By Raghuraman Raman of Snowball ResearchA compilation of letters sent by Roumell Asset Management.
Introduction – Roumell Asset Management
In the past eleven years, Mr. Roumell has sent very few public letters to the Board and the CEO. Nevertheless, the letters sent by Mr. Roumell are rich with insights gathered through field check (“Scuttlebutt research”). It is apparent from his letters that he attends trade conference, speaks with competitors and customers to gather information about the company’s business. In one of his letters he wrote, “I personally sat in a commercial compressor distribution store to witness first-hand the strength and persistency of the Company’s after-market business”.
In fact, his fund’s website has a dedicated page named “company visit” (very rare practice among investment funds). You can see a few pictures taken during his field visit.
Vanguard’s move into PE may change the landscape forever
I’ve compiled the list of “interesting” excerpts from his letters. Also, the complete letters can be found in the “exhibits” section.
The purpose of reading this? Readers can use it for “idea generation” and to improve their research skills.
13F Portfolio, as on March 31, 2016
- “Our research process is relentless and includes regular travel to see management teams, assets, customers, and competitors firsthand.”
- “We typically do not get involved in situations where we do not have solid industry and/or company contacts.”
Source: Fund website
Roumell Asset Management – Excerpts From Eight Letters
June 15, 2016
Upon returning from last week’s TU-Automotive Telematics conference in Novi, Michigan, it is our belief that the company will warrant a significant premium to its current stock price in a sale to a strategic buyer. Underscoring the company’s belief in the strength of its Identity Management tools and its IoT platform, we confirmed that industry leaders, partners and customers remain very positive in the platform’s capabilities. Industry contacts who are deeply familiar with competing platforms – Telit, Aeris, PTC’s ThingWorx, GE’s Predix and IBM’s Bluemix (the company’s chief competitor, as we understand, in last year’s Jaguar Land Rover contract win) – indicate to us the superior depth, complexity and sophistication of the company’s platform. A key industry participant said flatly that the Covisint platform was the best platform among these leading IoT platforms. We spoke directly to key customers who underscored their positive view of the platform’s capabilities, including a major automobile manufacturer who expects to expand its relationship with the company. We were also happy to learn that a major beverage manufacturer appears to be a likely new portal customer.
Nonetheless, the primary reasons put forth for the lack of new subscription revenue were a lack of brand awareness and insufficient marketing heft. Additionally, the 6 month delay in introducing the company’s IoT platform, finally rolled out in January of 2016, appears to have been a costly event. Competitors with less robust platforms are described as possessing superior marketing and brand strength. In the absence of new subscription revenue, we believe the company’s platform would be far better leveraged in the hands of a stronger, better capitalized entity. Recent comparable transactions suggest a sales price would likely be meaningfully higher than the current share price. To wit, in 2013, PTC purchased the IoT platform, and Covisint competitor, ThingWorx for $112 million, plus a possible earn-out of up to $18 million. ThingWorx was reported to have only $10 million in revenue in the 12 months following the acquisition. Multiple industry contacts inform us that the ThingWorx platform is two notches below Covisint’s platform’s capabilities.
May 18, 2016
To be clear, Covisint boasts some compelling attributes. First, the company’s technology platform is strong and highly recognized in the automobile industry, underscored by longterm contracts. Second, it possesses a highly recurring subscription revenue stream, with 95% renewal rates, coupled with gross margins now over 50%, thanks to the company’s successful decision to outsource low-margin service work under the leadership of the company’s Chairman, Mr. Sam Inman III. Nonetheless, while it is true that the company has effectively replaced the revenue of the healthcare business it exited two years ago, the company has been unable to grow its subscription revenue sufficiently to justify its cost structure as a public company. Given the very high retention rate of its current revenue stream, we have little doubt that the company would be highly attractive to a strategic or financial investor.
Rosetta Stone Inc.
June 22, 2015
Lexia now has eight consecutive quarters of double-digit year-over-year revenue growth with mid-90% renewal rates. The company’s decision to combine Lexia Reading and K-12 language learning into Language Arts (LA), under the direction of proven education builder Mr. Nick Gaehde, makes great sense. Our field checks indicate that Lexia is being very well received in the marketplace and winning business as a result of its demonstrated efficacy through measureable results and consequently becoming more widely known among educators purchasing reading software. Lexia’s revenue has grown from $15 million at the time of purchase to today’s $25 million run rate. Through discussions with knowledgeable investors in the education space, we believe the LA segment itself, roughly $65 million in revenue, is worth more than the company’s current enterprise value. M&A transactions in the space are known to the board and don’t need to be reiterated here.
We were pleased to learn that the company does not view Fit Brains as core to its mission. Given that Fit Brains’ revenue has grown from $2 million to $5 million, it is our belief that selling it for at least its $12 million purchase price should be attainable and provide a nice cash infusion.
In summary, we are very pleased with the Management team’s renewed focus on returning RST to growth and profitability.
SeaChange International Inc.
January 28, 2015
Since Mr. Samit’s arrival, the company has clearly identified its pure OTT software offering, RAVE, to the marketplace. We believe RAVE will build on its recent contract with BBC and secure additional important customer wins this year. SeaChange’s OTT offering is differentiated given its ability to not just stream content, but to also leverage the company’s video-on-demand (VOD) expertise that enables consumers to easily access content libraries by combining Adrenaline back-office software with Nitro’s front-end user interface.
We are impressed with SeaChange’s recent acquisition of Timeline Labs, introduced by Mr. Samit. Timeline’s initiative with NewCoin augments the company’s OTT offering. NewCoin, which partners with industry giants Univision, Tribune and Fox to address measurement deficiencies in the local TV advertising market, leverages Timeline’s data gathering capabilities and adds additional clarity to the logic behind that purchase. Non-linear, multi-screen viewing is growing and local broadcasters need new tools to measure not just TV but the full viewing audience in order to better monetize their content. Currently, broadcasters are concerned that they are not being properly compensated for non-linear viewing, something NewCoin seeks to address in conjunction with the analytics developed at Timeline. These announcements underscore Mr. Samit’s vision to exploit SeaChange’s unique industry position and deep industry contacts to grow the company beyond serving traditional cable companies to now serve consumers in whichever format they choose to view content.
September 30, 2014
We invested because we believe the company is exceptionally well-positioned to take advantage of a major secular shift in how consumers view content. SeaChange sits squarely in front of the transition to “TV Everywhere” and has the technology and customer base to succeed. We applaud the Board’s leadership, and CEO Raghu Rau in particular, for implementing a clear strategy three years ago to exit non-core hardware and media services businesses and focus its R&D budget solely on next-generation software.
Our investment thesis is as follows:
- We believe Adrenalin is viewed as the best-in-class third-party back office VOD software architecture. In three years, SeaChange’s next-generation software has been selected by about 50 companies, covering roughly 50 million subscribers. We believe SeaChange’s future cash flow stream is fairly predictable as its software is rolled out to these subscribers over the next several years. As well, we estimate an additional 30 million subscribers will be added to Adrenalin’s footprint. Many of these potential subscribers are with customers still using SeaChange’s Axiom software, which is 15 years old. Operational stress on an antiquated system will increasingly force customers to upgrade.
- We believe the adoption of SeaChange’s Nucleus home-gateway software platform by Liberty Global, the world’s largest cable operator, illustrates the technological strength of this product offering. Liberty Global’s recent public comments in its second quarter conference call underscore its excitement and commitment to rolling out Nucleus more broadly throughout its subscriber base.
- Industry contacts have commented on the elegance and strength of the Adrenalin backoffice and Nucleus home-gateway combination. The traction that this dual-offering is gaining among providers, and SeaChange’s reputation as an expert in the emerging industry standard RDK protocol, should be recognized in the marketplace with additional design wins. This belief was underscored in our industry discussions at last week’s Cable-Tec conference in Denver, CO.
- SeaChange’s Infusion ad insertion software and its recent entry into the direct Over-The- Top (OTT) marketplace provide additional ways for shareholders to win, in our opinion. Infusion is now being deployed by Virgin Media, and SeaChange’s OTT strategy was validated by its high profile win with BBC.
- Cisco acquired NDS in 2012 for 5x revenue, and it acquired single point solution company BNI Video in 2011 for an estimated 10x revenue. While not suggesting SeaChange will warrant these multiples in a transaction, it is clear to us that the current stock market valuation at less than 1x enterprise value/revenue represents significant value. We believe that SeaChange is sitting in front of continued cable vendor consolidation as hardware-centric companies are increasingly challenged to differentiate themselves with software offerings.
- Finally, recent revenue declines are unrelated to next-generation software products, but rather have been due to the expected obsolescence of legacy software products, principally Axiom. Legacy product revenue will be down to just 10% of total revenue at the end of this year. The bottoming out of legacy software declines presents a unique opportunity to acquire stock at current prices.
Paratek Pharmaceuticals, Inc.
(Formerly Transcept Pharmaceuticals, Inc.)
September 05, 2013
As Transcept’s largest shareholder, we want to register with the Board our strong belief that pursuing an acquisition makes little sense while the company’s shares trade at a substantial discount to the cash on its balance sheet.
The Board has the opportunity to heed the straightforward wisdom and common sense of Warren Buffett, or otherwise rationalize strategies that no real independent, intellectually honest person would subscribe to. Mr. Buffett’s reflections on the question of share buybacks are instructive and worth quoting at some length.
- 1980 Letter to Shareholders. According to Buffett, if a business is “…selling in the market place for less than intrinsic value, what more certain or more profitable utilization of capital can there be than significant enlargement of the interests of all owners at that bargain price? The competitive nature of corporate acquisition activity almost guarantees the payment of a full or frequently more than full price when a company buys the entire ownership of another enterprise.” The “full price” reality is even more of a concern in today’s environment of broad asset appreciation.
- 1984 Letter to Shareholders. Buffett argues clearly, and persuasively, for buybacks below intrinsic value, as opposed to pursuing investment narratives involving alleged synergies. “The obvious point involves basic arithmetic: major repurchases at prices well below per-share intrinsic value immediately increase, in a highly significant way, that value. When companies purchase their own stock, they often find it easy to get $2 of present value for $1. Corporate acquisition programs almost never do as well and, in a discouragingly large number of cases, fail to get anything close to $1 of value for each $1 expended.” Further, “A manager who consistently turns his back on repurchases, when these clearly are in the interests of owners, reveals more than he knows of his motivations. No matter how often or eloquently he mouths some public relations-inspired phrase such as ‘maximizing shareholder wealth’, the market correctly discounts assets lodged with him.” This appears to well represent the market’s current view of Transcept’s management.
- 1994 Letter to Shareholders. In this letter, Buffett talks about the “sad fact” that most acquisitions will turn out poorly for shareholders; “…they usually reduce the wealth of the acquirer’s shareholders, often to a substantial extent. That happens because the acquirer typically gives up more intrinsic value than it receives.”
- 2011 Letter to Shareholders. “I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated.”
This is not rocket science and the persistency of Mr. Buffett’s strong preference for stock buybacks over speculative acquisitions, commented on in shareholder letters spanning decades, suggest that basic arithmetic and common sense don’t change over time.
Transact Technologies Inc.
January 11, 2012
- TransAct has a leadership position in the gaming industry, which has strong worldwide, long-term secular growth prospects and is uniquely positioned to benefit from the adoption of slot machines worldwide. With over half of the company’s gaming revenue coming from international markets, TransAct’s #1 market share in both Asia and Europe position the company to take advantage of growth in Macau, Singapore and other international markets.
- TransAct enjoys a duopoly environment with high barriers to entry in its gaming segment. Moreover, TransAct’s technological leadership is underscored by its 65%+ share of current printer shipments to the North American gaming industry. In fact only does the company participate in a duopoly, the data strongly suggests that it is gaining significant NA market share.
- New casinos are choosing TransAct and entering into exclusive agreements. The recently opened Resorts World Casino at Aqueduct Racetrack in NYC chose TransAct for 100% of its slot floor. In December 2011, the company announced that the Epic 950 printer was also selected exclusively by Revel in Atlantic City.
The company’s introduction of a software-centric product allows casinos to interact directly with their slot machine customers and “touch” highly-regarded carded players with a sophisticated couponing system that will generate recurring software revenue, which may be a game-changer for the industry. In fact, the Director of Slot Operations for Resorts stated, “We were pleased to choose the Epic 950 printer from TransAct for our casino floor due to its features and functions and capability to be connected to EPICENTRAL in the future.”
- Under the leadership of CEO Bart Shuldman, the company has innovated, diversified and won business seemingly above its weight-class. For instance, the win three years ago in designing and supplying printers to McDonald’s for their new grill initiative and then subsequently winning their coffee bar printer business demonstrates the strength of TransAct’s collaborative and innovative culture.
- The company continues to enjoy a long sole-source relationship with lottery terminal industry leader GTech Industries.
- The company’s 2011 acquisition of Printrex further diversified the business into the oil/gas market at an attractive price.
- Lastly, the company has accomplished all of the above while remaining debt-free.
Notwithstanding the above attractive attributes, we think it is likely that the company’s shares remain underappreciated, reflecting a micro-cap market discount that could persist for some time. U.S. stock funds witnessed a net $75 billion outflow in 2011, with a similar outflow in 2010. Given unusual levels of volatility in the global economy, and Eurozone uncertainty, we believe investors will continue to lessen their exposure to equities in general and to micro-cap shares in particular. As a result, even promising and niche-dominant enterprises could be open to persistent and significant liquidity discounts. As well, the EPICENTRAL sales cycle is turning out to be longer than management originally anticipated.
We believe there are investors that can see past the current market inefficiencies and appreciate the intrinsic value inherent in TransAct. These investors would likely be willing to purchase the entire company and offer shareholders an opportunity to realize substantial value on their current holdings. We believe there are both strategic and financial investors that would understand the opportunity and want to capitalize on the existing market environment. Corporations are sitting on record amounts of cash, earning little in the way of interest income, and are interested in deploying their cash into higher returning investments, much like TransAct did with its 2011 purchase of Printrex. Further, many financial buyers are flush with cash and are looking to invest in stories that combine mature revenue streams with identifiable secular growth opportunities, both of which are present at TransAct. When interest rates begin to rise, the incentives to more opportunistically deploy cash will diminish. Additionally, strategic buyers could provide greater resources to exploit additional verticals, while providing more growth capital to roll-out EPICENTRAL in a more timely fashion. In both instances, we believe buyers would be very attracted to a debt-free, positive cash flow story that is well positioned to take advantage of growth in the gaming industry, both domestically and internationally. Finally, management would be freed from the demands of public ownership and able to focus 100% of its time on growing the business without the diversion of such things as managing street expectations.
See the full compilation below.