Institutional Investors

New Long Micro-Cap Deep Value Positions

Excerpt from the Stanphyl Capital letter to investors for the month of December 2018 discussing their long position in three new stocks. Stanphyl was profiled in the second edition of HVS and has had some of the best picks among all the funds (including Stanphyl with several 100%+ returns) we have profiled with 200%+ returns on some pitches.

Institutional Investors

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New to the fund this month are shares of 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.

Also new to the fund in December are shares of 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.

Also new to the fund in December are shares of Greenlight Capital Re., Ltd. (GLRE) and Third Point Reinsurance Ltd. (TPRE), reinsurance companies with portfolios that mimic the holdings of David Einhorn’s Greenlight Capital and Dan Loeb’s Third Point (hedge funds), but sell at massive discounts to book value. In theory these companies could be liquidated tomorrow for over 50% more than we paid for them, based on our $8.80s (for Greenlight) and $8.90s (for Third Point) per-share basis vs. their estimated per-share book values in the $14s. These are also bets on a “comeback” by Einhorn, a truly great long-short value investor who (like me!) had his performance crushed by the recent stock bubble, and a resumption of historical outperformance by Loeb. So there are two ways to win here: the gap between the market value and the book value of these companies can close and/or their managers’ performance can bounce back and their book values will increase (which in itself would undoubtedly be a catalyst to eliminate the discount).

We continue to own Aviat Networks, Inc. (ticker: 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 0.7x revenue, which for AVNW (based on 2019 guidance) would be around $209 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 $219 million divided by 5.43 million shares = around $40/share.

 

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