Description

RCMT is a totally off-the-radar micro-cap with near term catalysts and 3x upside to fair value.  We view intrinsic value as $11 per share vs. a current share price of $3.63.

Background

RCM Technologies, Inc. (“RCMT") is a NASDAQ-listed mini-conglomerate of three unrelated businesses with its main office located in Pennsauken, New Jersey (just outside Philadelphia).  We think two of the three owned businesses are each worth more than the company’s entire current enterprise value.

The Specialty Health Care segment is a profitable, fast-growing healthcare practitioner staffing business.  The company primarily works on long-term contracts on behalf of large government entities (such as the New York City Board of Education, the Chicago Public School System, and the State of Hawaii Board of Education) to recruit key health care staffing positions including therapists, nurses, and care givers.  Over the last four years, revenues in this segment have almost quadrupled from $29M in 2013 to an estimated $95M run-rate exiting 2018.  Slower-growing (though considerably larger) peer AMN Healthcare Services, Inc. (“AMN”) trades at 0.85x EV/sales.  Using a 0.7x sales multiple, we think the Specialty Health Care segment is worth $65-70M.

The Engineering segment grows top-line organically at 8-10% per year (plus tuck-in acquisitions) and is expected to achieve revenues of $90M+ in 2018.  The segment provides 600+ engineers to projects across the US and Canada, with its largest vertical related to Canadian nuclear power plants which are going through a $10B+ refurbishment over the next 5-10 years.  We think there is opportunity for both growth and margin expansion as RCMT shifts simpler engineering tasks to the engineering hub it acquired last year in Serbia, freeing up US and Canadian personnel to focus on more value-added services.  Using a 9x EV/EBITDA multiple for this asset-light business, and assuming 8-10% EBITDA margins as the business achieves scale, we view fair value as $70-80M.

The IT segment, the smallest segment, is in the midst of a turnaround following years of underperformance.  Our due diligence indicates the company has divested the weaker pieces of this business and re-focused on the bits that can grow, with new leadership in place to drive success, and that the business has stabilized (it grew sequentially by 8% on the top-line and 25% in gross profit this past quarter for the first time in years).  We think the segment has a fighting chance to continue growing into the future.  That said, with about $25M in revenues, we value this business at only 0.4x sales or $10M.

Finally, there is the balance sheet.  The current net debt position is $29M, but we believe the company can pull another $15M out of accounts receivable (the outstanding balance has been worked down over time, but remains elevated at $52M) which, when combined with operating cash flows, can pretty quickly de-lever the business to less than $10M of net debt.

The Activist

In 2013, the small-cap activist fund Legion Partners won a proxy battle with RCMT (after raising an SPV and buying almost 20% of the company) and placed partner Brad Vizi on the Board of Directors.  Vizi has been a change-agent for the company, substantially improving working capital management and capital allocation, and doing right by shareholders.

Though a quick look at the stock chart does not show it, the investment has been a home run: since Vizi joined the Board, the company has paid out $50M in special dividends (the current market cap is $44M) that have received preferential tax treatment as “return of capital” not “return on capital.”

That said, the time for value realization is approaching.  Earlier this year, Vizi transitioned to Executive Chairman (from Chairman) and the company’s CEO (and his salary) stepped away from the business.  Each business segment now operates as a stand-alone entity reporting to a segment President, who then reports to Vizi.  This structure makes it relatively straightforward to separate the businesses for strategic purposes.

Importantly, in the company’s most recent earnings release, a special charge related to “transactional financial advisory fees” was called out (no such fee had been listed in the past).  Here is Vizi’s response when asked about it on the call:

Q (Frank Kelly): Okay.  So the transactional financial advisory fees, what was that in particular in relation to?

A (Brad Vizi): Well it’s not something I’m interested in commenting on (….) and what I’ve disclosed at this point is all we are interested in disclosing.

In our view, the end-game is upon us.  We believe Vizi will unlock value by selling either Specialty Health Care or Engineering, or perhaps (if he can do it) the entire company either in pieces or together.  The organizational changes made to the business, and Vizi’s comments on the call, lead us to believe one or more value-creating catalysts are likely near-term events.

The Stock

Importantly, we believe the current share price makes for an attractive entry point.  Over the last six weeks, based on information and belief, we think a mutual fund has been executing a tax-loss-selling program into the mutual fund fiscal year-end (Oct 31).  As a result, the share price has declined 40% from the mid-$5’s to the mid-$3’s on no news.  We also note that unlike in prior years, a special dividend is not expected in 2018 as the 2017 special dividend was debt-funded, so the current priority is reducing debt via cash flow.  Thus, there has been no expectation of a special dividend to focus investors’ attention.

Our view is this set-up presents a compelling risk/reward.  With a $44M market cap and estimated $10M of net debt in six months’ time, the total enterprise value for the business would be $54M.  We believe two of the business’s three segments are each worth well more than this figure.  As the tax-loss-selling abates, and as Vizi executes one or more transactions to create and/or realize value, we see a significant opportunity for the shares to reprice from $3.63 towards our target of $11 per share.

Disclaimer

The author of this posting and related persons or entities ("Author") currently holds a long position in this security. Author may purchase additional shares or sell some or all of Author's shares, at any time. Author has no obligation to inform anyone of any changes to Author's view of RCMT. Please consult your financial, legal, and/or tax advisors before making any investment decisions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in RCMT. READER AGREES TO HOLD AUTHOR HARMLESS AND HEREBY WAIVES ANY CAUSES OF ACTION AGAINST AUTHOR RELATED TO THE NOTE ABOVE. As with all investments, caveat emptor.

Catalyst

• Tax-loss-selling abates (Oct 31 fiscal year)
• Exec Chairman Vizi (20% ownership) unlocks/highlights value by selling one (or more) of the business units.
• Following any value-unlocking event, and assuming the company remains listed, we anticipate RCMT would begin an agressive investor relations effort (the company does zero investor relations today) to highlight the equity story and mispricing of shares.