ALJJ Update

I initiated a small position in ALJ Regional Holdings earlier this year. I was hoping to add more when the stock drifted below $3, but was not able to build out the position to its desired size.

I thought ALJJ was worth at least $3.60, and quite possibly $5-$7.

Then a few weeks ago, I read Dave Waters’ (Alluvial Capital) letter to partners. I have tremendous respect for him as an investor and writer.

He made ALJJ his largest position. Some key takeways from his assessment:

  • accounting obfuscates FCF (amortization of intangibles); true cash flow > reported earnings
  • using numbers, not terribly different from the ones I used, he came up with a valuation of $4.70, somewhere between my bear and base cases
  • the jockey, Jess Ravich, provides upside optionality

I have been waiting patiently for the price to dip back closer to $3 to increase my position.

 

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ALJ Regional Holdings

ALJ Regional Holdings (ALJJ) is a small-cap jockey stock, led by an enterprising CEO – Jess Ravich. It has attained celebrity status in the tiny universe of small-cap value stocks.

Over the years, it has been chronicled by OTC Adventures, Whopper Investments, Ragnar is a Pirate, GeoInvesting, etc. It has an active presence of COBF, and (is?) has been owned by savvy investors like Arquitos Capital Management, and JDP Capital Management.

As it was being showered with attention, it rose nearly 20x, from a penny stock ($0.30 in early 2011) to a high near $5.50/share in mid 2016. It has since deflated a bit, and currently sits around ~$3.40.

The clamor around the stock has also subsided substantially.

Since things had cooled off a bit, I thought I’d take a closer look.

If you want to know what happened to ALJJ in the last two years, I recommend looking at the following three sources:

  • In June 2015, Arquitos Capital Management published a case study (pdf). At the time, it had only two subsidiaries.
  • In Jan 2016, JDP Capital did a fantastic slide deck outlining ALJJ’s history, value proposition, and investment thesis (pdf).
  • In Aug 2016, Ares took a deep dive into the three segments at VIC, and came up with three valuation scenarios. Although the stock was trading at ~$4.80 at the time, the author was bullish.

The first two sources are useful in understanding the company, while the third provides a decent valuation framework.

Here’s the narrative. Jess Ravich, the “outsider”-ish CEO, inherited a company with significant NOLs. These NOLs have to be used before they phase out, starting from 2020. ALJJ has three subsidiaries (Faneuil, Carpets, and Phoenix color) all of which operate in tough niches. However, the CEO has demonstrated skill in acquiring businesses on the cheap through his deal-flow network, fixing them up by retaining and incentivizing management, shielding profits using NOLs, and, if needed, selling them when appropriate. The company runs a lean operation, and there is plenty of skin in the game.

Valuation

We can piggy-back on the VIC valuation. In that writeup, the author considered three cases – bearish, base and bullish. You should read that report, but I present some updated numbers (all numbers in million $), just to see how things are tracking since his report.

Screenshot from 2017-05-13 17-19-07

Essentially, 2016 was a year of sowing, and things seem to be turning a corner in 2017 (after two quarters). Currently, the performance of the units is tracking the “bear case”, based on which one could justify a price target of $3.40-$3.60. This is slightly essentially where it is currently trading.

However, if one is betting on the jockey and his team to turn things around, then one ought to look at normalized numbers. The numbers presented in the base case seem quite reasonable to me in a 1-2 year time-frame. If the stock rises to $5.40 in two years, we are looking at a respectable 25%/year return.

What are possible downsides?

The debt load, while manageable, is larger than I would like. The time-clock on the NOLs is ticking out – gradually, but surely. Collectively, this might reduce their edge in landing and monetizing new deals. Jess Ravich is 59; while there is “key man” risk, it doesn’t seem imminent. The operating businesses occupy tough niches; a big recession could create a perfect storm.

Overall, though, this is starting to look like a good risk-reward bet, in an environment with few bargains. I bought a starter position at $3.30.