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Geoff Gannon October 31, 2018

Digirad (DRD): A Cheap Microcap Transitioning into a Holding Company




Digirad is an attractive microcap special situation investment because the valuation is extremely low, there is a high likelihood of the proposed acquisition closing, and the underlying value proposition of Holdco structure is compelling.  Digirad announced on September 10th that they would be converting to a Holdco structure and acquiring ATRM, a modular homebuilder and specialty lumber company with an investment fund segment.  The logic behind this structure change is to cut public company accounting, legal, management and board costs and potentially save millions of dollars that will flow to the bottom line of the joint company.  I believe these savings will be real and expect a large uptick in EBITDA delivered from a combined company.  Cutting costs especially the types proposed are usually an easy way to drive profitability.  My valuation of the company suggests in a central case shares could yield a 100% return over the next year, and in my high case shares could yield a return of 179% over the next year (see details in the valuation section).  This investment does not come without risk.  Major risks include deal risk, underlying performance risk of the operating businesses, and the risk of a dividend cut.



To fully understand the risks and potential rewards of Digirad you really need to understand the recent history.  This history is also largely the reason that this attractive opportunity exists.  Digirad itself was a promising small cap healthcare imaging company a few years ago.  The company completed a transformative acquisition on January 5th of 2016 by acquiring DMS Health Technologies which was poised to roughly double the revenue and EBITDA of the company.  The acquisition did not end up as attractive as it was originally held out to be.  Margins in the space were pressured and top line revenues struggled to grow as originally projected.  On top of a lackluster DMS Health Technologies acquisition, the company lost a major servicing and sales contract with Philips Healthcare in October of 2017, which materially impacted their revenues and profitability.  This eventually led to the sale of their MDSS services contract to Philips Healthcare in February of 2018 for a consideration of $8 million.  This was a major hit on the underlying business and the stock price crashed from $3.50 down towards its current price of $1.35.  This led to a bit of soul searching on what would be the path forward, as the remaining Digirad business was a stable cash flowing business, but lacked growth pathways.  That is in part where the idea of the proposed acquisition stems.

All of the companies involved in this transaction are companies that the Chairman of the Board, Jeff Eberwein, has been involved in.  This transaction seems to be Jeff’s brain child, to bring together a few businesses that he has financial stakes in into one corporate Holdco in which Jeff will be the sole capital allocator.  Jeff will retain the Chairman of the board position in the …

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Geoff Gannon October 31, 2018

Follow-Up Interest Post: Resideo Technologies (REZI) – Stock Falls, My Interest Rises

The Resideo spin-off has taken place. And the stock has traded on its own for a bit now. So, I thought I would very quickly re-visit the stock here.

You can check the ticker REZI (Resideo Technologies). It’s $19.56 a share as I write this. Here is a link to the press release announcing the completion of the spin-off:

“Honeywell distributed one share of Resideo common stock for every six shares of Honeywell common stock held as of 5:00 p.m. Eastern Time on October 16, 2018, the record date for the distribution.”

Honeywell had 740 million shares outstanding about 17 days before that date. So, let’s assume Resideo now has 740 million / 6 = 123 million shares outstanding (actually, slightly more – but I’m simplifying).

Actual quote from a recent 8-K: “Immediately following the Spin-Off, we estimate that approximately 123,451,420 shares of our common stock will be issued and outstanding.”

Before we re-visit my initial interest post, you may want to read it.

Here’s my initial interest post (where I give Resideo a 30% likelihood of me following up further with it):

And here are the notes I took when reading the company’s spin-off document:

Now that you have that background. Let’s talk about why I’m upgrading my interest level in Resideo.

So, as I write this…

Resideo Technologies (REZI)

Price: $19.56 / share
Shares Outstanding: 123 million

Market Cap = $19.56 * 123 million
Market Cap = $2.41 billion

Net Debt = $1.15 billion

Taken from this recent investor presentation:

(Slide 45)


Enterprise Value = Market Cap + Debt
Enterprise Value = $2.41 billion + $1.15 billion
Enterprise Value = $3.56 billion

Let’s call it $3.6 billion in enterprise value

Now, there are two ways of doing this. One: we can capitalize the environmental obligations and add that capitalized value to the EV and add-back the $140 million a year payment to Honeywell to arrive at some sort of “adjusted EBITDA” figure.

Or, we can just use $3.6 billion in EV and we can fully include $140 million a year payment as an annual expense. We then have to understand that the expense can go down from $140 million toward zero over time.

The easiest way to do this is to assume the $140 million annual payment is a perpetual obligation that will never be less than $140 million a year and will never go away.

In that case…

Enterprise Value = $3.6 billion
Last 12 months EBITDA = $475 million

Enterprise Value / LTM EBITDA = $3.6 billion / $475 million
Enterprise Value / EBITDA = 7.58x

Let’s round that up…


Is that cheap?

It seems like it. Historically, an EV/EBITDA of 8 was pretty normal for a U.S. stock – paying a 35% tax rate at the federal level – because an EV/EBITDA of 8 translated into about an unleveraged P/E equivalent of 15 or 16. Basically, what I’m saying is that if a company had zero …

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Philip Hutchinson October 29, 2018

A few thoughts on Progressive

Geoff and Andrew did a podcast last week where they discussed all of Geoff’s picks when he wrote the Singular Diligence newsletter. One of those stocks was Progressive (ticker PGR). Progressive is primarily a personal auto insurer. The best thing you can do to familiarise yourself with the company is, obviously, to read Geoff’s report.

Progressive’s stock is a lot more expensive than it was when Geoff wrote his report, and it’s a lot more expensive than his appraisal of the company as well. But I really think that of all the stocks Geoff recommended, Progressive is one of the most interesting right now and one that would be of most benefit for members to look at.


There’s a few reasons for this. First, it seems clear to me (and it sounds like Geoff agrees) that the risk he identified relating to autonomous vehicles was overblown. I don’t mean this as a criticism. It was quite right to worry about that when Geoff was writing the  report. But this post really isn’t about that. It’s about the second reason – customer retention.


Geoff pointed out that one of the key constraints Progressive faced was its customer retention, which is lower than peers such as GEICO, USAA and Allstate. So, even if Progressive acquires customers at a fast rate (and it does), its snowball is melting faster than those of its competitors. It can still grow, but obviously the higher rate of attrition is a serious limiting factor in its growth and its economics. The reasons for Progressive’s lower retention rate are complex but really boil down to (i) having more single, renting, young people in their customer base, (ii) not offering bundled insurance (i.e., offering only auto insurance, not home and other insurance) and (iii) attracting more high risk drivers as a percentage of their customer base. The impact of bundling is particularly significant. I’ve seen a report that industry wide retention rates are 83% where the policyholder only buys auto insurance, but 95% where auto and home insurance are bundled. This is clearly a huge difference from the insurer’s perspective.


Progressive has recently been posting very strong (20%+) rates of growth in premiums. Obviously a big part of that is strong rates of new customer acquisition (and we could probably talk a lot about how Progressive has restored growth in its agency business). But, it’s also in very large part due to increased customer retention. Progressive has made huge strides in increasing customer retention towards the levels of their peers. There are a few components to this, but one of the really big differences from when Geoff wrote about the company is that Progressive now offers home insurance and so can bundle home and auto. They are attracting more and more customers who buy both home and auto insurance from them – a customer group they refer to as “Robinsons” – and who have by far the highest retention rates. Progressive segment customers into four categories (which they call

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Geoff Gannon October 20, 2018

OTC Markets Group (OTCM): A Far Above Average Quality Company at a Fair Enough Price

Member Write-up by PHILIP HUTCHINSON

Company EV / Sales
LSE 8.5x
Deutsche Borse 8.3x
Euronext 7.3x
BME 6.2x
CBOE 10.9x
ICE 8.1x
OTCM 5.7x




Many of you will be familiar with the concept of over-the-counter (“OTC”) stocks. OTC Markets Group is the owner and operator of the largest markets for OTC stocks in the U.S. The company trades on its own OTC market under the ticker “OTCM”. You can find its financial releases, earnings call transcripts and other disclosures at the following link:


And for purposes of full disclosure, OTCM is a stock that Andrew and Geoff hold in the managed accounts they run. The analysis here is, however, entirely my own. It’s not Geoff’s thoughts on the company.


OTCM was originally founded in 1913 and has, for many decades, published the prices of “pink sheet” OTC stocks. It has been run by its current CEO, Cromwell Coulson, since a buyout in 1997, under whose management it has digitised its business and standardised the structure of the OTC markets, while still remaining focused on the operation of OTC stock markets in the U.S.


Established stock market operators such as CBOE, NASDAQ, Intercontinental Exchange Group (“ICE”) (the owner of the NYSE), LSE, Deutsche Börse and Euronext, are all fantastic companies. However, they are in many cases much more diversified than OTCM. Take the LSE. It is undoubtedly a great business. However, it is also very diversified geographically and by business line. It owns the London Stock Exchange and Borsa Italiana. But, it also has a big business in clearing of other financial instruments, as well as owning the “Russell” and “FTSE” series of indices. It is today a much broader business than just a stock exchange.


The exchanges listed above are all good businesses. In OTC Markets, however, you can find a lot of the same financial and economic characteristics, but in a much smaller, more illiquid, more focused company, run by a CEO who is also by far the largest shareholder in the company.


OTCM originally used to simply publish prices of OTC stocks in a paper “pink sheet” publication distributed in a manner similar to old style Moody’s manuals. Under Coulson’s leadership, the company has overhauled its business, creating tiered markets for OTC stocks, with three different designations – the highest quality, most stringent, OTCQX market, the OTCQB “venture” market, and finally the pink sheets for all other OTC stocks. OTCM earns subscription revenues from all companies on the OTCQX and OTCQB markets, but not from any stocks on the pink sheets. It has turned itself from a publisher of stock prices to a standard setter, aggregator, and provider of data and trading services that is the owner of the leading OTC stock market in North America.


Unlike the competitors listed above, OTCM is not, technically, a stock market. The precise distinction between an OTC stock and a listed stock, and between the nature of …

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Geoff Gannon October 14, 2018

Vulcan International (VULC): A Dark, Illiquid Company Planning to Liquidate its Portfolio of Bank Stocks and Dissolve

This is another “initial interest post”. I was looking at Vulcan International for the managed accounts I run. As a first step, I write up the company here and rate my interest in following up on the stock – as a candidate for purchase in those managed accounts – on a scale from 0% interest to 100% interest. I’ll reveal my interest level at the end of the post. Now, that I’ve got you hooked with suspense, let’s start the post off with a discussion of just what “dark” means here.

Vulcan International (VULC) is a dark stock. And here when I say “dark” I don’t just mean it doesn’t file with the SEC. I’ve mentioned Keweenaw Land Association (KEWL), Computer Services (CSVI), and OTC Markets (OTCM) before as “dark” stocks. In those cases, all the word “dark” means is that they don’t file with the SEC.

Those dark stocks present less information about some things than SEC filing companies. But, about other things – like appraisals of their land in the case of KEWL and long-term historical financials in the case of Computer Services – they sometimes provide as much or more information. For example, Maui Land & Pineapple (MLP) is listed on the New York Stock Exchange and files with the SEC while Keweenaw Land trades over-the-counter and does not file with the SEC. MLP isn’t really more forthcoming about the likely market value of their land, their plans to develop or sell land, etc. than KEWL is.

Vulcan International though is a truly dark stock. It usually tells the public nothing. In fact, some investors have only gotten information on the company after signing a non-disclosure agreement.

There are two reasons why a company might be extremely secretive. One, management is using being a “dark” stock and not reporting any information to outside shareholders as a way to strip the company bare. It could be that the CEO or controlling family is siphoning off assets and slowly converting shareholder wealth into management wealth. I’ve seen this before.

But, I’ve also seen a second reason for a company to be extremely secretive. Management knows they are valued in the stock market but they have no self-interest in their stock price getting more expensive. They are simply running the company for the long-term. As controlling shareholders, a board, etc. they can always realize the value of the business in a way minority shareholders can’t. Basically, insiders at a very valuable business can always elect to liquidate the business or sell it off to a 100% buyer. Unlike passive minority shareholders, the day-to-day trading in the stock isn’t the way they are going to get out of the business. So, the bid and ask prices you see in that public market just don’t matter to them.

Vulcan International is an example of reason #2. The company was sitting on assets that were very valuable and very underpriced by the market. However, in the last year or so …

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Geoff Gannon October 10, 2018

How Much is Too Much to Pay for a Great Business?

A Focused Compounding member sent me this email:


“I’ve just become a FC member and I’ve been listening to the very interesting podcasts from day one. Really enjoying them. Those have convinced me to purchase a membership of 1 year (for now).


I have a question that has been spinning my head for a while now.


Everybody is looking for this gem of a company with a sustainable competitive advantage and consequently… a high sustainable ROIC or ROIIC.


But when you invest in a company at 2 times invested capital doesn’t that hurt your compounding effect big time in the long term (ROIC of 20% becomes 10%?)? Or am I pursuing the wrong train of thought here?”


Yes, it does hurt your compounding. But, paying more than you normally would – in terms of price-to-book – for a great business may not hurt your long-term compounding quite as much as you think. However, there’s a tendency for investors to focus more on how high the company’s return on capital, growth rate, etc. is right now instead of how long those high rates of return on capital, of sales and EPS growth, etc. can last. What matters a lot – as I’ll show using numbers in a minute – is how long you own a stock and how long it keeps up its above average compounding.


Think of it this way. If you buy the stock market as a whole, it tends to return about 10% a year. A great business might be able to compound at 20% a year. So, how much more can you pay for a great business than you would pay for the S&P 500? It might seem the simple answer is that you can pay twice as much for a great business. However, that’s only true if you’re planning to sell the stock in a year. That’s because 20% / 2 = 10%. So, paying 2 times book value gets you the same return right out of the gate in a great business as what you’d have in the S&P 500.


When value investors like Warren Buffett, Charlie Munger, and Phi Fisher talk about how it’s fine to pay up for great, durable businesses – they mean if you intend to be a long-term shareholder and if the company continues to compound at high rates far into the future. This makes all the difference in what kind of price-to-book value you can afford to pay.


To figure out how much more you can pay for a great business and still beat the market, you can actually just sit down and work out the math.


Here’s what matters…


* Price / Asset (equity, invested capital, etc.)


* Amount of earnings reinvested in the business


* Return on that reinvestment


Over shorter holding periods in stocks reinvesting less of their earnings each year – the price you pay matters more.


Over longer holding periods where the stock …

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Luke Elliott October 9, 2018


This will be short and sweet.

DHI Group (NYSE: DHX) is the parent company of subsidiaries that are engaged in online career sites and services. Think or Their major platforms (assets) are,, and The sites are more targeted to specific groups than their larger competitors with being geared towards technology/software professionals and the other two, I’m sure you can guess.

The company’s performance over the last decade has been less than stellar. Ten years ago today, the stock price was at $6.40/share. It reached a peak of $18.75/share in 2011 and has since, steadily tumbled to its $1.85/share price today (all while the job market has boomed and their competitors have grown larger). Naturally, this has drawn the attention of activists.

Most recently, on May 25, 2018, TCS Capital Management filed a 13D, announcing that they had purchased 9.7% of the total shares. On August 23,2018, they released a scathing Letter to the Board, reprimanding them for the usual: terrible performance compared to S&P and peers, bad strategy, enriching themselves at the cost of long-time shareholders, low insider ownership etc. etc.. However, the interesting part is that they publicly disclosed that they were prepared to buy the Company for $2.50/share in cash (a 25% premium to the $2.00/share closing price the day before the press release). TCS closed with the ultimatum that if they didn’t accept, they’d start a proxy battle next year (2019) to campaign for seats. They closed the letter telling the company to respond to the offer by September 5, 2018.   

DHI’s response the next day- “The Board and Management, consistent with their fiduciary duties, plan to fully explore and respond to TCS’ new proposal.  The Board and Management are committed to acting in the best interests of the Company and its shareholders and will continue to explore any opportunity to enhance shareholder value. In its review and discussions with TCS, the Company is being advised by Paul, Weiss, Rifkind, Wharton & Garrison LLP, Evercore and Arbor Advisory Group.”

The price moved up to $2.40 in the following days.

Since, no word from either side. The September 5 date has passed, and the price has moved down to $1.85/share.

Maybe there’s an expensive 2019 proxy battle on the horizon, but then again, the company is definitely worth $2.50/share to a private buyer (and probably more since they wouldn’t make an offer they thought was a bad bargain). In other words, the $2.50 price tag probably has some margin of safety baked in. At some point, there will be an update on the review and discussions.  

May 2019 Call options are available for those interested.

Disclosure: I hold no position

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Geoff Gannon October 5, 2018

How Big Can Amazon Get?

(Note to Focused Compounding Members: Geoff here. This is one of my general investing posts – not a specific stock write-up. The first half of this post was made available free for everyone at “Gannon On Investing”. The second half of this article is exclusive for members like you. My actual stock write-ups are always exclusive to Focused Compounding. The first half of my general investing articles are available free at “Gannon On Investing”; you get the whole article here because you’re a member.)

Someone emailed me this question:

I’ve been looking at Amazon for a little short of a year and because the equity doesn’t provide a good price to value ratio and margin of safety, in my view, I’ve held back from investing so far. 


There’s a little brainteaser which involves asking people how much sales, as a percentage of total sales, are done online. The numbers people answered were surprisingly high. Right now they make up 10% of total sales in the U.S. and I’m positive that number won’t stop there.


Assuming internet sales grow at 8% for the next 10 years (16% right now) one-fifth of sales will be online (also assuming 4% historical growth rate on U.S. retail sales). It would be a $1.8tn industry, x4 the size of today. Is an 8% growth rate overly optimistic given that as the base grows, percentage growth usually slows? Not looking for exact numbers, just rough measures.


Amazon has 50% market-share and I would assume that isn’t sustainable and the market’s perception of a winner-takes-all is exaggerated, many businesses could co-exist. I don’t think this is a Facebook/Google “aggregator” situation in which the viability of a new company competing with them decreases as they get more users and advertisers. The viability surely decreases to some extent but not to the extent that it does for the other two advertising companies, the retail industry is also much bigger.  


All in all, bigger but perhaps fewer companies will co-exist in the online space, and when it comes to smaller online commerce firms, they’ll perhaps cater more to niches as a European pet food company is doing. However, even a 20% market-share comes out to a huge revenue number when we extrapolate what the internet sales number might be in the future. 


Very successful U.S. retailers like Walmart have ~6% market share of total retail sales, that’s significantly higher for specific categories. In terms of online though I would apply a higher than average market share for Amazon because the supply chain is significantly harder to build and optimize (e.g. more nodes) and therefore in my view this increases barriers to entry. My second question is: Do you think this is a fair assumption?


Anything I say in this post is not a suggestion to buy Amazon as a stock today. This is because of the price. We’ll get to that at the end of my article. For now, let’s just say that Amazon stock is priced high enough that …

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Geoff Gannon October 3, 2018

Resideo: Honeywell’s Boring, No-Growth Spin-off Might Manage to Actually Grow EPS for 3-5 Years

Yesterday, Honeywell set the distribution date for the spin-off of its home comfort and security business “Resideo”. So, I thought now would be a good time to do an “initial interest post” on Resideo. In this article, I’ll give my first impressions of the stock and then I’ll conclude by giving you an idea of how interested I am in following up with this stock idea. As always, I’ll grade the idea on a scale ranging from of 0% interest to 100% interest.

To give you some context, let’s start with a review of how interested I was in the five other stocks I looked at.

Keweenaw Land Association (KEWL): 90% initial interest level

Pendrell: 90%

Maui Land & Pineapple (MLP): 80%

U.S. Lime & Minerals (USLM): 50%

Babcock & Wilcox Enterprises (BW): 10%

The details for the ratio of shares of Resideo to Honeywell (1-for-6), record date (October 16th), and distribution date (October 29th) can be found here:

The notes I took when reading the Resideo spin-off document can be found here:

Resideo includes a products business (“Honeywell Home” or “Products”) and a distribution business (“ADI global distribution” or “Distribution”). Resideo will operate in multiple countries. And it will spin off with about $1.23 billion of debt from Honeywell and liabilities related to over 200 environmental clean-up sites. We’re interested in valuing the stock (the equity portion, not the debt). So, it’s easy to get lost in the complexities of this situation. The first thing we need to do, then, is to focus on those aspects of this spin-off that could drive returns in the stock. In other words, we need to start simplifying things right from the start.

Here are some of the first questions we need to ask:

How much debt will Resideo have when it spins off?

How big will Resideo’s environmental liabilities be when it spins off?

How expensive will the stock be when it spins off?

Where will most of Resideo’s “owner earnings” (“free cash flow”) come from?

Let’s start with the last question first. In recent years, Resideo has gotten about 75-80% of its profits from the “products” business rather than the distribution business. There’s a lot of information in the spin-off document – and therefore, in my notes – about ADI. However, ADI only accounts for about one-fifth of profits (about half of revenue) at Resideo. It’s easy to get sidetracked by spending as much time on ADI as we would on Honeywell Home (“products”). On a sales basis, the two businesses are equal in size. But, sales aren’t what matters to a shareholder. Profits are what matters. Gross margins at Honeywell Home (the products business) are about 4 times higher than gross profits at ADI (the distribution business). Therefore, the same amount of sales at each business translates into roughly 4 times more profit (80% of profits versus 20% of profits) at Honeywell Home.

In this initial interest post, I really want to set ADI …

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Geoff Gannon October 3, 2018

Homasote (HMTC): A Perfect “Cocaine Brain” Candidate

Member Write-up By Luke Elliott

Quote: $10.58     

Shares Outstanding: 360,219    

Market Cap: $3.81M USD

Before getting started, read Geoff’s latest memo “Cocaine Brain,” if you haven’t already.

Homasote is a well-known brand name associated with the product generically known as cellulose-based fiber wall board. The material is 98% recycled paper fiber and 2% environmentally-friendly materials. The company has two divisions and claims to be America’s oldest green building products manufacturer. The millboard division makes sound insulation and concrete joint filler and their industrial division focuses on protective shipping products for glass, paper, and steel.

To get a snapshot of where the company was in 2012, take a look at this Oddball Stocks post by Nate Tobik.

As Nate notes, this is a company that went an 11-year duration, from 2002 to 2011, losing money hand over fist. They somehow managed to destroy almost $40/share in equity over that period and accumulate over $6M in long term debt on a $1.4M Market Cap. The company had negative $15/share in book value when Nate wrote up the stock. Fast-forward 5 ½ years and the company has made some serious progress.

The company posts their financials on, although their reporting is not the most punctual. The 2017 Annual Report was just posted a few weeks ago in August 2018. From 2012 through the first half of 2018, the company has sustained profitability. Below is a Five Year Highlights Table the company provides in their Annual Report, but I’ve consolidated two to show the last decade.

The table gives a clear picture of Homasote’s Jekyl and Hide history.

At this point you’ve probably picked up on a few things. At a superficial glance, the company looks really cheap on an earnings basis. It’s trading at a trailing P/E of 2.2 (10.57/4.77). This is what perks investors excitement. Two, the company has used that profit stream to take a chunk out of the debt and subsequently reduced the equity deficit to negative $6/share at the end of 2017. Looking at the below chart, we’re starting to infer that this must be a turnaround. We’ve seen it in the movies so many times that we immediately identify the same story playing out in real life.

These results are good and well. The company has survived and scrapped back. But here’s where we typically pump the brakes a little and try to force ourselves to be rational. We know that it can’t all be good news. When we look at the balance sheet, it’s clear that the creditors still own the company.

Now the brain starts searching for a way to discount or justify the remaining leverage and pension obligations. We want to believe it’ll get paid down before the company experiences a downturn and that the 2002-2011 period won’t happen again. The company has turned a new leaf, right? To be fair, the company has come a long way and their results have been impressive.

Take a look at the aggregate maturities of …

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