This article is excerpted from a letter by Brad Hathaway, managing partner at Far View Capital Management.
In H2 2019, I sold the vast majority of our investment in Lawson Products (LAWS), a position that Far View has held since late 2016. LAWS is a distributor of consumable maintenance, repair and overhaul (MRO) supplies (fasteners, lubricants etc.) for industrial clients. At the time of Far View’s purchase, the company’s stock was undervalued as a result of depressed short-term earnings from the company’s investments in growing its sales force as well as investor concerns about weakening demand in the industrial economy.
LAWS sales representatives manage a territory, visiting industrial locations to learn the needs of the businesses and make sure that they are always properly stocked with parts. As LAWS CEO Mike DeCata described it, “We’re selling items to customers that they use over and over again, so it gives us a level of predictability to anticipate the customer’s needs. From the customer’s perspective, if we do our job, they never call us. Whenever the mechanic reaches into the drawer, it’s there for them.”
Because it takes some time for a new representative to create relationships with customers, this sales force expansion had created a large number of new salespeople who were not yet generating enough revenue to be profitable for the company. However, as these reps continued to work in their territories, their book of business would continue to build as acquired customers tended to be very high retention due to quality of the Lawson service. Thus, I expected sales per rep per day (the key metric of the investment thesis) would continue to grow as the sales force matured and LAWS revenue would expand significantly.
To test the investment thesis, I interviewed multiple former sales representatives from LAWS as well as competitors, spoke with LAWS customers, and visited the main LAWS distribution center in McCook, Ill. to assess its ability to smoothly handle a significant increase in volume. I also tracked the results of various cohorts of LAWS representatives to verify that sales force maturation was leading to an increase in overall sales per rep per day. Finally, my diligence included multiple conversations with CEO Mike DeCata and CFO Ron Knutson, which gave me confidence that they were strong operators who were capable of driving this sales force improvement.
When Far View made the LAWS investment, the company was relatively fairly valued its near-term expectations. However, looking forward a few years to when the sales force had matured, I could see a much more profitable company as its fixed costs would allow a significant portion of the increased revenue to drop to the bottom line. Given that LAWS was relatively poorly followed by sell-side analysts, I thought this long-term inflection in earnings was misunderstood. Fast forward three years and the sales per rep per day has increased similar to my expectations driving LAWS EBITDA to more than triple from 2016 levels.
Given that the thesis has played out as expected, why did I sell in H2 2019? While LAWS relationships provide a source of recurring revenue, the business does depend on the health of the industrial economy. For example, if you are using your equipment less frequently, there is less wear and tear on the parts, and you don’t need as many replacements. Throughout the investment, I tracked the health of the industrial economy by following macro indicators and investigating the results of LAWS’s larger distribution peers to assess the strength of industrial demand. In H2 2019, I began to see the first signs of weakening demand at those peers, suggesting a less healthy environment for LAWS.
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Disclaimer: This letter is provided on a confidential basis for informational purposes only and does not constitute the provision of investment advice. If you are not the intended recipient or an agent responsible for delivering this letter to the named recipient, you have received this letter in error and any review, dissemination, distribution, or copying of this letter is strictly prohibited. Please contact us immediately by e-mail or telephone. Certain information presented herein constitutes “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology. Any projections, market outlooks or estimates in this letter are forward-looking statements and are based upon certain assumptions. Due to various risks and uncertainties, actual market events, opportunities or results or strategies of the Fund may differ materially from those reflected in or contemplated by such forward-looking statements and any such projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. This letter includes indications of past performance of certain investments of Far View Partners L.P. (the “Fund”). Past performance is not a reliable indicator of, and is no guarantee of, future results. Investment returns will fluctuate with market conditions and every investment has the potential for loss as well as profit. The value of investments may fall as well as rise and investors in the Fund may not get back the amount invested. All performance figures are estimated and unaudited. A partner’s actual returns may vary due to, among other things, the timing of a partner’s investment and any special terms granted to a partner. The source for all information included in this letter is Far View Capital Management, unless stated otherwise. While all the information prepared in this letter is believed to be accurate, Far View Capital
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