Value stocks have been underperforming growth stocks and value investors have been hurting. According to Ken French’s calculations growth stocks outperformed value stocks by 16 percentage points since the beginning of 2017. Historically value stocks outperformed growth stocks by an average of about 5 percentage points per year, so the recent underperformance of value stocks is out of the ordinary. This is creating a lot of pain for value hedge funds and investors. Last month $2.4 billion value hedge fund Marble Arch said it is closing down. Bloomberg mocked famous value investor David Einhorn last month in an article titled “Einhorn is Having A Hedge Fund Midlife Crisis” (read my take about Einhorn’s poor performance).
In this article I am going to talk about another value investor, Jim Roumell, who invests in deeply undervalued stocks. Roumell Opportunistic Value Instl (RAMSX) lost 2.5% so far this year but managed to return 18.3% in 2017 and 18% in 2016. Though the fund got crushed in 2015 delivering a loss of 21.2%. I should note that I am not endorsing value investing as the best investment approach in this market environment. Insider Monkey’s flagship investment strategy identifies the best stock picks of only the best performing hedge funds and its performance has been stellar. Our picks returned 17.4% ytd, vs. 4.4% gain for the S&P 500 ETF (SPY). Our picks also outperformed the market in 2017 after returning 30.7% vs. 21.7% for SPY. Since its inception four years ago, our strategy returned 96.9% vs. 57.7% for SPY (see the details here).
You can download a copy of the previous issue of our quarterly newsletter free of charge. Now, back to Jim Roumell’s stock picks. I am going to present Roumell’s investment thesis in several stocks that are in his fund’s portfolio and then opine on whether I find the thesis compelling or not. Let’s start with the Rubicon Project, Inc. (NYSE:RUBI). Here is Roumell’s company description and investment thesis:
Company Description: Founded in 2007, Rubicon Project’s mission is to keep the internet free and open and fuel its growth by making it easy and safe to buy and sell advertising. Rubicon Project pioneered advertising automation technology to enable the world’s leading brands, content creators and application developers to trade and protect trillions of advertising requests each month and to improve the advertising experiences of consumers. RUBI’s business was built by helping publishers (ESPN.com, Hearst, Time, etc.) maximize the monetization of their online advertising inventory through programmatic trading, i.e., live bidding and selling of advertising space. The programmatic space is fragmented with RUBI estimated to have 37% market share as reported most recently by Serverbid.
Investment Thesis: RUBI’s investment thesis rests on a foundation of data points that suggests it is well-positioned as an online advertising marketplace. Secondarily, it is a company likely to be purchased for its asset value. To wit, RUBI owns its own network, possesses significant client relationships, owns a technology asset in nToggle (an A.I. software platform which could be repurposed) and, finally, it possesses a cash hoard.
RUBI is a hated stock priced with a significant margin of safety to whatever headwinds a detractor can raise. In the meantime, trends are quantifiably improving – commissions have stabilized, 4Q advertising spend was up 25% q/q and the company announced that advertising spend since February is up 10% y/y. RUBI’s market share, as reported by a third-party industry source, has moved from 30% in October of 2017 to 36% in March of 2018.
RUBI trades at 80% of book value and 90% of tangible book value. While clearly wrong in our original investment thesis, we believe we have gone a long way in correcting that mistake with significant recent purchases. A $100 million enterprise value seems very attainable – particularly if one believes, as we do, that nToggle has held its $38.5 million value – plus $100 million in year-end cash, equates to $4.75/share.
Current Market Valuation:
Shares 50mm @ $2.34/sh = $117mm
Net cash $119mm
Enterprise Value Negative $2mm
nToggle acquisition $38.5mm (we believe value is at or higher than RUBI’s purchase price)
Adjusted EV Negative $38.5mm
Revenue $100mm
Free Cash Flow Base case cash burn is $20mm; RUBI has guided to be FCF positive in 2019
Key Considerations:
– RUBI is creating a highly transparent, open market for programmatic ad impression monetization via desktop, mobile, video or audio. Many of the new players who came into the market as a result of header-bidding will not be able to compete, thus reducing the number of marketplaces back down to roughly a half dozen from the twenty-plus today.
– A look at Demand Side Platform (DSP) The Trade Desk’s valuation is instructive, despite RUBI being historically associated as a Sell Side Platform (SSP). Trade Desk supports an enterprise value of $2.5 billion. The company processes roughly $1.5 billion of ad-spend at a 20%-plus commission. RUBI processes roughly $850 million in ad-spend at half the take rate but possesses a negative enterprise value (after accounting for its nToggle acquisition). In effect, RUBI’s core business is being priced near zero.
Insider Monkey’s Take: the Rubicon Project, Inc. (NYSE:RUBI) was trading at $20 two years ago. Personally I wouldn’t touch an online advertising company that is burning $20 million cash with a 10-foot pole. Google, Facebook, Adblock and European regulations are killing advertising based businesses (our site’s advertising revenues are crashing too). Unless a credible activist gets involved with RUBI and forces its liquidation or sale, I don’t believe RUBI is worth the risk.
On the next page we will share Roumell’s other stock picks. The next stock in our list is Liquidity Services, Inc. (NASDAQ:LQDT) which lost 62.6% in the last 4 years. Here is Roumell’s investment thesis:
Company Description: LQDT operates several leading online auction marketplaces for industrial surplus, salvage and retail assets. The company enables retailers like WalMart (WMT) and over 10,000 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.
Investment Thesis: We believe the value of LQDT’s GovDeals business, plus the cash on its balance sheet, sums to a meaningfully greater value than the company’s current market capitalization leaving its retail and capital goods divisions as free options. GovDeals, which we view as the company’s anchoring asset, is a fabulous business. It has been consistently growing at a digit double pace for the past several years while increasing its margin by over 20%. GovDeals is an asset-light, eBay-like business that provides a platform for municipalities throughout North America to sell no longer needed municipal assets. GovDeals collects a commission of 10%, up from 8% a few years ago, and takes no responsibility for storing or shipping goods. GovDeals is the market leader, double the size of the next largest competitor, PublicX. LQDT recently introduced a commercial self-serve platform mirroring the GovDeals model.
Current Market Valuation:
Shares 32mm @ $5.60/sh = $179mm
Net cash $112mm
Enterprise Value $67mm
Adjusted EV Negative $83mm (after backing out $150mm for GovDeals)
Revenue $175mm
Free Cash Flow FY17 Negative $21mm; FY18 Negative $15mm
Key Considerations:
– We believe there are identifiable, non-existential, reasons for the company’s overall margin erosion of the past several years. For instance, the company was out-bid on its very profitable legacy DoD business choosing to walk away from an unprofitable business contract.
– Sophisticated online liquidation offering secure, authenticated high-quality service to customers is likely to continue to take share from onsite auctions and “Mom & Pop” liquidators.
– The company’s new integrated Liquidity One platform, is expected to be completed by year-end after several years of investment. Liquidity One spend will end and the cost of managing a single platform will materially drop from the costs to manage several platforms.
– Founder and CEO, Bill Angrick, owns 17% of outstanding common shares.
Insider Monkey’s Take: Liquidity Services, Inc. (NASDAQ:LQDT) hasn’t seen any insider purchases since the end of 2015. It seems like another value trap. I wouldn’t get involved with this stock unless an activist investor gets involved and forces a major restructuring and sale of assets.
Next we will discuss Roumell’s thesis in Medley Capital Corporation (NYSE:MCC). Medley Capital lost 71% over the last 4 years.
Company Description: Medley Capital Corporation (MCC) is a publicly-traded business development company (“BDC”) primarily engaged in providing debt capital to a wide range of U.S. based companies. MCC is externally managed by MCC Advisors, pursuant to a management agreement. MCC Advisors is controlled by Medley Management Inc., (MDLY) a publicly-traded asset management firm, which in turn is controlled by Medley Group LLC, an entity wholly-owned by the Taube brothers, Brook and Seth.
Investment Thesis: MCC is primarily a large portfolio of loans (roughly 12% of the portfolio is in equity securities derived from debt for equity swaps) owned at a 50% discount to the most recently reported net asset value, NAV. Roughly 70% of the loans are first-lien loans. MCC’s legacy 2nd lien loans have been a disaster for the company. However, even in our most draconian stress test, we arrive at a NAV materially higher than today’s share price. In no scenario do we conclude a NAV below $5.50/share versus today’s price of roughly $3.60/share.
Current Market Valuation:
Shares 54mm @ $3.55 = $192mm
Company reported NAV (March 31, 2018) $7.02
RAM Base Case NAV $6.17 (wipe out 50% of Class 4 & 5 assets)
RAM Bear Case NAV $5.33 (wipe out 100% of Class 4 & 5 assets)
Discount to Base Case 42%
Discount to Bear Case 32%
Dividend yield 11%
Key Considerations:
– Deep stress-testing still results in a material appreciation from the current market price of the security.
– MCC pays over a 10% dividend even after a recent dividend reduction.
– Class 1 and 2 assets (assets performing “better than expected”, and “as expected”, respectively), now account for 83% of the portfolio.
– MCC insiders made significant open-market purchases last year, at prices materially above today’s price, and now control roughly 15% of MCC common stock.
Insider Monkey’s Take: Medley Capital Corporation (NYSE:MCC) looks like another value trap. Seth and Brook Taube purchased shares last year at prices around $6.35. One would expect them to base these purchases on superior inside information about the value of their holdings. Well, the stock currently trades at $3.42. I don’t see any major hedge funds getting involved with Medley Capital Corporation. I also wouldn’t recommend a position in this stock at this moment.
Next in our list is Marchex Inc (NASDAQ:MCHX). This stock lost more than 73% over the last 4 years but more hedge funds are currently involved in this stock than the previous three. Here is Roumell’s investment thesis:
Company Description: Marchex, Inc. was founded in 2003 and is headquartered in Seattle, Washington. Marchex operates two business lines. Marchex Search Analytics is the company’s legacy business (often referred to as its marketplace business). It provides a product for search marketers that drive phone calls from search campaigns, as well as attributes inbound phone calls made directly from paid search ads and landing pages to a keyword. The company’s primary focus is on its second business line – emerging mobile advertising analytics software products. Its products include Marchex Call Analytics, an analytics technology platform that provides data and insights to measure the performance of mobile, online, and offline advertising for advertisers and small business resellers, and Omnichannel Analytics Cloud, which provides marketers the ability to quickly see which media channels are driving high-value phone calls so they invest in the right media.
Investment Thesis: MCHX is a super well-capitalized company leveraging its legacy online telephone lead-generation marketplace business into a leading phone call analytics platform. The company continues to segue into a phone analytics business providing customers with actionable data from dissecting customer telephone calls. When a client engages, it uses a MCHX generated phone number that allows the company to track the number of calls generated by a particular ad campaign, the average length of each call, what percentage of calls resulted in a sale, etc. Companies can use this information to determine the efficacy of ad campaigns designed to generate phone calls. MCHX has spent roughly $90 million in R&D in the past three years developing its analytic platform, below the company’s market capitalization.
Current Market Valuation:
Shares 44mm @ $2.62/sh = $115mm
Net cash $85mm
Enterprise Value $30mm
Revenue $100mm
Free Cash Flow Breakeven to positive
Key Considerations:
– The company is cash-flow neutral even during its transition into an analytics-dominant platform. In fact, MCHX’s confidence in its cash needs and the stability of its business resulted in the company recently paying out a special 50 cent dividend.
– MCHX continues to win new customers and picked up roughly 40 new customers in 2017.
– MCHX signed a partnership agreement with Facebook eighteen months ago in which FB allowed the company to embed their technology, allowing advertisers a third-party source to measure their advertising spend.
– Insiders own 20% of the company’s common stock.
Insider Monkey’s Take: Marchex Inc (NASDAQ:MCHX) looks more promising than the previous three stocks. We have reported on Prescott Capital’s MCHX purchases in the past. Unfortunately, Prescott Capital has recently been selling its holdings. On the other side of the trade was probably Edenbrook Capital that’s been purchasing Marchex shares as recently as May, paying $2.65 per share on May 10th. This is another advertising related stock that is facing stiff competition from Google and Facebook. I wouldn’t recommend a position in this stock either.
This article is getting quite long. I will split it into two article. I will publish the next installment of this article on Monday discussing other stocks in Roumell’s portfolio like Hall Financial Services (HALL), Sandridge Energy (SD), Paratek Pharmaceuticals Inc., (PRTK), A10 Networks Inc., (ATEN) and many other stocks.
