees.

Summary

HHS is the kind of stock that only a value investor could love. There is no momentum in any area of the business. It is very risky, but the upside potential is multiples of the current stock price given the tiny valuation. I can’t guess at a price target, but at 0.1x revenues it wouldn’t take much for the stock to go a lot higher. There’s probably no reason to buy HHS ahead of the Q4 report and the first conference call by the new management team. We should hear more on cost cutting, tax refunds, and efforts to fix the balance sheet. I’m posting this idea on the hope that the new management has a plan to stabilize the business.

Legal Disclaimer: This research report expresses my research opinions, which I have based upon certain facts, all of which are based upon publicly available information. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward-looking statements, expectations, and projections. You should assume these types of statements, expectations, and projections may turn out to be incorrect. This is not investment advice nor should it be construed as such. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. The author has a position in this stock and may trade this stock.

Catalyst

new management, cost cutting, possible sale