Is There A Liquidation Sale At Liquidity Services?

| About: Liquidity Services, (LQDT)
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June 18, 2013, Tim Gallagher

Liquidity Services (NASDAQ:LQDT) is writing the book on Reverse Supply Chain Logistics, as a global, efficient B2B and B2C e-commerce sector. It's consolidating the highly-fragmented industry liquidation, logistics, and reverse supply chain, with a growing online auction place, capitalizing with scale of economy and efficiencies, technology innovation, domestic savvy, a solid reputation based on performance excellence and track record, and tailoring a fully-integrated service option to Fortune 1000 companies, federal, state , and municipal governments, and synergies with the e-Ecosystem, benefiting the leaders in this space, notably eBay (NASDAQ:EBAY) and Amazon.com (NASDAQ:AMZN).

This stock has been hammered over the past year, falling from an all-time high in May 10, 2012 of $66.57 to $31.09 at close last Friday. The selling is mainly due to temporary slowing growth, due to "growing pains" and capex/ investment outputs to continue global expansion, most recently to burgeon strength in Southeast Asia. Sales and earnings estimates, results, and guidance have fallen short, however LQDT is still profitable, as it has been every year since 2000, excepting 2009 with the recession. Technical analysis shows the stock failing off the 200 day simple moving avg. (SMA) at $38.94, rushing non-stop past and across the 50 day SMA of $35.13, having been over $40.90 on May 31st last month. The last time the stock tried to hit the sky was back on Sept. 21, 2012, at $57.42. There have been some notable drops in the price action during this time period, without any real notable high-volume days, and only some modest buying on Thurs., with a cancelled uptick. Those of you that make investment decisions based on pure technical analysis (TA) need go no further

Fundamentally, this small growth stock tells a different tale altogether. This young small-cap growth company has made great strides in its thirteen year history, having IPO'd in early 2006. Aside from a few slowing and stumbles, notably at present-where sales and earnings estimates are disappointing both internal and analysts' projections, this has been a consistently high growth, highly profitable company, and still off the radar of many investors. LQDT's online auction marketplaces are liquidation.com, govliquidation.com, govdeals.com and liquibiz.com. It also operates a wholesale industry portal goWholesale.com.

Key advantages derive from LQDT's value proposition, as basically it has created a business from selling and returning some profits to their diverse client base, of which I'll touch on later. Prior to LQDT, many of its customers, such as the Department of Defense (DOD), Wal-Mart (NYSE:WMT), Pfizer (NYSE:PFE), Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP), and recently, Hoffman-La Roche (OTCQX:RHHBY), used to pay scrap haulers to haul off surplus and outdated equipment, either to liquidate or to the landfill. Whenever companies needed to retool, upgrade, recapitalize, relocate, or liquidate, or hit insolvency, they paid for the privilege of having someone dispose of these materials, and write-off these expenses. LQDT offered to auction them off, and partnered with each, for a split of the realized price.

LQDT has expanded a proprietary moat by creating additional tailored services, of which are provided at no additional charge, only profiting when a sale is made, so LQDT aligns itself with its customer base with this singular, common interest-a revenue share structure. LQDT doesn't finance purchases or extend credit, accepting only cash on delivery (before delivery). This negates any credit, finance and cash reserves, default risks, and the sellers get money in hand before LQDT even reports sales. LQDT added to profitability of its business model by an expertise in auctioning, using an online set of platforms, and created a unique set of professional buyers globally that now numbers around 2.2 million. Many of these buyers are repeat customers, and LQDT doesn't hype user/website "hits" by counting the same online viewers unless they buy once per quarter, even if they buy multiple times per auction or quarter. Unlike many internet and social media companies in the e-business cohort, "eyelids" don't count. LQDT monetizes on traffic, and by developing a reliable, dependable clientele.

The network of these buyers has grown, as has the repeat client list, and Liquidity's maximizing internal knowledge with use of business analytics and database, search optimization in a marketing strategy, further setting the standards in auctioning surplus (reverse) supply chain logistics, suggestive selling alerts to past clients, and target demographics, relational selling, plus strategic acquisition strategies, based on an internal criteria of adding to a base of unique buyers and expanding business and capital equipment lines.

Business Metrics: Performance and Profitability: GMV has grown at a compound annual growth rate of 33% since fiscal year 2002 with 42 consecutive quarters of profitability***

Market Cap: $983.2m; EV: $925.17m

Rev. Growth: (ending 03/13): 25%, however, management uses non-GAAP internal metric of gross merchandise volume, as a key performance metric, similar to eBay and Amazon.com, as this drives free cash flow (FCF).

Gross Margin: (TTM, ending Mar. 31, 2013): 58.3%; Net Margin: (TTM, ending Mar. 31, 2013): 9.7%/ Net Income Growth: (3 yr. history): 103.6%

EPS: (TTM): $1.21'MRQ (05.21.13): 0.48c, vs. consensus forecast of 0.48c (Note: This MRQ has been the only in-line report, as the last 5Qs have beaten estimates from 8.2 to 40.9%).

ROE: (TTM, ending Mar. 31, 2013): 15.4% ROA: 10.7% Free Cash Flow: $9.985m

P/B: 3.5/ PE: 5 yr. avg: 22.6 Forward: 16.5/ PEG: (Forward): 0.9 5 yr. avg: 1.1/ P/S: 2.1

Current Ratio: (TTM, ending Mar. 31, 2013): 1.6

Average Annual inventory turns: 12/yr., No inventory issues.

Debt to Capital: 11.3% Sep.11-Sep.12/Y-O-Y/ Debt to Equity: 0

Beta: (5 yr. historical): 0.8 Dividend: 0%

(Sources: www.liquidity.com ; www.morningstar.com ; Source: S&P, Company Reports; Thompson Reuters Stock Report).

MODEL: Key competitive strengths include revolutionizing standards and efficiency, and performance in both e-commerce, surplus, and the auctioning industries, global supply chain and reverse supply-chain logistics in over 200 countries. LQDT creates additional revenue streams through multiple channel selling, and have a well reported, transparent, actionable chain for the end customers throughout the intermediary chain. LQDT is widely regarded as the "gold standard", with first-to-market advantages, and consistently use technology, relational and cross-selling focus and strategy, and value-added (i.e. "free" services), thus adding convenience and the intangible reliance and trust factors to an expanding vertically-integrated model. The results have been a near oligopolistic entrenchment in its respected marketplace. Contrary to many competitors in all things e-based", where creative destruction, as well as quick formation evolving from idea to IPO outrace each other to either validity, profitability, and/or dominance (or destruction), LQDT also possesses non-technology-based, industry-specific and knowledge of trade fundamentals not easily duplicable. An example resides with the public service sector, from international right down to local municipalities. These entities, more than any other, have regulatory, compliance, and accountability issues to deal with. LQDT has that specific know-how to legally and safely navigate the myriad policies, for instance international and maritime laws, and trade agreements.

Classes of merchandise sold include new, like new, surplus, and salvage. Since payment to LQDT is before or at delivery of goods, LQDT represents the details and description of the available merchandise with photographs and/or video, and goes to diligent measures to track the origination and history and usage(s) of each item individually, in order to enhance customer satisfaction. With under 1000 U.S. employees (1300+/- worldwide), and free of capital-intensive asset and capital spending needs, most of its expenditures are in IT spend for expansion across lines of merchandise, regions, and acquisitions. Space for storage and auction, and shipping activities is leased cheap, avg. $1-4.00/sq. ft., as reported on the most recent quarterly earnings conference call. The emergent increase in C-suites of Chief Sustainability Officers brings with it the responsibility of a shareholder, corporate governance, and eco-friendly mindset to an orderly disposition of capital goods and non-perishable, non-toxic materials. What once went to landfills at a cost to the business now has a return, termed a recovery value, right into LQDT's niche.

-Over 6000 Clients (sellers) including notably: Sanofi-Aventis (NYSE:SNY), Hoffman-La Roche, Parker Hannifin (NYSE:PH), Tellabs (NASDAQ:TLAB), Hewlett-Packard (NYSE:HPQ), Proctor & Gamble (NYSE:PG), General Motors (NYSE:GM), Wal-Mart , Merck (NYSE:MRK), Coca-Cola, Caterpillar (NYSE:CAT), Pepsi Co./Frito Lay, UPS (NYSE:UPS), Echostar (NASDAQ:SATS), CNN, Dana (NYSE:DAN), 2012 London Olympics….

-Over 2.2 million buyers worldwide.

Industry Range: consumer electronics, general merchandise, apparel, mining, scientific equipment, aerospace parts and equipment (including planes and helicopters, safety equipment, pharmaceutical, biotech, and chemical equipment, textiles, leather, woodworking, commercial kitchen, utility goods, commercial and residential real estate, technology hardware and specialty equipment (consumer packaged goods, bottling, canning and conversion & producer capital equipment and automated machinery), oil/gas/energy/petrochemical rigs and drilling equipment, and other specialty segments, so it encompasses a broad and diverse set of potential buyers currently covering 27 industries.

LQDT also doesn't compete with Ritchie Brothers (NYSE:RBA), perhaps its closest segment competitor, in the commercial construction space, although indirectly it handles some like goods (e.g. forklifts &, power equipment).

Federal Contracts: Department of Defense/ DOD, LQDT sells bulk scrap from multiple bases. This includes large ships, aircraft, vehicles, and other base materials after any critical systems (i.e. control panels, radar/sonar equipment, missile and ordnance delivery and targeting systems, etc.) have been removed.

Past consistent success has enabled renewal of contracts, and performance-based incentive bonuses annually. LQDT's performance on all things stock-based inaccurately compares them to eBay, Target (NYSE:TGT), Wal-Mart, discount retailers, and other internet or software-based companies. LQDT doesn't have any direct competitors that are public. Most competitors are local, maybe regional, and usually the Mom 'n' Pop variety, and LQDT is making these players obsolete, at least nowhere near close to their previous scope and scale.

Synergistic relationships exist with both e-commerce and discount stores such as Ross Stores (NASDAQ:ROST), Kohl's Corporation (NYSE:KSS), T J Max/ The TJX Companies (NYSE:TJX), Tuesday Morning (NASDAQ:TUES), as they don't compete, but are customers. Many eBAY-based businesses and similar small merchants are regular customers of LQDT on both ends. Liquidity can provide these smaller buyers with decent and profitable goods to sell, or save them money on increased returned merchandise, which, with internet sales up 20% in the past three years, benefits LQDT with another revenue stream of consumer discretionary goods. Logistical efficiency allows them to ship these goods with a good margin to these and other end customers, and shipping charges, which include the entire transport cost charged to even individual e-commerce buyers, is still profitable, even at full-truck/delivery costs. The added transportation expense is embedded in LQDT's receivables.

On a recent Analyst Day Presentation, LQDT cited purchasing activity similar to the dollar stores and discounters named above, as an unnamed Mexican discounter with approx. 50+ stores, buys a goodly amount of general (i.e. unallocated surplus goods) merchandise to fill inventory, catch as catch can, on a weekly basis).

State & Municipal contracts:

(A Bread and Butter business segment)- LQDT serves over 5400 municipals on asset sales, and that list is expanding. This has historically been a relational ("Good "Ole Boy") network that can't compete on profitability or performance and reliability measures, so LQDT is steadily taking market share here.

Note: a D.O.D. Case study (source: www.liquidity.com website); results/summary:

"USS Long Beach, commissioned in 1961 as the first nuclear-powered surface warship, was a one-of-a-kind cruiser that served in Vietnam and the Gulf War, and participated in Operation Sea Orbit, the first all-nuclear cruise around the world."

"The USS Long Beach, located at Puget Sound Naval Shipyard in Bremerton, WA was sold at 118% of her initially projected value and scrapped for her non-hazardous and demilitarized base materials in the form of 7.35 million pounds of steel, aluminum, and copper wiring along with galley equipment, fixtures, and furnishings, which included tables, chairs, lockers, and bunks. This disposition process was part of the largest green and zero-waste initiative by the U.S. Government. Since 2001, Government Liquidation has successfully partnered with the U.S. Defense Logistics Agency, reselling over 2 billion pounds of scrap material and returning revenue to the U.S. Treasury."

That's a lot of scrap, and total assets.

Public Sector Results Summary, to-date: (source: LQDT corporate website- www.liquidity.com )

-- $1.8 Bil.+ of government surplus sold/ -- 5,400+ government agencies selling on our marketplaces/ -- 580,000+ items sold for municipalities

Management also cites another example for potential of steady repeat business as the U.S. federal gov't. having a replacement need for 10-15k computers monthly.

Mergers and Acquisitions: Key part of strategy-enabled industry expansions into retail/chain stores, strengthened Wal-Mart relationship, added gov't. connections and expertise.

Oct. 2006: STR, Inc. (8.5 million all cash transaction)

Jan. 2008: GovDeals: ($10 million all cash transaction); Added initial base of

1,500 state, local & government clients; Added 2,300 new clients + increased GMV by 20% annually since acquisition

June 2010: Network International: ($15 million all cash transaction (including earn-out)

June 2011: TruckCenter.com ($9.0m up-front cost, addition like performance payments

Oct. 2011: Jacobs Trading Company: ($140 million asset-purchase transaction [cash, seller note, common stock]; potential for $30 million performance payments over 24-month period.

July 2012: GoIndustry-DoveBid plc.

November 2012: National Electronics Service Association (NESA): upfront payment of approximately CA$18 million in cash plus additional cash payments based on NESA's future revenues and earnings before interest, taxes, depreciation and amortization (EBITDA) performance 24 to 36 months after closing.

Weaknesses:

LQDT has stumbled recently, and has been downgraded by several firms, none of which have a "Sell" rating (no surprise). LQDT had implemented a growth plan to double GMV sold from $1.0 B. to $2.0 B by year-end 2016. This year so far, sales have been slow, and have slowed by roughly one-half of the stated projections and guidance. Since, as stated earlier, management's targets are GMV-based as the key driver of generating FCF, this hiccup has had an adverse effect on the integration and implementation of both the recent acquisition and integration of Canadian-based National Electronics Service Association (NESA), plus an expansion into S.E. Asia.

This has given pause to analysts, although I believe the company will be successful in both the integration and expansion, and LQDT has the scalability to profit on the capital flows, relocation and increased import/export trade throughout Asia. Also, LQDT has a good success record in tuck-in acquisitions. The one major exception to that was an untimely expansionary foray into Europe, right near the crest of the global recession. This was a key contributing factor to the one year in LQDT's entire operating history where it wasn't profitable (FY 2009).

Management longevity and their track record suggest the recent shortfalls will be overcome and surpassed, expressed by resumed stock outperformance, and my belief is that LQDT will have another ensuing burst of growth, most likely within the next 1-2 yr. range. These are the growing pains of a great growth company with ambitions and the knowledge and execution to expand in a volatile, currently curious, and ever-changing global and macro-economic world. May you live in interesting times!

I'd like to see LQDT plan to gain a larger foothold in commercial marine fleet and equipment, much as with the U.S. Naval fleet replacement and liquidation, as well as recreational watercraft. Wal-Mart is cited as a steady customer, with massive truck upgrades. Pending trends that suggest both bankruptcies and consolidation in marine fleets in the private sector will be an opportunity, and LQDT has extensive experience in selling the U.S. Navy's large fleet-type ships when they're decommissioned, so it has a developed potential buyers' market to call on, and scrap conversions and sales alone are profitable.

Expectations and Growth Strategy: Additional client and transactional safety, as well as customer communications and service improvement has caused adaptation of cloud-based options and mobile app user-friendly actions. This week, LQDT auctioned off 360 pieces of art from a "NYC Fortune 500 company collection." That may be a new revenue source that can be exploited. LQDT's logistics solutions have made such results commonplace for its clients, as greater store level controls & inventory management, reduced shipping & transportation costs, zero percent waste (green sustainability/recycling), due to an ability to sell 100% of asset dispositions. The reputational and network effect will leverage both repeat cross-selling and new customers. Procurement and fulfillment improvements will enable the company to be first on the short-list of partnering. LQDT is sticking to its focus on basics, increasing GMV, intent on doubling by Y/E 2016. LQDT expects the NESA deal to add approximately US$20 to US$25 million of annual Revenue and, excluding one-time deal expenses, to be $0.02 to $0.03 cents accretive to its fiscal year 2013 earnings results. It also adds customers and repair and refurbishment, and returns management services, a cloud-based transactional platform, and additional payment transaction methods. Provided LQDT can again normalize GMV and commensurate profitability and free cash flow, expect about one strategic acquisition per year, again relatively low-cost tuck-ins that will leverage both the customer base, core strengths in industry segments, and increased or new service options and infrastructure.

Analysts covering the stock still have high ratings, and a general "Buy" consensus, but there have been two downgrades, due to revised earnings and revenue decrease for the remainder of 2013. Short interest has risen in both the most recent 30 & 90 day periods. Short interest as a percentage of float is high, at 37.8%, as of May 31st, with an increase over 3% in the past month. Some technical indicators will show a buy only at the $20.50-22.00 level, because it's crashed through the 50 & 200 MA in a series of lower highs and lower lows, and in a channel that suggests support well down below here…..but I think the selling's largely done, and believe the $28.60-30.10 range will bring renewed buying as support. It has tested these levels as support twice since Jan. 31st, and is close to that range now. This $30.85-31.20 range looks like a good entry point to scale in.

I've owned shares since a month (and the first pullback) from its 2006 IPO date, and was able to sell amounts higher and buy back on pullbacks below my selling points, then bought big during Sep. 2008 thru Apr. 2009, I intend to buy on any general down day that's only 1-3% down from the $31.09 current price, and anything in the range given above will be a compelling valuation. My only regret was not pulling the trigger & selling some in the $55-66 range, but valuations got a bit ahead of themselves, hence the brief lofty level. My M.O. is to generally trade around core positions, with the only disadvantage is that good stocks sometimes don't go lower. I think that there's a promising future for this company, that the stock price will reflect that, and will do so in the next two years, unless other exogenous macro events reel us again. In that event, or in prolonged lagging performance with continued profitability, the $38.0-45.0 range seems fair, suggesting a potential appreciation in a range of 22-50%. Once a solid company with internal performance like this can reap the rewards of its global growth plans and ensure its fortress of niche strength and leadership, the stock will be hard-pressed to visit these valuations again.

Note: An update- Since price ranges in this article were based on Friday, June 14th at the close, Monday's open showed a drop into my near-term low price range of $30.74, then had buyer support-back into the current $31.29, with today's high so far at $31.71.

Disclosure: I am long LQDT, PFE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may initiate a position in Ross Stores (ROST), and am considering a long position in Ritchie Brothers (RBA).