Description

Background

I have as much respect as the next person for Brad Jacobs’ entrepreneurial accomplishments, and would welcome an opportunity to invest alongside Brad in his next venture QXO at a sensible valuation.  But the current valuation of SilverSun Technologies (SSNT), which will convert into a stake in Jacobs’ next venture QXO, implies a valuation of QXO that is far too optimistic: a market capitalization of QXO of ~$46 billion for a company that will have $2.6 billion in pro forma cash and no operations when the transaction closes beyond SSNT’s current business, a largely undifferentiated value-added reseller of business application software. 

Brad Jacobs is well known to VIC, and has completed approximately 500 M&A transactions in his career, and built five multi-billion dollar publicly traded companies to date: XPO, one of the largest providers of less-than-truckload services in North America; GXO Logistics, the largest pure-play contract logistics provider in the world; RXO, a leading tech-enabled freight brokerage platform; United Rentals, the world’s largest equipment rental company; and United Waste Systems, the fifth largest U.S. waste management company at the time of its sale to USA Waste Services (now Waste Management, Inc.) in 1997.

But a ~$44 billion enterprise value for a company with $2.6 billion of pro forma cash and no operations yet (beyond SSNT’s current business, which had a $13 million enterprise value before the transaction announcement) is placing an extremely high value on expectations for Brad Jacobs’ execution, and I believe it is already giving full credit for much of the growth Jacobs has projected. Similarly, a $22.3 billion enterprise value after the initial close for a company with $984 million of pro forma cash and no operations yet is placing an extremely high value on expectations.

Jacob’s forecast for QXO revenue growth is “By the end of the first year, we should be on a revenue run rate of at least a billion dollars. At the end of the second year, we should be on a revenue run rate of at least $5 billion. And, over the next decade, we expect to get this into the tens of billions of dollars of revenue size.” 

QXO’s implied market cap is larger than the current market cap of the largest company in the industry according to Brad Jacobs, Ferguson plc (FERG) which he called a “great company” in a recent interview.  Ferguson has a $43 billion market cap, LTM revenue of $29.4 billion, LTM EBITDA of $2.9 billion, LTM EBIT of $2.6 billion, and LTM FCF of $2.0 billion.  So over a decade, Jacobs plans to grow to the neighborhood of Ferguson’s size, but QXO’s implied valuation today is already larger than Ferguson’s current market cap.

Over time, Jacobs plans to raise additional equity, which will further dilute the stake held by the legacy SSNT stockholders.  His plan to finance acquisitions beyond the initial capital is additional capital raises for additional acquisitions: “More equity than debt than in the past. In the past, I’ve been comfortable going up to two to four times of leverage. Here, I’m thinking more roughly half of that.”

The current SSNT price has a downside to fair value of at least 50%, and up to ~57%.  Based on the shares available to short and daily volume, this investment is more appropriate for PAs.

Investment Agreement

On December 3, 2023, SilverSun Technologies entered into an Investment Agreement with Jacobs Private Equity II, LLC (JPE) and other investors including Sequoia Heritage providing for an investment of $1 billion in cash: $900 million from JPE and $100 million from co-investors.  Upon the closing of the equity investment, JPE will become the majority stockholder of SilverSun, and Jacobs will become the Company’s CEO and chairman.  The Investment Agreement provided for the spin-off of SilverSun’s existing business to current SilverSun stockholders.  The remaining Company will be renamed QXO, Inc. and will become a platform for significant acquisitions in the building products distribution industry.

On April 14, 2024, SSNT entered into an Amended and Restated Investment Agreement with JPE.  Under the new agreement, the spin-off of SilverSun’s existing business will not occur, and SilverSun’s existing operations will be retained. The Company’s stockholders as of the date one day prior to the closing of the Equity Investment will be entitled to receive an aggregate cash dividend of $17.4 million (amended from the aggregate cash dividend of $2.5 million contemplated by the original investment agreement), to be paid from proceeds received by the Company from the Equity Investment. The other material terms of the other transactions contemplated by the original investment agreement are not affected by the amendments in the A&R Investment Agreement.

Although on March 15, 2024 SilverSun announced that stockholders voted to approve the transactions in the initial investment agreement, the A&R investment agreement is still subject to approval by stockholders and other customary closing conditions.  The closing can be no later than October 15, 2024.

Prior to the closing of the JPE investment, the Company will amend and restate its certificate of incorporation to, among other things, effect an 8:1 reverse stock split with respect to the Company’s common stock. Upon the closing of the Equity Investment and giving effect to the reverse stock split, the Company will issue to the Investors, in the aggregate: (a) 1,000,000 shares of Convertible Perpetual Preferred Stock of the Company that, in aggregate, will be convertible into ~219 million shares at an initial conversion price of $4.566 per share (equivalent to $0.571 per share pre-split); and (b) warrants to purchase an additional ~219 million shares at initial exercise prices of $4.566 per share (equivalent to $0.571 per share pre-split) with respect to 50% of the warrants, $6.849 per share (equivalent to $0.856 per share pre-split) with respect to 25% of the warrants, and $13.698 per share (equivalent to $1.712 per share pre-split) with respect to the remaining 25% of the warrants, in each case subject to customary anti-dilution adjustments.

QXO Strategy

Distributors of building products offer materials, finished goods, value-added solutions and expertise to a broad range of customers across residential, nonresidential (i.e., any building that is not a house: commercial facilities, hospitals, schools, etc.), industrial and infrastructure (e.g., roads, bridges, tunnels, underground pipes) end-markets. Their products are used in new construction and in repair and remodeling. Key categories include access control, construction supplies, doors and windows, electrical components, fencing and decking, HVAC, infrastructure, landscaping, lumber, plumbing, pools, roofing, flooring, windows, tiles, doors, siding and water, among others. 

The business bridges the gap between a large and fragmented supplier base with an even larger and more fragmented customer base. The business has a transportation and logistics aspect to it, buying building products materials wholesale in large volume, storing them in distribution centers and warehouses, and then shipping them via truck to the end customer.

The building products distribution industry is highly fragmented, with ~7,000 distributors in North America and ~13,000 in Europe.  The market is ~$800 billion between North America and Western Europe, and has grown at a revenue CAGR of 7% over the last five years.  It benefits from growth in the residential, nonresidential and infrastructure sectors.  Industry observers think the current supply of U.S. homes is 3 million units short of demand, potentially creating long-term tailwinds for both new construction and the repair and remodeling of aging homes. In the nonresidential sector, long-term demand is expected to be driven by growth across multiple industrial and commercial verticals.

The industry is nascent in the use of technology, and the percentage of industry revenue derived from e-commerce is currently only mid-single digits. QXO’s strategy is to create a tech-forward leader in the building products distribution industry through accretive M&A and organic growth, including greenfield openings.

Jacobs believes these market dynamics, together with the fragmented nature of the industry, offer an opportunity to unlock growth potential through scale and technology. National distributors can serve large customers across multiple geographies and project types with standardized efficiencies, providing consistent, data-driven customer services across a broad operating scope. Additionally, a scaled technology ecosystem can expand the array of value-added services offered to customers, such as job site visibility into product consumption, digital configuration tools for custom ordering and tracking, and virtual design capabilities that interface with product order flow.

Additional types of technology adoption by distributors that will be explored include price optimization, demand forecasting, warehouse automation and robotics, automated inventory management, route optimization for delivery fleets, supply chain visibility, and end-to-end digital customer connectivity. Jacobs described the opportunities to leverage technology in the business as follows: “The tech component to this business plan is big. The way we’re going to use tech in this industry is, number one, we’re going to use it for pricing, rather than just picking a price out of the air, or by tribal knowledge, it can be done very, very methodically through tech.  Number two, there’s a warehouse component to this business, because you buy all of these materials wholesale, you store them in warehouses / distribution centers, and then you truck them to the end user. Sometimes they’re drop shipped. Sometimes they are stored in the local branches, but a lot of warehouse / DCs. In my due diligence, I was surprised to find that the warehouses and DCs, some of them have some level of automation. None of them are anywhere near as automated as GXO was, for example in those thousand warehouses that they have there. On the delivery part, there is some level of route optimization going on, but not a significant amount. So, there’s tons and tons of ways to use technology, particularly in machine learning and AI, to take waste out of the system. To take inefficiencies out of the whole supply / value chain. And, I’m going to do that. Also, from an e-commerce perspective, e-commerce now is about 3 – 5% of sales done digitally. That reminds me of where truck brokerage was ten years ago. Today, at RXO, in truck brokerage, 97% of the orders are either sourced or covered digitally, and I expect that’s where this industry is going as well.”

According to Brad Jacobs the largest company in the industry is Ferguson plc (FERG), which has a $43 billion market cap, and LTM revenue of $29.4 billion, LTM EBITDA of $2.9 billion, LTM EBIT of $2.6 billion, and LTM FCF of $2.0 billion. Ferguson has ~36,000 suppliers, a network of 11 national distribution centers, three market distribution centers (MDCs), 5,700 fleet vehicles, 1,762 branches, and ~35,000 employees.

QXO Capitalization and Implied Valuation

Following the closing, the Investors will own ~99.85% of company on an as-converted, as-exercised basis, and SSNT’s Legacy Stockholders will retain only ~0.15% of the renamed QXO, Inc.:

QXO’s total investment on an as-converted, as-exercised basis will be $2.6 billion:

Following the initial closing, stockholders of SSNT as of the close of business on the record date (expected to be one day prior to the closing date of the Equity Investment), will own the following:

• $17.4 million cash dividend, funded from proceeds of the investment six days after closing.
• 0.302% of the renamed QXO, Inc.  (0.151% on an on an as-converted, as-exercised basis)

Netting out the $17.4 million dividend from SSNT’s current market cap results in an implied value for SSNT’s stake in QXO of ~$70.3 million.  The valuation that implies for QXO depends on how much of the warrants QXO ends up exercising over time, but Brad Jacobs certainly plans to fully exercise the warrants, and the fully-diluted market cap implied for QXO an as-converted, as-exercised basis is $46.4 billion, implying an enterprise value of $43.8 billion (although by the time all warrants are exercised, the company will have deployed cash on acquisitions). For each phase of JPE’s future investments, today’s valuation implies a multiple of the valuation JPE will be paying for its ownership stake, varying from 7.7x – 23.2x:

A ~$44 billion enterprise value for a company with $2.6 billion of pro forma cash and no operations yet (beyond SSNT’s current business, which had a $13 million enterprise value before the transaction announcement) is placing an extremely high value on expectations for Brad Jacobs’ execution, and I believe it is already giving full credit for much of the growth for much of the growth Jacobs has projected. Similarly, a $22.3 billion enterprise value after the initial close for a company with $984 million of pro forma cash and no operations yet is placing an extremely high value on expectations. 

As I said, I have as much respect as the next person for Brad Jacobs’ capabilities, but that is not a valuation at which I would be comfortable investing.  Each $1 increase in SSNT’s stock drives a $3.51 billion increase in the implied fully diluted valuation for QXO, and a $1.76 billion increase in the implied valuation following the first closing.

SSNT Fair Value

A short position will have to cover the resulting stakes in both the post-transaction QXO and its share of the $17.4 million dividend to SSNT Legacy Stockholders ($3.27 per share).  JPE Investments will be made at the following valuations for the initial Preferred and subsequent warrant exercises, as well as the stake that will be held by SSNT Legacy Stockholders, the cash invested, and SSNT’s net cash (debt will be paid off prior to closing), net of the $17.4 million dividend and a $3 million payment for termination of the Meller SilverSun Employment Agreement:

The table below shows various scenarios including the investment valuations for each round above as the base case at each stage of capital raising / warrant exercise, and the range in each case also includes the valuation of the next upcoming financing as well as higher valuations.  SSNT is meaningfully overvalued in every scenario.  Even if QXO grows to a $10 billion valuation after all of the warrants are fully exercised (prior to any future capital raises that Jacobs contemplates), the current stock price still has 43% downside:

SSNT value per share should actually be discounted even more than the values shown above, because it will be sitting behind $1 billion of convertible preferred with a liquidation preference, and dividends when, as and if declared at the rate 9% annually on the accreted liquidation preference in effect at the time. But I have treated the preferred on an as converted basis to be conservative.  The warrants are exercisable for common stock.

SSNT’s Current Business

JPE’s investment in SSNT does not reflect their view of the potential of SSNT’s business.  SSNT merely gives QXO a public listing.  Brad was asked in an interview about the structure, and described the original agreement as follows:

Julie Hyman: But why do this versus, say, a SPAC, or another kind of investment vehicle?  

Brad Jacobs: I don’t like SPACs from the point of view of I don’t know that there’s a real, fair alignment between the “promoter,” so to speak, and the investors. They don’t put any money in, usually, and they get 20% off the top. What I’m doing is something very different. We’re actually putting, we’re putting our money where our mouth is. We’re putting a billion dollars into a very small-cap company who’s $15 million or $20 million of market cap, as of a few days ago. And then we’re going to spin back that company to its legacy shareholders. We’re going to give them a little dividend, $2.5 million dollars. We’re going to give them a little taste of the new company, like less than half a percent. Then we’ll be left with a publicly traded company with a billion dollars of cash in it, and we’re off to the races.

Julie Hyman:  And how did you pick this one? I mean, could it almost have been any company? I mean, what criteria then, because you’re getting rid of that fundamental business?

Brad Jacobs:  I like the fact that it was small, so we had less dilution. You remember with XPO, we did a similar concept, where we had a company called Express-1—which is where the ticker, “X-P”, Express, “One” came from—and we put $150 million into it, we did a PIPE into it, and we got about 70% of it. We had a lot of dilution. 30% made billions of dollars on our backs. So, this time, we’re going to have over 99% of the company from the beginning. So, its small size actually was a benefit to us.

SSNT is a largely undifferentiated value-added reseller of business application software solutions for accounting and business management, financial reporting, ERP, HCM, WMS, CRM, and BI. Revenue is primarily derived from the purchase and resale of vendor software products and services. SSNT either resells software directly to customers or acts as a sales agent for various vendors and receive commissions for these sales efforts.  They also offer various ERP enhancements, consulting and professional services, and IT network and managed services. The majority of SSNT customers are small and medium businesses.  SSNT’s market is highly fragmented, with a large number of competitors, including several large companies.  A significant portion of SSNT revenue is derived from RFPs, and price is often an important factor in awarding the agreements. 

SSNT generates ~40% gross margins on both its services revenue and its software revenue.  SSNT financials for 2023 and LTM when the transaction was announced as well as the multiples prior to the transaction announcement are the following:

The divergence between the growth in revenue / EBIT / EBITA / EBITDA and the simultaneous decrease in FCF and NOPLAT in the recent quarter were due to SSNT recognizing $618k of Deferred Revenue in 2023 compared to increasing the Deferred Revenue balance by $1.2 million in 2022.

The most recent investor presentation on SSNT’s investor relations page is from June 2019, so they do not appear to have been actively engaged with the investor community, at least in recent years.

Short Opportunity

Based on the shares available to short and daily volume, this investment is more appropriate for PAs.

As of 4/17/24, the current fee rate at Interactive Brokers is 13.25%.  Interactive Brokers does not trade put options for SSNT.  Short interest increased following the original transaction announcement, and was at 317,612 shares as of 3/28/24 (9.29% of float; 5.98% of total shares outstanding as of 3/13/24).  Data for 4/15/24 has not yet been released.

CEO Mark Meller has recently sold 28% of the shares he beneficially owned (406,534 shares) when the transaction was announced (with his most recent sale on 3/26/24), for aggregate proceeds of $1.5 million.  Related parties (i.e., Meller’s wife’s family trust, and Mark M. Meller Family Trust) own an additional 800,000 shares each.

Risks

• The stock traded as high as $21.98 following the announcement of the original investment agreement, and the stock price could get more irrational from here.
• Investors who are short the stock will have to pay their share of the $17.4 million dividend ($3.27 per share) six days after the initial closing.
• Following the initial closing, there will be $1 billion of convertible preferred outstanding (convertible into ~219 million shares) and only 664K common shares outstanding.  That structure could cause some investor confusion about the fully diluted valuation—just as investors appear to be confused about the proposed structure and the valuation implied by the resulting ownership for the legacy SSNT stockholders—and could lead to investors overvaluing the QXO common.
• When the April 14 Amended and Restated Investment Agreement with JPE was announced on April 15, the stock traded up as much as 27% midday, even though the deal for current SSNT shareholders may be arguably less attractive in the new agreement.  Although the dividend increased by $14.9 million from the original agreement, legacy SSNT stockholders will no longer own the legacy SSNT SpinCo.  SSNT was valued at $19.3 million prior to the announcement of the transaction, and had the potential to trade higher than that following the spin-off.
  • In the initial deal, SSNT stockholders would have received the following:
    • $2.5 million cash dividend, funded from proceeds of the investment
    • 0.151% of the renamed QXO, Inc. on an as-converted, as-exercised basis
    • 100% of the shares of SilverSun Technologies Holdings, Inc., (SpinCo, which would have been the legacy SSNT). 
  • In the amended deal, SSNT stockholders will receive the following:
    • $17.4 million cash dividend, funded from proceeds of the investment
    • 0.151% of the renamed QXO, Inc. on an as-converted, as-exercised basis

Catalyst

After the initial closing, I believe the value of QXO should start to reflect and converge on value between $7.25 - 8.00 per share of SSNT (pre reverse split) rather than the current $16.50 (i.e., $1.25 – 2.6 billion rather than the currently implied $23 billion following the first closing, and $46 billion on an as-converted, as-exercised basis).