This post is excerpted from a letter by Jim Roumell, partner and portfolio manager of Roumell Asset Management.
This is our second time investing in LQDT. At its current price, LQDT once again qualifies as an out of favor, overlooked and misunderstood security. To recap, LQDT operates several leading online auction marketplaces for industrial surplus, salvage and retail assets. The company enables the Department of Defense (DOD), WalMart (WMT) and over 9,000 municipal governments to cost effectively liquidate obsolete or excess assets. LQDT’s reverse supply chain management online platform allows customers to realize greater value for their goods due to much greater buyer reach as compared to traditional onsite auctions which are typically attended by local buyers. William “Bill” Angrick co-founded LQDT and is its Chairman and CEO.
LQDT qualifies as a business with currently poor operating results and near-term uncertainty. To wit, revenues and EBITDA declined from $475 million and $96 million in 2012 to last year’s revenue of $316 million and negative $28 million in EBITDA. LQDT’s downturn can be traced to several factors. First, the company was forced to renegotiate its DOD contracts on much less favorable terms than prior contracts. Second, the company walked away from what was previously a highly profitable contract with WalMart that it had purchased three years ago after WMT sought to effectively change the terms of the contract by altering the mix of inventory provided to LQDT. Third, the downturn in the oil/gas industry significantly reduced LQDT’s energy business that once accounted for a sizeable portion of the company’s GMV (gross merchandize value). The DOD and WMT issues can generally be viewed as the result of heightened competitive pressures.
LQDT is currently a very unpopular company. Few investors want to own the shares given the trend of its operating metrics. Five years ago, the company’s operating margin was over 10%; today, it’s effectively zero. Who wants to hang out with a loser? Notwithstanding the dramatic drop in revenues and profitability over the past five years, the investment question today is straightforward—does the 90% drop in the company’s shares since 2012 represent a bargain when compared to today’s intrinsic value? We believe the answer is yes.
First, LQDT’s balance sheet is exceptionally strong, cash-rich and debt-free, providing time for the business to be turned around. The company has $126 million of cash (this includes a $10 million short-term note), representing about 60% of the company’s market capitalization based on our purchase price. Moreover, the company has generated $40 million of average annual operating cash flow over the past five years, coupled with a modest $7 million of average annual capital expenditures, despite its operating margins turning dramatically downward. In the past six months, however, the company did—uncharacteristically—burn $18 million, likely a contributing factor in sending the shares south by about 35% in the past few months. We expect the recent cash burn to reverse itself and believe the company has ample levers to pull to avoid becoming a perennial cash burner.
Second, LQDT possesses unique assets. The company has invested heavily in having built what is one of the leading online industrial strength reverse supply chain platforms. The company is regularly named “Asset Disposal Firm of the Year” by ACG Magazine’s Global Awards. LQDT’s GMV is the largest of any online platform we’re aware of and no other platform has the breadth of liquidation services. The company still transacts over $600 million of GMV and over $300 million in revenue. Despite having walked away from what was a particularly profitable WMT contract, WMT remains a major customer. In fact, the relationship with WMT is growing and now accounts for roughly 15% of company revenue. LQDT has a sizable, and hard to duplicate, community of buyers and sellers.
Third, LQDT possesses multiple shots on goal as a result of serving multiple end markets. We’ve identified one online marketplace in particular that we believe is worth the company’s current enterprise value alone. LQDT’s GovDeals business marketplace now accounts for roughly $200 million in GMV and $25 million of revenue. GovDeals is a pure commission business, with payouts of roughly 10% of GMV. LQDT manages no inventory for this vertical, so this is effectively a self-service platform. LQDT reports having signed up over 9,000 municipalities (there are over 80,000 in the U.S.), up from 6,000 two years ago. The next largest competitor is estimated to have less than 1,000 clients. In the last quarter, GovDeals revenue was up 26% on a year-over-year basis. Although the company does not break out segment margins, one can safely assume that this division has a highly desirable business model given that it’s asset light, self-serve, has repeat customers, and is growing nicely. RAM interviewed a number of LQDT’s GovDeals clients and the feedback was very favorable:
- “We are very happy. Over the years, our value (on goods sold) has increased. Excellent customer service. To change vendors would require us to put a resolution before our town council and we have no reason to do that.”
- “We love GovDeals and how they handle things. We’ve never had a problem. We used to do an annual live auction— it was too much work, we would have to warehouse things for up to a year. Now, we just sell stuff when we want to and the buyer picks it up.”
- “Wonderful, wonderful, wonderful. We used to do live auctions, it was so time consuming, costly, a waste of time. We’ve looked at it and we’re getting 30% more on our sales compared to our live auctions because we’re now reaching a national audience. We have so many repeat buyers now.”
We believe LQDT’s GovDeals business alone is worth the company’s current enterprise value of $75 million ($200 million in market capitalization at $6.50/share and 31 million shares, less $126 million in cash and no debt). In effect, the additional shots on goal are free and include the other $275 million of revenue flowing from its DOD, retail and industrial/energy liquidation marketplaces. Candidly, we don’t know which business line(s) might turn out to be profitable, but we understand the value of “free options”— the cornerstone of our investment thesis.
There are several private market transaction data points that underscore our LQDT thesis. Optoro is a private company that competes with LQDT in the retail vertical. In December 2016, Optoro closed on a $30 million funding round, bringing to $100 million the total capital raised by the company. Our industry contacts suggest that the pre-money valuation used was $300 million. Further, we believe Optoro is at best one-third the size of LQDT in terms of GMV. If Optoro is being valued at even $200 million, we believe it is quite reasonable to assume that LQDT’s business, with multiple marketplaces, a much stronger brand and a significantly larger buyer/seller community, is worth considerably more than the $75 million implied business value after subtracting the company’s net cash from its current market cap. In fact, we find it hard to fathom that LQDT isn’t worth more than its much smaller, single vertical peer, Optoro.
Separately, LQDT’s principal competitor, privately-owned IronPlanet, was purchased by Ritchie Bros. in August 2016 for over $700 million. Industry contacts suggest that IronPlanet’s GMV was in line with LQDT’s, albeit the company had good margins and generated handsome operating income. We assume that over time the gross margins in the reverse supply chain business should be more or less the same for all industry participants. Moreover, LQDT is roughly two-thirds complete on its Liquidity One platform, which will absorb what is today eight separately managed platforms onto one with an estimated $6 to $8 million in cost savings per year.
Lastly, in terms of alignment of interests, Mr. Angrick owns roughly 18% of LQDT’s outstanding stock, a nearly $40 million stake, that we believe is a very meaningful piece of his net worth given the fact that Mr. Angrick has never been an active seller of his company’s shares.
Read about another idea, also discussed in the same letter.
Read Jim’s take on deep value vs. “great company” investing.
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