This post is excerpted from a letter by Jim Roumell, partner and portfolio manager of Roumell Asset Management.
Edgewater helps the C-suite drive transformational change through its selection of business and technology services, and channel-based solutions. The classic consulting disciplines (such as business advisory, process improvement, organizational change management, mergers and acquisitions due diligence, and domain expertise) are blended with technical services (digital transformation, technical roadmaps, data and analytics services, custom development and system integration) to help organizations leverage investments in legacy information technology (IT) assets.
In our opinion, EDGW is a typical under-earning, mismanaged, small consulting company ignored by investors who fail to appreciate the durability and recurring nature of its revenue. Given a newly constructed board, resulting from a shareholder proxy fight won by Ancora Advisors earlier this year, we believe a turnaround or sale is likely. We have a high degree of faith in Ancora’s team as operationally savvy, shareholder friendly and overall solid stewards of capital. Ancora, based in Cleveland, OH, has combined assets under management of over $4 billion. It is highly experienced in shareholder activism and the firm’s principals and employees have significant personal investments in their underlying investment vehicles. Ancora is not a “quick sell” activist, but brings real operational heft to the table, unlike many of today’s activists. In particular, Ancora combines the ability to analyze a business’s cost structure, and to right-size it, with the need to build a work culture that rewards high performing employees.
Ancora now owns roughly 11% of the company. The four board members put forward by Ancora, including its CEO Frederick DiSanto, have all personally made significant open-market purchases of EDGW stock, separate and apart from the firm’s 11% stake.
EDGW’s market capitalization is roughly $90 million, with $13 million in net cash and about $125 million in annual revenue. While the company’s cost structure has been bloated, it has nonetheless consistently generated free cash flow over the past five years. The company’s SG&A expenses have averaged roughly 33% over the past five years versus an industry average among its North American IT consulting peers of about 20%. Similarly, its EBITDA margins have averaged 5.5% versus industry peers of 11%. Thus, the opportunity to double margins is not unrealistic. Moreover, prior executive compensation was absurdly high despite underwhelming operational results. In its proxy filing, Ancora noted, “Since 2002, EDGW’s CEO, CTO and Board have been cumulatively paid nearly 50% of the Company’s total cumulative EBITDA.”
Our purchase price represents a premium to company book value (which has grown over the past five years despite mismanagement) of a modest 20% and an enterprise value to sales multiple of roughly 0.7x. Simply bringing SG&A costs in line with industry averages results in an additional $0.50 per share in earnings on a $7 per share stock. We believe the odds are quite high that the business is right-sized and ultimately sold at an appropriate time. We trust the new leadership ushered in by the people at Ancora to successfully manage the company’s turnaround.
Read about another idea, also discussed in the same letter.
Read Jim’s take on investing in deep value stocks vs. great businesses.
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