Thursday, April 7, 2016

Data Group is Really Cheap

Data Group provides print marketing (e.g. direct mail) and other document management services for businesses, with six locations across Canada.

I have been watching this company for a few of years, because I found the debt to be undervalued. I have previously written 3 articles about this company available here.

I found the equity to be too risky, which is why I owned the debt. A few months ago, however, they basically bankrupted the equity by repaying some of their debt (which I own/owned) with shares. So that made me a shareholder at the expense of previous shareholders, and reduced some of the company's debt.

At the same time, under new management the company has been reducing expenses, and therefore is now making decent profits. Quarterly results came out on last month, and the company's EBIT (ignoring one-time expenses) for the last 12 months is about $16 million.

Enterprise value is $83 million ($55 million in debt plus $8 million pension shortfall plus $20 million current market value), for an EV/EBIT of 5. This is already cheap, however, I believe the trailing-twelve month EBIT is understated because the cost cuts took effect over the whole year, and so the most recent quarter has the highest EBIT (ignoring one-time expenses), of $6.5 million. Annualizing this to $26 million per year gives an EV/EBIT of barely over 3.

Finally, I expect capex to be lower than depreciation for at least a while. The company's construction of its final facility (meant to consolidate smaller facilities) is complete, and so the company recently agreed with its debt holders that it would limit capex to $5.5 million per year. With the most recent quarter EBITDA at $8.4 million, annualized to $33 million, and less $5.5 million in capex, gives EBITDA - CAPEX of something like $27.5 million.

As such, I think the equity is a good deal. Adjusted net income (i.e. after interest payments) was $3 million last quarter. Annualized to $12 million, gives a P/E of less than 2!

I think a couple of technical factors unrelated to the business may be keeping the price low. One is the ridiculous-looking share price. Because the company had to issue so many shares to "settle" its debt obligation (which is how I became a shareholder), the share price is only 2 cents. So while Data Group is a credibly-run, $300 million revenue company, it looks like a penny stock, where a lot of funds/institutions probably can't go. There is an easy fix to this: maybe the company does a reverse-split in the future.

The second technical factor is one I've already alluded to, and that's the forced conversion from debt to equity. Investors who are fixed-income oriented by mandate just lost their ability to own this security. There may be some forced selling going on as a result of this. To me, this represents an opportunity to pick up a bargain, and so I have been adding on weakness.

There are some risks, though. As mentioned, there is debt and a pension ahead of the equity. The print marketing business is probably also going to continue to decline. While the new management has been focused on reducing costs until now, it is now switching gears to increasing revenue. If it can't do this, profits will probably decline and more cost cuts will have to be made, and if they are not, the equity will once again be in doubt.

Disclosure: Author has a long position in both shares and debt of DGI

Update: Right after this article was written, Data Group announced that its CEO Michael Sifton would be resigning in two months. On the one hand, this is bad news for shareholders, as Sifton was able to cut costs and generate a level of profitability that previous management proved unwilling and/or incapable of doing. On the other hand, Sifton was not a beacon of shareholder-friendliness. He essentially bankrupted previous shareholders by paying the company's debt in shares, which gave him and the rest of the board breathing space, but at the expense of shareholders. Previous to this, he pulled out of a shareholder rights offering he had originally stated he would personally subscribe to, presumably because things were worse or became worse versus what he originally anticipated. Therefore, I view the resignation as an opportunity for the company to select a manager that actually works for shareholders and that shareholders can trust, while at the same time this new manager can benefit from the positive changes that Sifton made which have put the company on a sustainable trajectory.

No comments: