Liquidity Services (LQDT) operates several online auction marketplaces for surplus assets. The company deals in over 500 product categories, including consumer electronics, apparel, energy equipment, scrap metals, and several others. Transactions usually occur in bulk, with lots ranging from ship containers to individual pallets. Revenue is collected in a few different ways, including transaction fees, profit-sharing agreements with large sellers, service charges, and advertising fees. About 57% of the company's Gross Merchandise Value, or GMV, comes from the commercial segment, 20% from state and local governments, 15% from the Department of Defense (DOD) surplus contract, and 8% from the DoD scrap contract (both detailed below). Its marketplaces can be found at www.liquidation.com,www.govliquidation.com, www.govdeals.com, www.networkintl.com, www.truckcenter.com,www.secondipity.com, and www.go-dov.com.
About 45% of GMV and well over half of revenues came from 3 contracts last year. One is the DoD surplus contract, where LQDT agrees to resell DoD equipment (computers, electronics office supplies, clothing, you name it) - this accounts for 27% of 2012 revenue and 16% of GMV. Two is the DoD scrap contract to resell scrap metals and building materials. This was 16% of revenue and 9% of GMV. Finally, deals with Wal-Mart (WMT) alone accounted for about 20% of GMV.
The Value Proposition - For Clients
Liquidity Services provides an important resource for liquidating excess assets. Sellers (manufacturers, retailers, large corporations and government agencies) are often stuck with surplus inventory due to many factors, including over-ordering, returned items, packaging changes, product transitions, and so forth. While these organizations spend a lot of time and energy building supply chains, little effort is spent on developing efficient de-stocking processes. Traditionally the process was messy, involving small brokers, ad-hoc auctions, or negotiated sales. LQDT provides a simple outlet to handle all or a portion of these organization's liquidation needs.
The value proposition is similar on the buy side. Small retailers, scrap recyclers, refurbishers, etc. are forever in need of inventory, and face the same fragmentation issues that sellers do. Instead, they can simply rely on LQDT's websites for a reliable and reasonably priced procurement stream.
And this is to say nothing of the various services LQDT provides to both sides, including asset valuation, pick-up transport and delivery, financial transaction processing, and so forth.
Growth Potential Still Exists
Given the usefulness of its services, Liquidity has grown rapidly, from $264 million in 2008 sales to almost $500 million in the past 12 months, a 14% compound annual rate. However, it has slowed markedly over the past several quarters - GMV was up only 2% in Q3. Two factors were cited for this. One, the firm is experiencing unfavorable trends in consumer electronics, a business vertical that is 35% of revenues. Two, the DoD's asset flow has slowed down recently - GMV declined 1.7% from the surplus contract, and 8% from the scrap contract.
While the market may be concerned about flagging growth, I'm really not. Management noted the start of a turn for consumer electronics in the last conference call, and I don't see it as a long run concern. DoD order flow was termed "lumpy", which also makes sense. Liquidity has recently won contracts with some big names, including Danone, Costco, and several other large-but-unnamed firms, and is using its acquisition of GoIndustry to expand its services internationally. Liquidity Services will grow again.
The Value Proposition - For Investors
Clearly there are things to like about LQDT. We already mentioned the growth potential. The firm also has a nice economic moat in the form of a network effect. Liquidity is now established as the largest provider of large-scale liquidation services, with some huge sellers, making it easier to pick up new large sellers, attracting more buyers to the platform, which in turn makes it harder for either to leave! This protects the company's revenues and, in time, allows it to charge higher fees or collect higher percentages of sales.
LQDT has a great balance sheet, debt free with over $60 million in cash. Financial health is a non-issue.
Finally, there is management. William Angrick is the Chairman and CEO, a co-founder of the company, only 45 years old, and owns 20% of the stock. His track record building his company has been excellent. I love founder-run companies: they are usually managed for long term success instead of short-term goals. Think of Sam Walton, Reed Hastings, Mark Zuckerberg, Jeff Bezos, James Sinegal, Steve Jobs... Great companies are often built from the vision of the founders.
Last but certainly not least, let's talk price. I'm assuming a 10% decline in pre-tax earnings this year, on weak GMV and higher expenses from integrating the 2012 acquisitions. Going forward, however, I see Liquidity sustaining a 5-year average growth rate of 8%. My earnings yield assumption is about 8%, better than the current 8.7% but above the 7.5% average of the last 5 years. Putting it all together gives me a target price of about $28 per share.
Unfortunately for us value investors, that's about exactly where the stock trades today! I'd like to see it drop to around $20 before getting interested. Q4 earnings are set for November 21. The business is solid, so this could be one stock to add to your watch list and hope the share price drops into more interesting territory.