Description

SUMMARY 

SMIT has no past analysis in VIC, so even though it is a pretty short idea, we will expand a little. 

SMIT is one of the smallest companies traded on NASDAQ with a ±$15m market cap. For 15m you get a pile of cash, profitable but small business, some real estate, zero debt and an activist investor as a CEO who, as I read the map, probably wants to liquidate the company. If he does, you will not double the money here. But you sure can make a decent return (30-50%) pretty quickly.  

SENTENTIA CAPITAL MANAGEMENT

Sententia is a new hedge fund (first filing in 2017) run by Michael Zapata, an ex-navy seal. In June 2018 Zapata Published his first 13D regarding his SMIT holdings and stated he had 6.6% of the stock. Since then he bought up to 9.2%.  

A couple of months later, Zapata released an open letter (https://www.sec.gov/Archives/edgar/data/922612/000092189518002462/dfan14a11872002_08222018.htm) to the company’s management, asking them to work with him to deliver more value to shareholders. 

Time went by and Zapata got the CEO’s chair by Aug 2019.   

BUSINESS SEGMENTS

Until recently, SMIT had 2 mainline businesses – Balancer and Measurement, which Zapata expanded on in his investment research letter (https://www.sec.gov/Archives/edgar/data/922612/000092189518002489/ex1dfan14a11872002_08242018.pdf). The 2 lines had 3 different businesses:

1. SBS (Schmitt Dynamic Balance System) – Balancer. This was the largest of the three, and they recently sold it. SBS is a balancing system for grinding wheels. 

2. Accuity – Measurement. This line is a distance and size measurement accurate device, based on laser measurement.  

3. Xact – Measurement. This line is an ultrasonic measurement product that measures the fill level of tanks holdings liquids. This system also has recurring revenue – it sends the data through satellite and the data is accessible through cloud technology, a service that the customers pay additional money on. 

At any rate, 2 months in (last Oct) Zapata made a deal to sell the SBS business for $10.5m and a 10 years lease in SMIT’s facility for $23,000 a month. The deal was closed a few days ago and the stock responded with rising. 

SBS had an operating loss in 2017, 2018 and 2019 of 931k, 50k and 1,500k. Measurement business, on the other hand, had rising operating income in the same period: -57k, 206k, and 400k. Zapata sold the losing (but larger) business and kept the profitable two.

Measurement’s numbers are pretty solid, and the NOI is solidly positive (2/13 of the last Q’s were meaningfully unprofitable). EBITDA speaking, it had two negative Q’s, which you may see in the table (https://drive.google.com/open?id=1VHExrrj5zYFhOfU_J2g32sC92PRbANXd).

Measurement also doesn’t need any yearly CAPEX. The company invested only $10k in caps in the last 3 years (>1% of NOI).

So it is a tiny business that could barely justify being a public company. EBITDA margin for the last 3 years + 1 Q was 8.28% on average. But still, this is a debt less business that competitors might want to purchase for the right price. If purchasing it for 1x sales would yield 8.28% a year, that could be a good investment for someone in the same business area who can merge it well and save some costs. 

That being said, the measurement business has another growth opportunity – the recurring revenues of the Xact monitoring systems (tank measurement). This is a high-margin business that grows 16% YOY. So, while on the last Q Xact product revenues were 50% lower (the reason: “Xact customers intermittently purchase Xact products based on their respective business needs and capital expenditure budgets, causing irregular product revenue over quarterly periods.” Not good enough, but that’s what it is), the monitoring (recurring) business continued to grow and the EBITDA margin was up from 14.75% to 21%.

Last year Xact revenues were about 50-50 in terms of product vs monitoring. This ratio needle should move more towards the monitoring in the following years, a move that will create better margins. 

REAL ESTATE

Schmitt owns 40k sqft of real estate in the Pearl District, Portland, Oregon. Zapata claims that 10k is an investment real estate that the company held for sale and pulled back due to rethinking about zoning. He claims that this could be worth around $2-3m. I couldn’t find anything about this land, so let’s keep this one at $1m.

In addition, as I already said, the company signed a deal to lease it’s SBS building (maybe not all of it. I can’t tell), for $270k a year NNN. With a high (bad) cap rate of, say, 10x (it’s low because the average cap is low these days and it’s NNN). So, this property market value could be worth at least around $2.5m.  

I couldn’t find any other data on its real estate. For example, the lease deal could be for part of the building, and not all of it. Zapata claims that the total real estate could be worth as much as $9m. To keep this thesis clean, let’s keep it at $3.5m. 

SOME OF THE PARTS VALUATION

For around $15m you get:

1. ±$13m of cash

2. Real estate worth around $3.5m.

3. Measurement business that could be worth at least 1x sales. That about $4.5m. 

These alone creates a $21m worth of business (30% discount). If $3.5m of real estate is rock solid, we are in the 10% discount to the hard assets range. But we still got a positive business going on, potential upside on the real estate and we still have lots of stuff under the current assets which I never mentioned.

BACK TO ZAPATA 

Liquidation usually takes time, and time is expensive. But all signs show that Zapata is in for quick liquidating.

In his thesis, Zapata said that the SBS business could be improved. Yet he decided to sell it just a couple of months after becoming a CEO. Besides, he has his own business – a hedge fund, and the salary he gets from SMIT, of about $170k, is not high enough in order to believe he is in it for this money. 

Therefore, it is reasonable to believe Zapata will try to liquidate it ASAP. 

Catalyst

- Assets liquidation