Angie's List (ANGI) has been discussed in detailed by many contributors passionately over the past year. Instead of repeating these arguments, I have decided to contribute to the discussion through a calculation of risk as defined by Harry Domash in his book "Fire Your Stock Analyst!". In Chapter 10 Domash describes his "Financial Fitness" methods which we can apply to evaluate how risky an investment in ANGI or any other stock is.
According to the author, companies likely to go bankrupt are in 1 of 3 groups:
- Busted cash burners: new firms, never made a consistent profit, little or no long-term debt, run short on cash and can't raise more.
- Overburdened debtors: large, mature, history of using debt, something changes and can't cover debt service
- Solvent and/or profitable companies: established firms that file for bankruptcy due to lawsuits.
To figure out in which group your prospective investment is, you use the ratio of assets / equity. If this ratio is greater or equal to 2.5 or equity is negative you apply the "Detailed Fiscal Fitness Exam", otherwise you apply the "Busted Cash Burner" analysis.
As ANGI, has negative equity we need to apply the "Fiscal Fitness Exam". However, let's also apply the "Busted Cash Burner" analysis to see what it would conclude.
The "Busted Cash Burner" method looks at operating cash flow and net working capital (current assets - current liabilities). The ideal scenario is for both to be positive. In ANGI's case, operating cash flow was a positive $8.9 million, however net working capital was a negative -$21.9 million. The data/press release can be found here. According to Domash:
"To pass this test, the estimated annual operating cash flow, at a minimum, should equal the working capital deficit."
In other words there is a working capital deficit that must be covered by operating cash flow. ANGI therefore fails this test.
Moving on to the prescribed test, the "Fiscal Fitness Exam" is a modified Piotroski F-Score. Piotroski is a university professor who wrote the following paper: "Value Investing: The Use of Historical Financial Information to Separate Winners from Losers" The paper describes a backtested model that outperforms the market based on a 9 step binary model and focusing on low Price/Book companies. For further details on Piotroski you can read a review here by Ricardo Espinosa.
Domash uses a modified Piotroski where he uses the 9 steps and adds 2 steps of his own for a total of 11. Applying these to ANGI:
- Bottom line net income (apply 1 pt if positive). ANGI: negative so fails.
- Operating cash flow (apply 1 pt if positive). ANGI: positive (1)
- Net income growth > Total asset growth (1 point if this hold). ANGI: Net income is negative however it is signficantly less negative this year while assets grew less than 10%. (1)
- Operating cash flow (ocf) > Net income (1pt if this holds). ANGI: ocf > net income: $9 > -$33m. (1)
- Total asset growth > Total liabilities growth (1pt if this holds). ANGI: 10% < 37% so fails. Domash differs here from Piotroski that uses longer debt.
- Current ratio is higher this year vs last. (1pt if this holds). ANGI: decline so fails.
- Shares outstanding increase by less than 2% (1pt if this holds). ANGI: shares increased by less then 2% (1). Domash differs here from Piotroski that awards 0 pts for any increase.
- Gross margin is higher this year vs last. (1pt if this holds). ANGI: This is a grey area as neither the 10-K or the 10-Q shows a gross margin calculation. Morningstar assumes that the only cost of sales is the operations and support figure. If we use only that figure then gross margin is 84% vs 83%. (1)
- Sales growth > Asset growth (1pt if this holds). ANGI: 58% > 10% so passes (1).
- Total liabilities/EBITDA (1pt if less than 5, 0pt for 6 or 7, -1pt for 8 or above). ANGI: Has negative EBITDA so this implies it is highly indebted and -1 point is deducted.
- Total liabilities/Operating Cash Flow < 4 (1pt if this holds). : 124m/9m = over 13x and so fails.
Total Score: 5.
According to Domash:
"In Piotroski's original 9-point system, 5 points constituted a passing grade. My changes didn't affect Piotroski's passing criteria. I found that companies that ended up in bankruptcy court almost always scored between 1 and 4 points."
Domash shows several examples of companies that filed for bankruptcy in 2009. These had scores of 4 or less and the majority had negative equity. Some of the firms with low scores were Charter Communications, Nortel Networks, Smurfit-Stone Container, Tarragon, Trump Entertainment Resorts and others.
So while ANGI failed the "Busted Cash Burner" test, it did pass the "Fiscal Fitness Exam", if only just barely. Therefore I decided to also calculate the Piotroski F-Score for 2011-2013. Based on my calculations, ANGI scored a 5 in 2011, a 3 in 2012 and a 5 in 2013.
How does this help us? If anything, ANGI is not a financially strong company. The math tells us that it is flirting which danger and that these numbers will need to be watched closely. So to answer the question the article title poses, I would say its inconclusive, but doesn't look too good.
Investors considering a long position should consider these numbers and decide whether this stock is worth the risk, while the short sellers (of which I am included) can feel comfortable that the company is far from solid.
My personal conclusion is that my analysis further supports the short case for a company that has never made a profit, has negative equity and working capital, has numerous insiders constantly selling (including the founder at $16.69 in Jan '14, at $14.49 in Dec '13, and $12.10 in Nov '13), and is facing severe direct competition (eg. YELP, homeadvisor.com) and indirect competition (eg. FB, nextdoor.com).