Description
Synopsis: Moduslink (MLNK) presents one of the most compelling long opportunities I have come across recently with the possibility of a double or even triple return over the next few years. The stock, currently at $3.20, is trading close to liquidation value and a reasonable base case gets to $6.50/share or +100% over the next 6-12 months with an upside case of approx. $9.80/share (~200%) over the next 2-3 years. This is a textbook special situations investment - high margin of safety coupled with significant, underappreciated catalyst-driven upside! For helpful background information on the company/situation see dr123's submission of MLNK in October 2013. Several events have occurred since then and I believe the company is much closer to generating value for shareholders.
Situation:
- MLNK’s operations are the remnants of a dot-com era conglomerate that once owned Altavista
- In 2004 they re-focused on a supply/logistics business which is now the vast majority of operations
- However, the real value here is in the significant federal NOLs created by the dot-com losses - worth ~$2.1 billion
- Seasoned activist investor Steel Partners got involved in early 2013 at an average cost of ~$4/share (20% underwater) – they have a history of unlocking significant value in similar situations (e.g. Handy & Harman (HNH)); Steel controls ~27.6% of the company (~31% including 2 million warrants struck at $5/share) and has two board seats, including Chairman Warren Lichtenstein; Steel recently added to its position acquiring 185k shares at $3.05/share through HNH.
- In 2013, the company publicly stated that it intended to fix the supply chain business, which it has now done, and then to utilize the NOLs through acquisitions "as quickly as possible"
- Convertible offering ($6/share strike) in early 2014 pummeled the stock price by 15-20% as most of it was placed with convert arb funds, but I believe the deal was actually value-accretive as it provides MLNK with additional cash to go after a deal to utilize their NOLs
- On August 26th 2014, MLNK disclosed a 9.9% stake in publicly-traded Medifast (MED) which I believe is the first step in an acquisition for the company – MED’s financial characteristics are uniquely suited to maximizing the value of the NOLs
- At the current stock price, the market is ascribing no value to the NOL, visibility on a pending catalyst or Steel's track record of value-enhancing capital allocation
So why is the stock mispriced? Main reasons include:
- Zero analyst coverage
- Non-existent investor outreach (no quarterly conference calls; don’t even announce earnings dates)
- Main value driver is hidden off balance sheet in the company’s $2.1 billion federal NOLs
- Core business is in a recovery phase, LTM financials understate the earnings power due to ongoing restructuring initiated by the current CEO who came on in January 2013
- Stock doesn't screen well due to the sizeable short interest from technical hedging of the recent convertible
Valuation: 3 main scenarios:
- Scenario 1 - Downside case: value of core business using conservative assumptions + "excess cash" + nominal value of NOLs: $4.42/share
- Scenario 2 - Base case: value of core business + acquisition using cash on balance sheet and some NOLs + nominal value for "excess" NOLs: $6.50/share
- Scenario 3 - Upside case: Value of core business + full utilization of the NOLs: $9.77/share
Key value drivers:
- The core business - after a period of operational restructuring, the supply chain/logistics business now generates approx. $21 million EBITDA / $12 million in Adj. FCF / $6.5 million in EBIT.
- Accretive acquisition using significant tax attributes and cash on balance sheet - as aforementioned, the company has a $2.1 billion in federal net operating loss carry forwards and $185 million cash on balance sheet (net cash is $85 million), and recently filed a 13D in MED (~$400 million market cap).
- Residual value of NOLs - post the acquisition of MED or a similar size company, MLNK would have ~$1.5 billion in un-earmarked NOLs to do additional deals.
SCENARIO 1: DOWNSIDE CASE
1. The core business - Operational Turnaround
The company provides logistics fulfillment services to companies looking to outsource their supply chain management. MLNK's key services include assembly of materials for transport/shipping, oversight of goods for warehousing and distribution, and monitoring/management of returns. Despite a successful operational turnaround under the stewardship of industry veteran John Boucher (formerly at Celestica, joined MLNK in January 2013), supply chain management remains a competitive business among industry incumbents and in-house customer platforms. While the business absorbs ~$25 million in working capital and can be feasibly wound down for that amount, Boucher has done a good job cutting SG&A (now 10% of revenue down from 13.2% in 2012) and exiting unprofitable/low margin customer accounts. As a result, gross margins have increased 70bps from 9.6% to 10.3% between 2012 and 2014, and the business is now profitable and generates positive free cash flow.
Former Management Boucher/New Team
($M) FY 2011 FY2012 FY 2013 FY 2014
Revenue 844 714 755 723
YOY % Change (8.1%) (15.4%) +5.7% (4.1%)
Gross Profit 81 69 74 75
Margin 9.5% 9.6% 9.9% 10.3%
Adj. EBITDA 14.6 2.2 14.9 20.7
Adj. FCF 4.0 (9.1) 5.8 11.9
Note: FYE is in July
There is additional upside to FCF of $1.6 million starting in 2016. In 2000, the company announced it had acquired the exclusive naming rights to the New England Patriots' stadium for a period of 15 years (dot-com heyday extravagance!) for annual payments of $1.6 million through 2015. As such, while EBITDA and FCF should be higher by this amount starting in 2016, I have conservatively assumed steady-state EBITDA of $20 million and FCF of $12 million per annum.
Comparable company analysis:
($M)
Name Ticker Gross Margin Mkt Cap TEV TEV/EBITDA
Ingram Micro IM 5.9% 4,195 4,825 6.3x
Synnex SNX 8.0% 2,657 3,516 7.8x
Celestica CLS 7.3% 1,883 1,305 5.0x
Plexus PLXS 9.5% 1,348 1,268 7.2x
Base case: assuming a 1x multiple turn below the low end of the comp range, at 4x EBITDA, the core operations alone are worth ~$80 million or $1.57/share.
Bull case: given MLNK's relatively high gross margins, perhaps a higher multiple is warranted. At 6x (still 0.5x below the average), the business is worth ~$120 million or $2.35/share.
Bear case: Unwind scenario - in addition to the ~$25 million of net working capital that can be extracted in a wind down, there is an incremental ~$19 million of potential upside in 2018. As part of the 2011/2012 accounting restatement, the company had to create a reserve of ~$31 million as an accrued pricing liability associated with customer contracts. By the end of FY 2012, the liability dropped to ~$19 million after the company paid out some customer claims for pricing adjustments. In the last 4 quarters, there have been no claims or payouts associated with the pricing liability. The company is required to hold the liability on balance sheet until 2018 when the statute of limitations expires. Assuming a 50% haircut to the $19 million, liquidation value is ~$35 million or $0.69/share.
2. Excess Cash
The company has $85 million of unencumbered cash on the balance after paying down the converts. This equates to $1.67/share.
3. Nominal Value for NOLs
Precedent transactions suggest that standalone NOLs are worth ~30% of the tax asset, or 10-20% of the NOL (Ambac tolling, WMIH). Conservatively ascribing a 5% value to the $2.1 billion NOL = $105 million or $2.06/share.
In the downside case: liquidation value of core business + "excess cash" + nominal value for the NOLs = $0.69 + $1.67 + $2.06 = $4.42/share or +35% vs the current stock price
In my view the market seems to be valuing the core business using the conservative base case (4x EBITDA) and ascribing NO value to the NOL: $1.57 + $1.67 "excess cash" = $3.24/share
SCENARIO 2: THE BASE CASE
Recent events suggest that MLNK is significantly mispriced and (at least some portion of) the NOL value should be reflected in the stock: 13D filing in MED.
1. The core business + Acquisition of MED or a similar size business
MED is a direct seller of nutritional and meal replacement products that generates sustainable free cash flow, mostly in the US, and has an unlevered balance sheet. Unlike other direct sellers, MED only compensates its third-party sales agents on products sold, not on self-consumption. For a more in-depth review of MED as a standalone long idea, please see the write-up posted by lasrikas on October 17th, 2014. On an LTM basis, MED generated $331 million revenue, $42 million EBITDA and $22 million FCF. MED currently trades at 11x EV/EBIT.
Here are my assumed sources/uses for a deal:
| MED Unaffected Stock Price |
$29.20 |
|
Sources of Cash: |
|
|
|
Uses of Cash: |
|
|
| Est. Premium req'd |
25% |
|
MLNK cash on hand |
|
185,000 |
|
MED equity (unowned) |
|
421,812 |
| Take-out Price |
$36.50 |
|
Less: used already |
|
(35,391) |
|
Deal Fees @ 2% |
|
8,436 |
| |
|
|
|
MLNK pro forma cash |
|
149,609 |
|
|
|
|
| MLNK-owned shares |
1,261 |
|
MED cash on hand |
|
68,571 |
|
|
|
|
| Non-MLNK-owned |
11,556 |
|
New Debt (1st lien @7%) |
|
212,068 |
|
|
|
|
| Diluted shares out |
12,817 |
|
|
|
|
|
|
|
|
| |
|
|
|
Total Sources |
|
430,248 |
|
Total Uses |
|
430,248 |
On a PF basis, MLNK/MED would generate free cash flow of $0.50/share :
| |
|
|
|
|
| LTM Adj. EBITDA: |
|
|
Est. Cash Flow: |
|
| MLNK |
20,696 |
|
Adj. EBITDA |
62,413 |
| MED |
41,717 |
|
Less: MLNK Capex |
(5,000) |
| Pro Forma |
62,413 |
|
Less: Med Capex |
(8,500) |
| |
|
|
Less: Convert interest |
(5,250) |
| LTM D&A: |
|
|
Less: PF interest on acq debt |
(14,845) |
| MLNK |
13,179 |
|
Less: Cash Taxes |
(2,800) |
| MED |
11,239 |
|
PF FCF |
26,018 |
| Pro Forma |
24,418 |
|
PF FCF/share |
$0.50 |
| |
|
|
|
|
| Pro Forma Adj. EBIT |
37,995 |
|
|
|
Applying a conservative 10x multiple to the $0.50 in FCF gets to $5/share for MLNK/MED pro forma (prior to MLNK's 13D filing, MED was trading at 17.5x FCF). Simplistically, I assume the company uses ~$500 million in NOLs for the foreseeable future in this transaction and has $1.5 billion remaining. Valuing the leftover NOLs at 5% gets to $75 million or $1.50/share.
Total base case valuation: $6.50/share
SCENARIO 3: THE UPSIDE CASE
Base case value for the core business: $1.57/share
Value of acquisitions to monetize the NOL: I assume the cash on balance in utilized in M&A and value the NOLs on a more normalized basis, at 20% of gross value: $420 million or $8.20/share
Upside case: $1.57 + $8.20 = $9.77/share
Catalysts
- Acquisition of MED (or MED proxy) – I estimate that pro forma FCF/share could be ~$0.50/share, providing an anchor for valuation
- Involvement of Steel Partners – they have explicit plans to monetize the NOL through utilization of the cash balance and news like the MED stake suggests they are actively sourcing ideas; while Steel may not be sensitive to mark-to-market, they are losing money on this investment and are incentivized to make it work as they have also been granted warrants to acquire 2 million shares at $5/share (included in the fully diluted 31% ownership)
- Continued improvement in the underlying business
Risks
- Steel Partners fails in structuring a transaction to maximize the NOLs - downside is limited as the stock does not reflect any value associated with the tax attributes
- Business performance weakens - the board has stated that they are not tied to the supply chain business and in the event the company starts to burn cash, it will consider exiting the business via a sale or unwind.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
- Acquisition of MED (or MED proxy) – I estimate that pro forma FCF/share could be ~$0.50/sh, providing an anchor for valuation
- Involvement of Steel Partners – they have explicit plans to monetize the NOL through utilization of the cash balance and news like the MED stake suggests they are actively sourcing ideas; while Steel may not be sensitive to mark-to-market, they are losing money on this investment and are incentivized to make it work as they have also been granted warrants to acquire 2 million shares at $5/share
- Continued improvement in the underlying business