Excerpt from the Stanphyl Capital letter to investors for the month of January 2019, discussing their long position in Westell Technologies, Aerohive Networks, Greenlight Capital Re., and Aviat Networks.
We continue to own Westell Technologies Inc. (WSTL), a telecom equipment maker (primarily small-cell repeaters that should benefit from the looming wave of 5G cellular deployment) that’s in turnaround mode. This company has a 43% gross margin and is roughly cash-flow break-even with over $1.80/share in cash (and no debt) vs. our $1.97/share average acquisition cost. In fact, we bought Westell at an enterprise value of less than 0.07x (i.e. 7% of) revenue! The “hair” on the company is a long-term decline in revenue (which should halt with the looming 5G deployment), a cash pile that could potentially be squandered on dumb acquisitions (a risk with all cash-rich companies) and—perhaps most annoyingly—a dual share class, with voting control held by descendants of the founder. However, the company is so cheap on an EV-to-revenue basis that if management can’t start generating meaningful profits it seems primed for a strategic buyer to acquire it. An acquisition price of 1x revenue (on an EV basis) would be around $4.70/share.
We continue to own Aerohive Networks (HIVE), a cash-flow positive maker of enterprise level wi-fi equipment with a 65% gross margin and a massive amount of net cash on the balance sheet (over $1.30/share of our $3.28/share purchase price), for which we paid just a hair over 1x annual gross profit (on an EV basis). Aerohive is a “busted IPO” from 2014, abandoned by the market due to a disappointing lack of revenue growth, but at the price we paid the high-margin revenue is so cheap that—as with many of our long positions—it makes an attractive target for a strategic buyer if the company is unable to grow itself. An acquisition price at an EV of just 1.5x revenue (reasonable for a 65% gross margin company with 29% subscription revenue) would be around $5.60/share. By way of comparison, Brocade bought Ruckus Networks, Aerohive’s most direct competitor, for around 2.5x revenue in 2016, and although at that time Ruckus was still in “growth mode,” it was earnings & cash-flow negative.
We continue to own Greenlight Capital Re., Ltd. (GLRE), a reinsurance company with a portfolio that mimics the holdings of David Einhorn’s Greenlight Capital but sells at massive discounts to book value. (I did reduce the position in mid-January after the S&P 500 had rocketed straight up off its December 26th low.) In theory this company could be liquidated tomorrow for approximately 40% more than its January closing price, based on its estimated per-share book values in the $14s. It’s also a bet on a “comeback” by Einhorn, a truly great long-short value investor who (like me!) had his performance crushed by the recent stock bubble. So there are two ways to win here: the gap between the market value and the book value of the company can close and/or its manager’s performance can bounce back and its book value will increase (which in itself would undoubtedly be a catalyst to eliminate the discount). (I sold our position in the similar Third Point Reinsurance Ltd. [TPRE] due to the same market run-up that caused me to cut back on GLRE, as TPRE’s discount-to-book was significantly smaller than GLRE’s.)
We continue to own Aviat Networks, Inc. (AVNW), a designer and manufacturer of point-to-point microwave systems for telecom companies, which in November reported a weak Q1 for FY 2019, with revenue up 7.7% year-over-year but, as was pointed out to me by one of our eagle-eyed LPs, that was entirely due to a new GAAP-mandated change in revenue recognition practices from ASC 605 to ASC 606; under the old standard revenue would have been down by 11%. Nevertheless, for FY 2019 the company guided to $255 million of revenue and non-GAAP EBITDA of at least $12.5 million, and because of its approximately $332 million of U.S. NOLs, $10 million of U.S. tax credit carryforwards, $214 million in foreign NOLs and $4 million of foreign tax credit carryforwards, Aviat’s income will be tax-free for many years; thus, GAAP EBITDA less capex essentially equals “earnings.” So if the non-GAAP number will be $12.5 million and we take out $1.7 million in stock comp and $6 million in capex we get $4.8 million in earnings multiplied by, say, 16 = approximately $77 million; if we then add in at least $30 million of expected year-end net cash and divide by 5.43 million shares we get an earning-based valuation of just under $20/share. However, the real play here is as a buyout candidate; Aviat’s closest pure-play competitor, Ceragon (CRNT) sells at an EV of approximately 0.9x revenue, which for AVNW (based on 2019 guidance) would be around $230 million. If we value Aviat’s massive NOLs at a modest $10 million (due to change-in-control diminution in their value), the company would be worth $240 million divided by 5.43 million shares = around $44/share.