Andy Fligel works as a venture capitalist, however, his posts on Seeking Alpha cover his personal investments and views on public companies and are unrelated to his venture capital investments in private firms. An avid investor, Andy enjoys finding quality investments across multiple disciplines and is equally comfortable evaluating high growth technology companies as he is value oriented opportunities. In managing his personal portfolio, Andy takes more of a private equity approach to his personal stock selection, searching for fundamentally sound businesses with strong leadership that are trading at a discount to historical levels and with attractive free cash flow yields, especially if those firms happen to be out of favor or underfollowed. He seeks opportunities which are capable of generating 20% or higher annual returns with favorable risk/reward profiles. Andy Fligel http://seekingalpha.com http://seekingalpha.com/instablog/256511-andy-fligel/104503-djsp-post-mortem-of-a-value-trap?source=feed 104503
By background, DJSP's results for 2009 were $260M in gross revenues, $120M in net revenues (some gross revenues are simply reimbursement of client costs which also show up as an expense) and $69M in EBITDA (57% of net revenues).  It also generated $46M in free cash flow (38% of net revenues).  Legal issues aside, processing foreclosures is a very profitable business.

In my original post, I noted that DJSP was trading a 4x the company's then current guidance for EBITDA and earnings.  I also noted that the CEO personally bought ~$2.8M worth of shares in June at an average price of $6.20.  The company had already seen its shares fall substantially after reducing guidance once, and I theorized that DJSP shares would eventually appreciate once it got past the headwinds surrounding government mortgage modification programs and a large client's system conversion project.

DJSP gets paid a flat fee for each foreclosure case that it processes, making its growth a function of the number of cases it can process.  In 2009, DJSP processed over 70K foreclosure cases and over 27K other cases (REO, bankruptcy, eviction, etc.).  Since the dominant source of revenues is foreclosure files, I reasoned that the stock could reverse its slide once the catalyst of growing foreclosure cases became apparent.  In Q1, DJSP's foreclosure cases were 15.6M, and Q2 foreclosure cases declined to 10.3M (impacted by the customer system conversion issue).  The system conversion is now completed, and the company noted in its Q2 results that referrals were beginning to come back from that client in Q3.  DJSP also disclosed that July foreclosure cases were 25% higher than June.  In general, the level of foreclosure cases appeared to be bottoming in Q2, in line with the original thesis.

So what did I miss?  My biggest mistake was discounting the allegations of wrongdoing as being minor issues.  Several readers commented on ethical accusations about Stern, his law firm and the paralegals working for DJSP, and I misjudged these risks.  The major undoing of DJSP occurred on August 11, when the Florida AG announced an investigation of 4 law firms for potential fraud, including the law offices of David Stern, the organization that refers all cases to DJSP.  Stern's law firm represents Fannie, Freddie, Bank of America, etc.  After the AG launched his investigation, politicians began asking why the government-owned Fannie and Freddie were doing business with a law firm being investigated for fraud.  The mainstream media also began to jump on the foreclosure mess as big mortgage servicers like Bank of America, JP Morgan and Ally suspend active foreclosure proceedings to review internal practices due to the "robo-signer" issue.  Further, former employees of Stern's law firm testified to the AG of shady practices such as backdating documents.  Thus, in early October Fannie and Freddie instructed their mortgage servicers to stop sending new referrals to Stern's law firm until they completed independent reviews.  Citigroup similarly decided to suspend referrals until the AG's investigation was complete.  In my original analysis, I did not expect the loss of any large customers.  I had noted in my original post the inherent risk of having the top 3 customers make up over 50% of revenues, but in the absence of a smoking gun, I did not foresee losing these customers given how difficult it might be to replace an incumbent service provider at the high volumes that DJSP was processing.  But the AG's investigation has now caused all current customers to reevaluate their relationship with Stern's law firm, which could lose its major customers regardless of the ultimate findings by the AG's investigation.

Another data point I completely misread was Stern buying $2.8M of stock at over $6 a share.  Historically, I have found insider buying (or selling) to be a very good indicator in controversial situations like DJSP, and an effective way to avoid potential value traps.  In retrospect, I should have discounted his buying given the fact that Stern had already issued overly aggressive guidance to investors out of the gate, and his open market buying could also have been influenced by overly optimistic tendencies.

Suffice it to say that DJSP is now fighting for its very survival.  In the last week, three recent senior hires and one board member resigned from DJSP, which can only be interpreted negatively.  We will see over the coming months if DJSP is able to pull out of its tailspin or not.  In the meantime, DJSP will remain my worst call ever, and I'll look to learn from the experience to avoid making the same mistakes again.

Disclosure: Previously long DJSP and DJSPW, currently have small stake in DJSPW ]]> Mon, 25 Oct 2010 19:27:21 -0400
By background, DJSP's results for 2009 were $260M in gross revenues, $120M in net revenues (some gross revenues are simply reimbursement of client costs which also show up as an expense) and $69M in EBITDA (57% of net revenues).  It also generated $46M in free cash flow (38% of net revenues).  Legal issues aside, processing foreclosures is a very profitable business.

In my original post, I noted that DJSP was trading a 4x the company's then current guidance for EBITDA and earnings.  I also noted that the CEO personally bought ~$2.8M worth of shares in June at an average price of $6.20.  The company had already seen its shares fall substantially after reducing guidance once, and I theorized that DJSP shares would eventually appreciate once it got past the headwinds surrounding government mortgage modification programs and a large client's system conversion project.

DJSP gets paid a flat fee for each foreclosure case that it processes, making its growth a function of the number of cases it can process.  In 2009, DJSP processed over 70K foreclosure cases and over 27K other cases (REO, bankruptcy, eviction, etc.).  Since the dominant source of revenues is foreclosure files, I reasoned that the stock could reverse its slide once the catalyst of growing foreclosure cases became apparent.  In Q1, DJSP's foreclosure cases were 15.6M, and Q2 foreclosure cases declined to 10.3M (impacted by the customer system conversion issue).  The system conversion is now completed, and the company noted in its Q2 results that referrals were beginning to come back from that client in Q3.  DJSP also disclosed that July foreclosure cases were 25% higher than June.  In general, the level of foreclosure cases appeared to be bottoming in Q2, in line with the original thesis.

So what did I miss?  My biggest mistake was discounting the allegations of wrongdoing as being minor issues.  Several readers commented on ethical accusations about Stern, his law firm and the paralegals working for DJSP, and I misjudged these risks.  The major undoing of DJSP occurred on August 11, when the Florida AG announced an investigation of 4 law firms for potential fraud, including the law offices of David Stern, the organization that refers all cases to DJSP.  Stern's law firm represents Fannie, Freddie, Bank of America, etc.  After the AG launched his investigation, politicians began asking why the government-owned Fannie and Freddie were doing business with a law firm being investigated for fraud.  The mainstream media also began to jump on the foreclosure mess as big mortgage servicers like Bank of America, JP Morgan and Ally suspend active foreclosure proceedings to review internal practices due to the "robo-signer" issue.  Further, former employees of Stern's law firm testified to the AG of shady practices such as backdating documents.  Thus, in early October Fannie and Freddie instructed their mortgage servicers to stop sending new referrals to Stern's law firm until they completed independent reviews.  Citigroup similarly decided to suspend referrals until the AG's investigation was complete.  In my original analysis, I did not expect the loss of any large customers.  I had noted in my original post the inherent risk of having the top 3 customers make up over 50% of revenues, but in the absence of a smoking gun, I did not foresee losing these customers given how difficult it might be to replace an incumbent service provider at the high volumes that DJSP was processing.  But the AG's investigation has now caused all current customers to reevaluate their relationship with Stern's law firm, which could lose its major customers regardless of the ultimate findings by the AG's investigation.

Another data point I completely misread was Stern buying $2.8M of stock at over $6 a share.  Historically, I have found insider buying (or selling) to be a very good indicator in controversial situations like DJSP, and an effective way to avoid potential value traps.  In retrospect, I should have discounted his buying given the fact that Stern had already issued overly aggressive guidance to investors out of the gate, and his open market buying could also have been influenced by overly optimistic tendencies.

Suffice it to say that DJSP is now fighting for its very survival.  In the last week, three recent senior hires and one board member resigned from DJSP, which can only be interpreted negatively.  We will see over the coming months if DJSP is able to pull out of its tailspin or not.  In the meantime, DJSP will remain my worst call ever, and I'll look to learn from the experience to avoid making the same mistakes again.

Disclosure: Previously long DJSP and DJSPW, currently have small stake in DJSPW ]]> djsp.pk http://seekingalpha.com/instablog/256511-andy-fligel/39188-consolidated-graphics-makes-for-intriguing-small-cap-value-play?source=feed 39188 Consolidated Graphics (CGX) looks poised to deliver strong investor returns over the next several years.  Despite its 42% YTD return, the shares trade at a discount to historical multiples and do not fully appreciate the firm's strong free cash flow generation.  I believe future cash generation coupled with modest business or multiple improvement could drive 30%+ annual equity returns with limited downside risk.  Here's why.

1) Revenues and EBITDA should be stable to higher going forward.

CGX has trailing revenues of $1B and trailing EBITDA of $110M.  The company increased September quarter revenues 11% sequentially, and is guiding for flat or sequentially higher revenues in the December quarter as well.  September quarter EBITDA margins were 11%, which is below historical margins of 12.5%-14%.  Revenues and EBITDA stand to improve with any economic recovery.

2) The current valuation is below historical EBITDA multiples and is attractive relative to cash generation.

At the current price of $31.50/share, the stock has a $358M market cap and $580M enterprise value.  The enterprise value is 5.3x trailing EBITDA, 25%-30%below the historical range of 7x-8.5x.  The EBITDA multiple could expand as the economy recovers and margins improve.

CGX generated nearly $140M of free cash flow over the past year (albeit with some stretching of payables) and should generate at least $70M of annual free cash flow going forward.  This equates to a projected free cash flow yield of at least 17%.

3) Strong cash flows could drive 25%+ annual equity returns even without much multiple expansion.

Assume calendar 2011 EBITDA of $110M (no growth over trailing) and a 6x EBITDA multiple (slight multiple expansion but still below historical norms), for a total enterprise value of $660M.  If the company generates ~$140M of free cash flow over the next two years and reduces net debt to $80M, the implied market cap would be $580M, which equates to a $51 share price, 62% higher than the current price and a 2-year CAGR of 27%.

Further, all of the above assumptions could prove low.  Annual EBITDA came in at $135M-$150M before the downturn, historical EBITDA multiples exceeded 7x and free cash flow could eclipse $140M over the next two years. Any positive surprise in one or more of these areas could drive annual returns north of 30%.  For example, $120M-$130M of 2011 EBITDA at a 6x-7x multiple and $140M of net debt reduction would imply 2011 prices of $56-$73, or a CAGR of 34%-52%. 

4) The debt load is manageable.

Current net debt of $222M is a manageable 2x-2.5x annual EBITDA, and annual net interest expense is only $8M-$9M.  CGX used its free cash flow to reduce debt by $146M over the past year.  The existing debt facility matures in October 2011, and CGX should be able to significantly pay down outstanding amounts with its cash flow and refinance any remaining portions.

5) There could be an opportunity to make accretive acquisitions.

Management claims to have an M&A pipeline in excess of $500M in annual revenue as smaller players that lack the scale to compete effectively are driven to consider a sale.  The current dynamic should enable CGX to be choosy in pursuing only the most financially attractive opportunities.

Disclosure: Long CGX]]> Wed, 09 Dec 2009 18:17:15 -0500 Consolidated Graphics (CGX) looks poised to deliver strong investor returns over the next several years.  Despite its 42% YTD return, the shares trade at a discount to historical multiples and do not fully appreciate the firm's strong free cash flow generation.  I believe future cash generation coupled with modest business or multiple improvement could drive 30%+ annual equity returns with limited downside risk.  Here's why.

1) Revenues and EBITDA should be stable to higher going forward.

CGX has trailing revenues of $1B and trailing EBITDA of $110M.  The company increased September quarter revenues 11% sequentially, and is guiding for flat or sequentially higher revenues in the December quarter as well.  September quarter EBITDA margins were 11%, which is below historical margins of 12.5%-14%.  Revenues and EBITDA stand to improve with any economic recovery.

2) The current valuation is below historical EBITDA multiples and is attractive relative to cash generation.

At the current price of $31.50/share, the stock has a $358M market cap and $580M enterprise value.  The enterprise value is 5.3x trailing EBITDA, 25%-30%below the historical range of 7x-8.5x.  The EBITDA multiple could expand as the economy recovers and margins improve.

CGX generated nearly $140M of free cash flow over the past year (albeit with some stretching of payables) and should generate at least $70M of annual free cash flow going forward.  This equates to a projected free cash flow yield of at least 17%.

3) Strong cash flows could drive 25%+ annual equity returns even without much multiple expansion.

Assume calendar 2011 EBITDA of $110M (no growth over trailing) and a 6x EBITDA multiple (slight multiple expansion but still below historical norms), for a total enterprise value of $660M.  If the company generates ~$140M of free cash flow over the next two years and reduces net debt to $80M, the implied market cap would be $580M, which equates to a $51 share price, 62% higher than the current price and a 2-year CAGR of 27%.

Further, all of the above assumptions could prove low.  Annual EBITDA came in at $135M-$150M before the downturn, historical EBITDA multiples exceeded 7x and free cash flow could eclipse $140M over the next two years. Any positive surprise in one or more of these areas could drive annual returns north of 30%.  For example, $120M-$130M of 2011 EBITDA at a 6x-7x multiple and $140M of net debt reduction would imply 2011 prices of $56-$73, or a CAGR of 34%-52%. 

4) The debt load is manageable.

Current net debt of $222M is a manageable 2x-2.5x annual EBITDA, and annual net interest expense is only $8M-$9M.  CGX used its free cash flow to reduce debt by $146M over the past year.  The existing debt facility matures in October 2011, and CGX should be able to significantly pay down outstanding amounts with its cash flow and refinance any remaining portions.

5) There could be an opportunity to make accretive acquisitions.

Management claims to have an M&A pipeline in excess of $500M in annual revenue as smaller players that lack the scale to compete effectively are driven to consider a sale.  The current dynamic should enable CGX to be choosy in pursuing only the most financially attractive opportunities.

Disclosure: Long CGX]]> cgx Small Cap Value