PS&C Ltd

Following a suggestion from a reader, I had a look at PS&C Ltd (ASX: PSZ), the IT and security consulting/services firm. I can see the investment case quite simply – the market capitalisation is ~$20m, whereas the people + security divisions are worth $15m and $10m on the books respectively. There is the pending spin-off of the security + communication division to unlock value. There’s obvious upside if I knew for certain that the People and Security segments would return to previous levels of profitability.

The whole company looks to be priced at 5-ish times EBIT which is about half what is normal for ASX listed companies. Cheap, sort of, but I have decided not to buy it in the near term for a couple of reasons:

Why i’m not keen on it

  • Despite forecasts of a stronger second half, management has made these forecasts in several previous years going back to 2014 and they have fallen short repeatedly (there are articles on the web covering this)
  • Management looks to be using double-speak, saying ‘we are not paying a dividend in order to save cash for the spinoff‘ but I looked at statement of comprehensive income and cash flows and I don’t think there was any cash available to pay dividends in the last half
  • Management reports EBIT before head office costs in their results announcement but doesn’t report EBIT after head office costs (always a warning sign)
  • Debt of $15 million is quite high. I might have missed something since they say they have ‘executed’ debt which is why it’s listed as a current liability, but I am not entirely sure what is meant by that (refinancing? repaying?)
  • I don’t understand the earnings drivers of the business (where growth will come from) and if a return to revenue + earnings of previous years is possible
  • Finally and probably the biggest issue, the company looks to have a Enterprise Value to EBITDA (EV/EBITDA) multiple of around 9x ($20m mcap + $15m debt, divided by $4m in estimated EBITDA for full year). This is higher than or equivalent to similar businesses like DWS Ltd (ASX: DWS). So it’s not as cheap as it might appear.

 

I can get behind the idea of a new CEO, I believe the business badly needed it. I also think a spinoff makes sense, although it’s a pity they’re bundling the unattractive (and unprofitable) communications business in with the attractive security one. Existing shareholders will receive shares in the new business, while PSC will also receive some cash which will be used to pay down debt.

The thing is, spin-off or no, it almost looks more like a capital raising to me. Where is the capital coming from to fund the spin-off? Management says they’ll receive some cash for selling the business. Cash from who? And how much of the new Security business will this buyer take, and how many shares will be left over for distribution to existing shareholders?  I could hypothetically buy PSC and end up with just 40% of the security business post spin-off. Or I could wait, and buy shares in the security business directly.

I’m also concerned about the mention of further acquisitions for both the People business and the spin-off. PSC appears to have got itself into this state through the use of acquisitions and I’m wary of management saying that more acquisitions are in the pipeline.

Of the $$ raised by the spin-off, probably most of it will go to pay down debt. It doesn’t appear likely that there’ll be a special dividend or anything like that. So management will sell an apparently attractive business (they keep telling investors how much the cybersecurity industry is growing), give shares in it to shareholders, then use their newly refreshed balance sheet to go and buy more businesses. I’m not sure I understand the logic.

Finally, I am wary of the ‘rising tide lifts all boats’ theory of earnings growth. E.g., ‘cybersecurity market is growing at x% over the next 5 years and we do cybersecurity, so we will benefit‘. In my experience, it doesn’t work that way. Earnings growth goes to the most competitive/best managed/most useful company, and PSZ has in my humble opinion not been that one.

As a standalone business with a new CEO, the security business could be well worth owning – especially if it can build a niche and or return communications to profit. However, for now, I think I’d like to see a few more cards on the table.

Disclosure: I don’t have any financial interest in either PSZ or DWS.

Mea Culpa: RNY Take 2

I made a mistake in my analysis of RNY Property Trust (ASX: RNY). You can find out more about that in my original post. Fortunately, the error occurred halfway through (after the bulk of the original analysis was done) and only the conclusions that I drew from my analysis were affected. I.e., I could cut out the last half of my investment thesis and return to the original data to redraw my conclusions. That is what I have been doing the past few days.

Let me reiterate here that I am bound by the rules I set myself in my disclaimer to hold all companies for 1 month from the date I bought them, except in the event of company fraud or a serious event (e.g. medical emergency). So regardless of what I decide, I will be holding RNY for at least one month, until 7 May 2017.

Here are my current thoughts on RNY Property Trust.

This is the investment thesis in a nutshell. The properties, once sold and used to repay loans, will generate ‘equity’ for the Trust that is greater than the value of the loans. The equity left over, if any, will be distributed to unitholders after fees and costs are accounted for. Here is an overview of the loans and asset values:

source: Company report

Now, I’ve actually written this post twice. I had a big post ready to go last weekend, nearly 2500 words long. It went through the investment line by line and addressed a variety of possible scenarios and their outcomes. It was very in depth and to be frank, it was a bit much. Even I got lost when I re-read it, as it basically forced me to relive the scenario inch by inch in order to (eventually) see what my conclusions were and why I formed them. For a blog that was constructed to record my investment theses in an accessible manner, that kind of defeated the point.

The end result is that I have decided to continue holding my RNY units. The short reason behind this is:

ISB Pool

The last remaining ISB asset, Bridgeport, appears much higher quality than the 2nd last asset (now sold) 300 Executive Drive, which required a 17% discount to sell. Bridgeport could sell for up to a 10% discount and still generate ~$1m leftover equity after fees and costs. That is not part of my base case but it is part of the potential upside.

ACORE Pool

One asset, Charles Lindbergh, has grown in value over TTM and recently saw major tenant Lockheed re-sign and expand its lease. I consider this property’s value to be ‘firm’, i.e., at least equal to its recent valuation.

At least one more asset, 6900 Jericho, should achieve close to its valued price as it has minimal renewals coming up and a good level of occupancy. That leaves 3 other assets.

These assets are in varying conditions but management has done a good job attracting renewals to account for tenant expiries, and I consider that my previous worst case scenario (no tenant renewals) is unlikely to occur. More importantly, another asset, 555 White Plains Road is on the same stretch of road as the held-for-sale 560 and 580 White Plains road. 555 White Plains sold for a 32% discount to its recently assessed value, but it had woeful occupancy and WALE. The other assets are better and, I consider, will require a smaller discount to sell.

Thus this gives me a vague ‘floor’ on 4 of the ACORE assets, with the remaining one, 6800 Jericho, an open question.

There is additional potential upside (well actually, lower downside) if management can secure more leases in the coming months, with significant progress made on this front in the first 2 months of the year.

The bottom line:

The obvious worst case scenario is a 100% loss, if properties fail to sell for enough $$ to pay off the loans and leave money leftover. I do not believe this is likely. I consider a likely downside scenario resulting in a 30%-40% loss if larger discounts are required than I expect, or if I’m wrong about some asset values like Charles Lindbergh.

A ‘safe’ estimate of upside is, in my opinion, around 50% (post fees, and excluding Bridgeport) with the potential of up to 300% or so (pre fees but including all assets sold at full value). Based on my research I believe the upside result is more likely than the downside, with an outside chance at the really good upside scenario. I have decided to stick with my RNY shares for the time being. The thesis should play out relatively quickly, within a year or so, as management intends to market the properties soon with a view to settling in Q4 CY17.

One final note:

I have been working long hours this month, around 2x my normal workload. This contributed to fuzzy thinking and fatigue that were a direct cause of the errors carried through in my first RNY thesis. It is entirely possible that there are more errors in the above, despite my best efforts. For readers I say again, this is not a recommendation, just my own record of the thought process I followed. If you’re looking at RNY, please do your own research, and also take the time to read my disclaimer.

Disclosure: I hold shares in RNY Property Trust.

Movie reviews?

I have a tiny side hobby reviewing movies on Facebook about once a month. I typically try to sum up a movie in a Facebook status, say 100 words or less, in a way that is funny and engaging. I have been doing it for a while and would really like to immortalise my reviews somewhere for my records, so I’m considering finding a little corner of the site I can tuck them away in.

It’s more fun to write about movies since they are designed to be consumed and criticised or applauded. Writing about investing can be a little dry at times, unless you’re mocking companies for their foibles. I don’t mind a spot of ‘company bashing’ but I try to avoid it as I believe it is bad form to piss on the efforts and aspirations of real people, regardless of how poorly they do. (If they’re dishonest, unthinking, or greedy however, all bets are off). Anyway, 10footinvestor could soon become 10footmoviereviewerinmysparetime.com.

(I joke; it will still be 99% about investing).