Description

Please note this idea is likely limited to PA and small funds only given ~$16k daily average trading volume.  

Executive Summary

Evercel is an owner/operator led holding company, which is comprised of the following assets:

• Common Stock and Convertible Note investments in SharpSpring (ticker SHSP)
• Cash and notes receivable
• 80.1% ownership in its operating business, Printronix, which is the global leader in Line Matrix printing solutions (90% global market share)

The thesis is simple:  After backing out the fair value of the SHSP investments, cash, and notes receivable (48 cents per share of which is hidden from the latest reported balance sheet figures), the operating business trades at a 37% free cash flow yield despite revenue growth, margin improvement, and resulting FCF growth reported in FY2018. Although the Printronix business is not a high-quality business and is likely in terminal decline, the current price represents a “cigar-butt” type investment with a low probability of permanent capital loss.

EVRC trades at $2.13 per share with 33mm fully diluted shares outstanding ($70.2mm market capitalization).    

NAV Analysis

An overview of the various assets within the Evercel holding company provides insight into the look-through earnings of Evercel’s 80.1% ownership in Printronix.  

SharpSpring

Evercel owns two investments in the publicly traded company SharpSpring (ticker SHSP).  

• Common Stock- EVRC invested $2.1 million in public shares of SHSP at an average basis of $3.97 per share (529k shares)
• Convertible Debt- The convertible is a 5-year note w/ 5% annual PIK payments issued at $7.50 per SHSP share.   SHSP can force conversion at $13.13 if it trades above that price for 120 consecutive days. After one year of PIK, if converted, EVRC would own 1.12mm shares of SHSP common stock.   The deal was co-sourced with a fund called Corona Park Investments – which is owned by the CEO of EVRC; and the deal was structured whereby EVRC is entitled to:
  • 100% of profits up to the initial investment amount ($10.1mm) and
  • 80% of gains above $10.1mm (i.e. Corona Park Investments receives a 20% carry)

I discovered EVRC after they provided the convertible note to SHSP with the objective of fueling SHSP’s high ROIC growth. I thought the deal was positive for both sides:   issuing equity above market prices to accelerate growth was intelligent for SHSP (the lifetime value of customer acquisitions at SHSP was, and remains, very high relative to the cost of acquisition); paying for equity in a convertible note structure was an intelligent move for EVRC given SHSP’s low valuation & the downside protection offered by a convertible note.

Please refer to my prior writeup of SHSP for full analysis on the business (I continue to hold shares in SHSP.  Despite the appreciation in shares, SHSP has a long runway ahead and one way of viewing EVRC is a compound mispricing with SHSP being potentially worth substantially more over a longer time horizon).  

Other HoldCo NAV items

Evercel’s financial statements largely pertain to the 100% consolidation of it’s 80.1% ownership it the operating business, Printronix.   Before getting to Printronix, there are a few items which are specific to the Evercel Holdco.

• Hidden Note Receivable - Under GAAP accounting, the principal of a related party note cannot be treated as an asset, but rather a reduction in equity until the note is paid. The result is that the receivable does not show up as an asset on the financials.  In 2013, Evercel sold 5.64mm shares of EVRC to the CEOs fund (Corona Park) in exchange for a promissory note.  The interest on the note is PIK, and it started at 1% flat but began compounding at 1% in 2017 (1.9% interest FY18, 2.9% interest in FY19).  This will likely be paid off over the next couple of years, otherwise compounding will create a large liability for Corona Park (interest rate will be 6.8% in FY2022). Currently there is $4.35mm outstanding on the note, which does not show up as an asset on the balance sheet as a receivable depsite the fact that the economics are the same as any other note receivable. It is worth noting that the note is fully collateralized by the 5.64mm EVRC shares held by Corona Park (currently worth ~$12mm mtm). It seems Corona Park paid near market prices back in 2013 so I'm not viewing this as malicious but rather further alignment/skin in the game.
• HoldCo Cash – Evercel has $18.7mm cash at the holdco (excluding cash held by the Printronix business)
• HoldCo G&A – General and administrative specific to the holdco can be determined by subtracting G&A on the income statement from G&A specific to Printronix as discussed in the MD&A section the financial statements.  HoldCo G&A has been $292k, $379k, and $946k for FY2016-2018, respectively. In order to facilitate the NAV analysis, I have capitalized $900k of at a 10x multiple for conservativism.

With the above items as a background, the following table presents the current NAV and implied value of Evercel’s 80.1% ownership in Printronix:

As shown above, on a look-through basis, Evercel’s 80.1% ownership of Printronix is priced at $21.6mm.   Printronix reported $10.8mm of GAAP EBIT in FY2018, and after adjusting for items described below, did roughly $10.1 in normalized post-tax post-capex FCF – implying a 2.7x FCF multiple ($21.6 / (80.1% * 10.1)).  

Printronix

Printronix is the global leader in Line Matrix printing solutions with 90%+ global market share.  A quick google search of “line matrix printers” indicates that this is largely an outdated technology, as compared to newer print options (e.g. laser, inkjet, etc) and consideration of the trend towards digitalization and resulting reduction in printing.    

While line matrix printers are largely a terminally declining product, there are a number of specific use cases where line matrix printers are the best solution for enterprises.  Some benefits of line matrix printers in relation to other printer types include:

• Rugged - Can withstand heat and harsh conditions better than other printer types (tough industrial environments)
• Reliable - Lower downtime due to fewer print jams and no ink toner replacements.  Uptime is important in certain industries (supply chain)
• Durable - Line matrix printers have a long useful life lasting 7-10 years (Printronix has a consumables business which provides recurring revenue over the long useful life of these printers)
• Cost - Lower cost (no ink/toner).   Ribbons (consumables product for line matrix printers) are ~6x < cheaper than laser cartridges  
• Energy Savings - Compared to laser printers, line matrix printers produce significant energy savings as well as lower cost per page (1/3 the energy of laser printers while printing)

As described in managements prior letters to shareholders, line matrix printers are used in the developed world across distribution and manufacturing centers of large Fortune 500 in industries such as automotive, transportation & logistics, food/beverage distribution and retail distribution.  In the developing world, use cases include distribution/manufacturing centers as well as banks and utilities (printing utility bills, banking records, and government checks).

Restructuring

Management has made significant progress over the past 3 fiscal years in restructuring the business with the objective of improving margins (and even driving revenue growth – although growth is not material to the thesis).  

• Sale of Thermal Printer Segment – Prior to 2016, Printronix had two business segments – the line matrix printer segment and a thermal printer segment.   Management, recognizing the competitive nature of the thermal segment (low single digit market share), low contribution to bottom line Printronix profits, and the fact that the market was valuing the thermal segment roughly equal to the two businesses together, decided to sell the thermal segment and keep the line matrix printing segment.  
• Consolidation of Global Operations –Printronix had manufacturing operations in multiple regions – Singapore, China, and Mexico. With the sale of the thermal printer business and resulting simplification of manufacturing one product set, management sold the Singapore building for $7.5mm and began creating a manufacturing plant in Malaysia.
  • Across FY16-FY18, management spent more than $7mm building the Malaysia facility and consolidating Singapore, China, and Mexico operations into the Malaysia facility.  The benefits of consolidation are starting to be seen – gross margins improved 3.8% in FY18 (actual growth of 4.9% after backing out one-time ramp-up costs and excess freight costs resulting during the restructuring) which is largely attributed to the cost savings of overseeing one central facility and the benefit of lower costs in Malaysia as compared to previous locations.  The 3.8% GP GAAP improvement amounts to $2.1mm in additional gross profit – a solid return on the investments made over the past 3 years (before factoring in proceeds from the sale of the Singapore building!)
  • Identified other targeted cost savings including:  reduced headcount by 23%; reduced facilities and IT costs (relocation of corp HQ and US tech facilities into a single location paying 63% less monthly rent/utilities); reduced audit/tax fees by $350k

Consumables Segment

One specific item to point out is the consumables segment of the line matrix printing business.  Per management, this is a source of recurring revenue and high incremental margin profit for the company.  In FY2017, the consumables segment did $24.7mm in revenue and $14mm in gross profit (57% margin) – management had expected these margins to increase with the consolidation of operations.   In FY2018, the consumables segment did $23.7mm in revenues and $16.mm in gross profit (69% margin). Management has stated that the consumables segment requires few sales and support resources as the installed base proactively orders supplies as needed.  

Fundamentals

I’ve included the financials from FY2016 – FY2018 below which provides further insight into the impact of restructuring events executed by management.

EVRC’s ownership of 80.1% of Printronix equates to $8.1mm in FY18 FCF, a 2.7x multiple.

Of course, a 2.7x multiple is only appealing if FCF doesn’t fall off of a cliff over the next few years.   Some considerations:

• Capex is historically high given the restructuring items discussed above, primarily pertaining to the build-out of the Malaysia facility.   Per the FS MD&A, management is guiding to $900k of capex in FY19 and “believes future sustaining capital expenditures after fiscal 2019 will be significantly reduced, predominantly focused on maintaining existing machinery and equipment”.
• Printer sales grew 13.8% in FY2018 (a component of the first segment in revenue) – this will provide a tailwind for sustained or increased consumables revenue over the 7-10 life cycle for these printers, but is not currently impactful to FY18 consumables revenue.  
• As mentioned above, the consumables business alone did $23.7mm a year with 69% gross margins and requires minimal support and fixed costs, per management.   Given managements comments, it is reasonable to assume that the consumables business can be run on 25% of FY2018 opex (engineering/development expense, S&M expense, and G&A).   Assuming 5% terminal decline for the consumables segment revenues, steady gross margins, 25% of FY18 total G&A, and $500k a year in capex, this business would run off in a DCF with a 15% discount rate to be worth $31.3mm (80.1% = $25mm value for EVRC).   While this is a quick back of the napkin calculation, it provides some directional view into the margin of safety in paying 2.7x FCF for the printer, service, and consumables segments combined.

As a side note, it is worth considering that while seemingly a “low quality business”, FCF for FY2018 of $10.1mm was earned on $19.4mm of tangible book value (ex-holdco cash), a 52% return on tangible book.  

While a qualitative assessment of management and the business is more important, a modest 6.6x (15% yield) FCF multiple seems generally reasonable for a business with moderate terminal decline yet solid management with a strong cost focus.   A 6.6x multiple on EVRC’s proportion of Printronix FCF would provide 45% upside to the current price:

Management

For a small microcap, the CEO has shown strong capital allocation and decisioning across the SharpSpring purchase, the sale of the low-margin segment of Printronix for greater than the purchase price paid for both segments (since original investment in Printronix in 2013 for $18.2mm, Evercel has received $26.7mm of distributions), and margin improving restructuring efforts in the operations of Printronix.

The CEO is Daniel Allen – his bio is as follows:   After nearly a decade at Bain Capital, Dan founded Corona Park to invest and grow profitable technology enabled companies.   He also serves as CEO of Evercel (EVRC), the parent company of Printronix. At Bain Capital, Dan also focused on investing in technology related growth opportunities.  He helped lead more than a dozen investments including supply chain robotics company KIVA systems, VoIP provider Vonage (NYSE: VG), mobile messaging technology provider m-qube, ProfitLogic, music sharing company LaLa, and the Tennis Channel.   He also built and ran the FoundersClub, a bi-annual event for top technology entrepreneurs and media executives in NYC. Prior to Bain Capital, Dan was on the founding team of Fandango, a strategy consultant at McKinsey and Company in NYC and London, and worked at ABCNews in Moscow, London, Hong Kong and NYC.  Dan graduated from Harvard College and Harvard Business School. Corona Park is based in New York City.

• Corona Park (CEO’s investment fund) owns 17% of the company
  
• It is worth noting that Michael Kahan of North Peak Capital is also on the Printronix board

Why does this opportunity exist?

• Illiquid – averages ~$16k daily trading volume
• Small and ignored
  • Dark pink sheet OTC with no SEC filing requirements
  • Financials are only found on the company website – www.evercel.com
  • 55 followers on seekingalpha
  • < $100mm market cap
  • No analyst coverage
• Investors looking for “quality” businesses will be quick to pass on the seemingly terrible product/operating business (selling old line-matrix printers), without considering price.  
• 2016+2017 restructuring and hidden asset value masking look-through earnings valuation.   For example:  Sharpspring is valued on the latest disclosed balance sheet at $11.4mm ($3.4mm investments AFS plus $8mm note receivable) versus a $21mm mark to market value.  Adding the $4.4mm related party note receivable which is reclassified in shareholders equity, and there is $15.8mm of hidden asset value (48 cents per share, or 22% of the market cap).  

Risks:

• Faster-than-expected declines in the Printronix business
• Valuation risk at SHSP
• Poor capital-allocation with excess cash and FCF generated by the Printronix business (The 20% carry seemingly added to every deal is certainly a drag on any future investments.  With that said, despite the carry the investments made over the past few years have been strong and the current price more than reflects any negatives associated with future deals with 20% drag).  

Catalyst

• Fiscal 2018 marked the completion of the Company’s repositioning and business transformation activities which began in fiscal 2016.  Continued execution under the companies enhanced cost structure will allow FCF to build up on the balance sheet.
• Similar deals with SHSP – despite SHSP’s increased equity valuation, if ROIC remains attractive given the competitive positioning of the business, a similar convertible debt offering would be beneficial for both parties.