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Geoff Gannon October 31, 2018

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

MEMBER WRITE-UP BY LONG SHORT VALUE

 

Summary

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.

 

History

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: https://www.otcmarkets.com/stock/REZI/news/story?e&id=1207602 “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...

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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...

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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     Overview 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...

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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...

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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

DHI Group (NYSE: DHX)

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 indeed.com or monster.com. Their major platforms (assets) are Dice.com, ClearanceJobs.com, and efinancialcareers.com. The sites are more targeted to specific groups than their larger competitors with dice.com 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...

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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...

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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...

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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. https://secureservercdn.net/198.71.233.153/575.8f7.myftpupload.com/wp-content/uploads/2017/06/2018_09_23_Sunday_Morning_Memo_Cocaine_Brain.pdf 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...

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