Via Steve Kiel of Arquitos
Current Price: $1.74
Disclosure: Arquitos Capital Management and/or its affiliates own shares of ALJJ at the time of this report. Please view our disclosure statement for more information.
ALJ is a unique holding company that recently acquired a subsidiary where ALJ can deploy their considerable net operating losses (NOLs). The subsidiary, Faneuil, was acquired at a reasonable price and has significant growth potential. Faneuil’s leadership is strongly incentivized to innovate and cut costs. ALJ’s chairman, Jess Ravich, is a demonstrated leader who has proven to be shareholder friendly while focusing on long term value creation.
Background on ALJ
I discovered ALJ in November 2012 when they announced they were selling their majority-owned steel subsidiary, KES, for $112.5m cash. ALJ is a holding company that had bought into the steel mill in the mid-2000s. Along the way ALJ borrowed against it and accumulated considerable NOLs. They also announced, after paying off their debt, they would commence a tender offer to acquire approximately 50% of their outstanding shares. The transaction closed in February 2013 and the tender offer closed soon thereafter. Through the tender, ALJ purchased 30m shares at a total cost of $25.2m.
At the quarter that ended on March 31, 2013, ALJ was left with approximately $30m total in cash, short term investments, a receivable, and about $2m in liabilities. They had approximately 27.5m shares outstanding. At that point ALJ had no operations, very limited expenses, and $176m in NOLs expiring between 2020 and 2027. Shares traded around 82 cents/sh.
ALJ’s stated intention was to purchase another company in order to utilize the NOLs. Jess Ravich’s in-depth experience as an investment banker meant this was likely to occur. In order to retain the NOLs and not have to convert into an investment company, which would have been a costly and undesirable situation, ALJ would have to purchase a new company within about a year of the sale of KES. This gave them until around February 2014. The value of ALJ would be maximized by purchasing a company that had predictable cash flow in order to apply the NOLs for years to come. It was also likely, given the potential target acquisition and Ravich’s experience, that ALJ would be able to purchase a company much larger than its current assets through some sort of debt financing.
The worst case scenario would be that ALJ would not have been able to find a company and would have liquidated, losing the value of the NOLs. For an investor, ALJ liquidating would have been far from an optimal result, but with no cash burn and the stock trading at that time for about 25% less than its net liquid assets, the worst case scenario would still have produced a positive outcome. However, liquidation would have been a very unlikely result given the other circumstances.
As 2013 progressed, ALJ retired more of its shares and made some money on its short term investments. There continued to be no cash burn. The final quarterly report before the acquisition of Faneuil, September 30, 2013, showed 26.7m shares outstanding and net cash and liquid investments of $27.8m, or about $1.04/sh in net assets.
The acquisition scenario described above occurred on October 18, 2013. ALJ acquired Faneuil from Harland Clarke (a subsidiary of Ron Perelman’s M&F Holdings). The acquisition was for 96.43% of Faneuil for $53m broken down as follows:
- $25m cash
- Contribution of $500,000 in cash for working capital purposes
- 3m shares of ALJ common stock valued at $2.5m
- A seller note to Harland Clarke for $25m (2 yr maturity with 5% interest in the first year and 7.5% interest in the second year)
ALJ acquired Faneuil at an attractive valuation when looking at 2013 figures. At the time of the acquisition, at the run rate of the first nine months of 2013, ALJ acquired Faneuil at the following multiples:
- 4.8x EBITDA
- 6.2x operating income
- 0.5x revenue
Faneuil also had signed two health exchange contracts that commenced in the last few months of 2013 and were not reflected in the financials at the time of purchase.
A little background on Faneuil. Their primary activities are as a government service processer and call center. Most revenue comes from the operations of their toll collection and processing services, health exchange contact centers, call centers for utilities, and medical device tracking. Clients include Florida’s
SunPass, health exchanges in Washington state and Tennessee, Bell South, and Dominion Power.
ALJ’s Q1 2014 report covering the quarter ending on December 31, 2013 was released on February 14, 2014.
Faneuil’s pro-forma results for the first nine months of 2013 aren’t directly comparable to the actual results reported of the last three months. We don’t know what the adjustments are and we don’t know how Harland Clarke allocated certain expenses. Because Faneuil’s contracts and cash flow appear to be relatively stable and predictable, I’ve decided to pro-rate the actual results to full year. Admittedly, this is a rough sketch, but it is the best we have to work with right now. Take these annualized numbers with a grain of salt and use them to compare to the actual results as they are released later in the year.
These annualized results are unlikely to be materially lower absent the loss of a contract. There should not be much seasonality involved. Results also could be materially higher if new bids are won. Given Faneuil’s new-found freedom from Harland Clarke and incentives to grow, it is probably more likely that results turn out better than expected.
According to the CFO, the reported results don’t include the first 18 days of October, so I’ve adjusted them to the full quarter and provided select annualized financials. See below:
|Cost of Sales|
I used diluted shares outstanding of 31,619,913 since it is likely options will be in the money.
At today’s price of $1.74, ALJ trades at the following multiples:
For the calculation of the enterprise value, I used the non-diluted number of shares and adjusted for the accounts receivables since Faneuil’s customers are typically states, municipalities, and other stable (but slow) payers.
At what multiple should ALJ trade? I don’t have an answer for that. We do want to