2 Different Valuation Models Say ITEX Worth 81%-119% More Than Current Price

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About: ITEX Corporation (ITEX), Includes: AMZN, EBAY
by: William Matson, CFA
Summary

ITEX is a countercyclical business hurt by booming economy, nevertheless able to consistently grow Operating Income despite declining revenues.

Enterprise Value/Trailing 12 Mo. Operating Income After Tax is currently 4.1x. Raising this ratio to 10x implies $8.02 per share valuation for ITEX.

Based on 2015 buyout price adjusted for decline in number of shares outstanding, growth in Operating Income, and lower tax rate, value of Operating Income stream has grown 194%.

Subtracting declines in Working Capital and Tangible Long Term Assets from value of Operating Income stream implies $9.68 per share valuation.

ITEX's Business, Target Markets, and Countercyclicality

In terms of market value, ITEX is America's largest publicly traded barter marketplace. The company makes its money by facilitating barter transactions between its thousands of members, generally charging them (in effect) a fixed $390 per year membership fee plus (typically) a 12% fee on transactions executed. 1/3 of the membership fee is payable in ITEX Dollars, the company's proprietary trading currency, which is pegged to one U.S. dollar (USD) and serves as the medium of exchange for all transactions between members. Half of each transaction fee is paid to ITEX (in USD) by the buyer and half (also in USD) by the seller. ITEX administers this marketplace, providing members with recordkeeping and payment transaction processing services. A network of approximately 100 brokers in the U.S. and Canada recruits new members and facilitates transactions between existing members.

Aside from helping cash strapped businesses obtain essential goods and services with alternatives to cash payment, ITEX is most useful to businesses that sell perishable/wasting items (e.g. hotel accommodations), hold excessive or stale inventory (e.g. retailers), or earn profit margins significantly greater than ITEX's fee (e.g. doctors, lawyers, and accountants).

Individuals are also welcome to join and may find that ITEX provides a convenient market for their personal services, as well as complementing their trading activities in venues such as Amazon and eBay. For $1.07 a day (i.e. $390 per year), Amazon and eBay traders can benefit from access to deals offered by the thousands of participants in ITEX's member network.

The directory at ITEX - Member Directory provides a comprehensive list of goods and services and the members who offer them - over 400 pages at 50 listings per page in 30 general categories. Maintaining this large network of members geometrically increases the opportunity for barter transactions to be successfully executed.

As is the case with barter in general, ITEX's business is countercyclical. In booming economies, the volume of business done through ITEX tends to decline. Businesses become less focused on conserving cash, hotels have fewer vacancies, retailers' inventories turn over more quickly, and service professionals have less idle time to fill. Not surprisingly, when economic booms create new jobs, some individuals accept these jobs and reduce (or abandon) their online trading in the sorts of items offered by ITEX members. Thus, ITEX's revenues are likely to decline in strong economies and rise in slow economies.

Assuming that S&P 500 returns are an appropriate indicator of economic strength, that has, indeed, been the case. Starting in ITEX's FYE 7/31/07 (the second full year following its acquisition of the BXI Exchange), the company's revenues have risen in both years that the S&P 500 fell (i.e. during the years ended August 1, 2008 and 2009).

During the ten years the S&P 500 rose (i.e. those ended August 1 of 2007, as well as of 2010-2018), ITEX's annual revenues declined nine times. Moreover, ITEX's trailing twelve month (TTM) revenues through April 2019 ($9.1 million) were roughly 7% below its FYE 2018 figure ($9.7 million), while the S&P 500 was rising from 2901.50 to 2932.47.

In other words, ITEX's revenues have moved counter to the S&P 500 in 11 ¾ years out of the last 12 ¾, giving reason to believe that they will increase when the economy slows down, as it inevitably must. In the meantime, however, ITEX continues to squeeze surprisingly strong operating profits from its declining revenues.

2006

2007

2008

2009

2010

2011

2012

Revenues

$14.6

$14.2

$16.0

$16.5

$16.9

$16.4

$15.8

Operating Income

$1,341

$1,505

$1,501

$1,027

$1,674

$1,103

$1,110

S&P 500 @ 8/1

1287.15

1454.62

1281.47

1009.73

1087.28

1185.31

1403.45

TTM

2013

2014

2015

2016

2017

2018

2019

Revenues

$14.8

$13.5

$12.0

$11.1

$10.2

$9.7

$9.1

Operating Income

$1,464

$849

$957

$1,228

$1,071

$1,262

$1,206

S&P 500 @ 8/1

1670.09

1961.53

2039.87

2170.95

2456.22

2901.5

2932.47

Revenues in $000,000's are shown for FYE 7/31, except for 2019

Operating Income in $000's are shown for FYE 7/31, except for 2019

2016 Operating Income does not include Goodwill impairment charge

2019 Revenues and Operating Income are shown as of 4/31 for trailing 12 months

2019 S&P 500 is shown as of 5/1

ITEX Valuation Based On Price/Earnings Multiple Of 10x

As the spreadsheet below indicates, one estimate of ITEX stock's "true" economic value is $8.02 per share.

Valuation Estimate

Based On 10x P/E

Shares Outstanding (including restricted)

1,681,568

times: 7/5/19 Share Price

$4.43

=Market Cap

$7,449,346

less: Cash

$3,670,000

=Enterprise Value (EV)

$3,779,346

Trailing 12 Mo. Operating Income

$1,206,000

times: 100% Minus Assumed Tax Rate Of 23%

77%

Trailing 12 Mo. Operating Income After Tax

$928,620

Current EV/Trailing 12 Mo. Operating Income After Tax

4.1

If EV/Trailing 12 Mo. Operating Income After Tax = 10x

10

times: Trailing 12 Mo. Operating Income After Tax

$928,620

= Value Of After Tax Operating Income Stream

$9,286,200

add: Cash

$3,670,000

ITEX Value (ex Deferred Tax Asset and Pre Dividend Payment)

$12,956,200

less: Dividend Payment

$208,000

plus: Deferred Tax Asset

$738,000

ITEX Value

$13,486,200

divided by: Shares Outstanding (including restricted)

1,681,568

ITEX Value Per Share

$8.02

In estimating the company's value it is essential to realize that it is a relentless gusher of cash. Because ITEX could literally operate with whatever is in its petty cash drawer, only a nominal portion of its current $3.67 million cash hoard should be considered essential to its day-to-day operations.

To appreciate the significance of this, imagine you are a very small time corporate raider interested in acquiring ITEX. The company's market cap is $7.4 million and you're hoping to buy it for $9 million, but between your own cash and available credit you only have $7 million.

Not a problem. Since ITEX has no debt, and its day-to-day business can get along just fine without the $3.67 million in cash, these funds can be (in effect) added to your $7 million war chest. At a price of $9 million, you could buy over 40% of ITEX with its own money!

The concept of "Enterprise Value" proves quite useful in situations like this, as it represents the total of all claims upon a company's assets - minus whatever cash the company has in excess of what it requires in order to function. Common stockholders' claims are represented by market cap. The value of preferred stockholders' and lenders' claims is also factored in. But the value of non-cash short term items that arise during the daily course of business, such as accounts receivable and payable, generally is not - as these accounts tend to roll over on a consistent basis and are rarely zeroed out in going concerns.

Add up the claims, subtract the excess cash, and you're left with Wall Street's implied valuation of the business's operations. In the case of ITEX, the implied valuation is about $3.8 million.

Without some context, we can't know whether this is too much, too little, or somewhere in between. So we turn our attention to the earning power of these operations and see that it was a bit over $1.2 million during the past 12 months, which equates to around $929,000 after tax (using ITEX's recent 23% tax rate).

Because of ITEX's cash hoard, any analysis using a Price/Earnings (P/E) ratio based on market cap (the usual method) would be misleading. Instead, Enterprise Value should be the "P" in Itex's P/E, with Trailing 12 month Operating Income After Tax being the "E".

Running the numbers in this manner gives ITEX a P/E of 4.1x. This is clearly far too low, given the consistency of ITEX's operating income in recent years. And especially in view of the S&P 500's P/E, which currently sits at 22.25x.

Though a P/E of 10x is still far below the market norm - even for illiquid microcap stocks like ITEX - that is the major judgment call on which my valuation of $8.02 is based.

Applying the 10x P/E multiple to after tax operating income and adding back cash brings us to a valuation just under $13 million, from which we subtract the $208,000 in dividends paid subsequent to April 30 and add in the $738,000 value of ITEX's deferred tax asset.

Annual

Reciprocal

Compounded

Present Value

Tax Asset

Annual

Of Annual

Annual

Of Tax Asset

Monetization

Discount

Discount

Discount

Monetization

Year

(in $000's)

Factor

Factor

Factor

(in $000's)

2019

85.11

1.075

0.9302326

0.930232558

79.17209302

2020

170.27

1.15

0.8695652

0.808897877

137.7310415

2021

170.27

1.15

0.8695652

0.703389458

119.766123

2022

170.27

1.15

0.8695652

0.611643007

104.1444548

2023

170.27

1.15

0.8695652

0.531863484

90.56039547

2024

170.27

1.15

0.8695652

0.462489986

78.74816997

2025

170.27

1.15

0.8695652

0.402165205

68.47666954

2026

170.27

1.15

0.8695652

0.349708874

59.54493004

Total

1277

738.1438773

In arriving at a $738,000 present value for the tax asset, I assumed that its current $1,277,000 balance would be monetized evenly during the next 7.5 years, and I discounted the resultant cash flows (i.e. from reductions in taxes paid) at a compounded annual rate of 15%. For the sake of simplicity and erring on the side of conservatism, I also assumed that these cash flows are realized only at calendar year end (rather than quarterly, when corporate taxes are actually due).

Our grand total valuation for ITEX is $13,485,200, which is divided by 1,681,568 shares outstanding to give us a per share valuation of $8.02.

Valuation Based On Developments Since 2015 Buyback

ITEX's $4 per share buyback in 2015, along with important developments since that time, provide a useful point of reference from which to assess the company's current value.

It is noteworthy that, although this buyback was oversubscribed, only 6.5% of the three largest shareholder's holdings were tendered (75,000 of Steven White's pre-tender 627,184 shares). The Lion Fund and Pagidipati Family held on to all of their 340,840 and 183,478 shares, respectively. Smaller shareholders, meanwhile, tendered 810,741 of their 1,695,000 shares (47.8%), causing the buyback to be oversubscribed - as only 750,032 shares were accepted.

Inasmuch as the three largest shareholders, who presumably were in an advantageous position to assess ITEX's value, tendered very little of their stock, I believe that the "fair" value of ITEX shares was substantially more than $4 per share at the time. This belief is also supported by the smaller shareholders, who tendered less than 50% of their stock. Overall, more than two-thirds of the company's stock (68.9%) was not tendered. For conservatism's sake, however, this valuation analysis will assume that $4 per share was ITEX's "true" value.

Between 1/31/15 and 4/30/19, three important developments greatly increased ITEX's "true" value - something that Wall Street failed to notice:

  • Shares outstanding declined from 2,645,000 to 1,681,568. Other things being equal, this would have caused each share's value to increase by 57% (2,645,000/1,681,568-1=.57).
  • Trailing 12 Month Operating Income grew from $754,000 to $1,206,000, a 60% increase.
  • ITEX's tax rate declined from 34% to 23%, a development that was not reasonably foreseeable in early 2015 and which allowed 17% more of ITEX's Operating Income to reach the bottom line (i.e. [1-.77]/[1-.66]-1=.17.

As the spreadsheet below indicates, multiplying these three factors together suggests a 194% increase in ITEX's value per share (from $4 to $11.74) prior to adjustments for changes in balance sheet items that remain to be made.

Adjustment

Cumulative

1/31/2015

4/30/2019

Factors

Adjustment

2015 Tender Price

$4.00

Shares Outstanding

2,645,000

1,681,568

1.57

Operating Income

$754,000

$1,206,000

1.60

Tax Rate

34%

23%

1.17

2.94

Cumulative Adjustment x 2015 Tender Offer Price

$11.74

times: 4/30/2019 Shares Outstanding

1,681,568

Valuation Estimate Before Adjustments For Balance Sheet Items

$19,742,785

Adjustment For Reduction In Working Capital Balance

-$711,000

Adjustment For Reduction In Tangible Long Term Assets

-$2,762,000

ITEX Valuation Estimate

$16,269,785

ITEX Valuation Per Share Estimate

$9.68

Our next step is to multiply the $11.74 by the 1,681,568 outstanding shares to arrive at an interim valuation for the entire company (i.e. not including adjustments for changes in balance sheet items). The resultant $19,742,785 figure is then reduced by changes in a) working capital balance ($711,000) and b) tangible long term asset balance ($2,762,000). This leaves us with a $16,269,785 valuation for the entire company, which equates to $9.68 per share.

Implications Of ITEX's 2019 Tender Offer

On March 4, 2019, ITEX made a tender offer to buy back 527,779 shares of its stock for $4.30 per share. As the table below indicates, only 427,446 shares were tendered. Inasmuch as the stock had traded at $4.40 immediately before the offer, this 19% undersubscription was not surprising and failed to inspire much movement (either up or down) in ITEX's stock price.

Shares Outstanding

Pre-Tender

2,109,014

Shares Tendered

427,446

Shares Outstanding

Post-Tender

1,681,568

Tender Offer Size

# Of Shares

527,779

@$4.30/Share

Undersubscription %

19.0%

Before

% Owned

After

% Of

Tender

Shares

Tender

ITEX

Owned

Tendered

Tendered

Owned

Owned

CEO - Vested

564,430

161,798

28.7%

402,632

23.9%

CEO - Unvested

76,000

-

0.0%

76,000

4.5%

CEO - Total

640,430

161,798

25.3%

478,632

28.5%

Other Directors

& Officers

74,700

54,700

73.2%

20,000

1.2%

Other Control Persons

Lion Fund

340,840

-

0.0%

340,840

20.3%

Pagidipati Family

183,478

59,249

32.3%

124,229

7.4%

Other Control - Total

524,318

59,249

11.3%

465,069

27.7%

Other Shareholders

869,566

151,699

17.4%

717,867

42.7%

Totals

2,109,014

427,446

20.3%

1,681,568

100.0%

Nevertheless, a variety of inferences - primarily bullish - may be deduced from the tender offer's results. The headline, of course, is that everyone who wanted to sell their ITEX shares for $4.30 was able to sell as many as they wanted back to the company.

One might still wonder, however, why anyone would want to sell stock for 10 cents per share less than its going market price.

Uppermost among these reasons is the illiquidity of ITEX's stock. Anyone needing to sell more than a few hundred shares on a single day is likely to drive the stock's price down by several percent. And the hurried sale of a couple thousand shares might well lower it by 10% or more. Thus, many of those desiring to sell several thousand shares in the short term would no doubt have been willing to accept a 10 cent haircut as a fair price for the liquidity provided by ITEX's buyback offer.

ITEX executives (including Steven White, the CEO) may also have been motivated to sell the company's stock by diversification considerations. Though selling by employees can sometimes be a harbinger of bad news, it is more often a prudent means of reducing the correlation between their investment portfolios and their employers' fortunes. The risk inherent in this correlation is magnified when the employer is as small as ITEX and its stock is highly illiquid.

Though the company's CEO tendered more stock in this year's buyback than any other shareholder, it is notable that his stake in ITEX has risen from 21.1% to 28.5% since July 2014. I see this as evidence that his recent sales are more likely to be associated with a long term, diversification-oriented financial plan than with pessimism regarding ITEX's prospects.

Similarly, I suspect that the Pagidipati Family tendered 32.3% of its shares in seeking greater diversification, rather than being motivated to avoid negative developments at ITEX. Had the family lost faith in the company, there was nothing to stop them from tendering 100% of their stake. Note also that their ownership of ITEX has increased from 6.4% to 7.4% since mid-2014.

The Lion Fund, ITEX's second largest shareholder (second only to Steven White), tendered no shares at all. This vote of confidence is especially meaningful in view of Lion Fund's familiarity with ITEX. During the past five years, the fund's stake in ITEX has risen from 11.9% to 20.3%.

Smaller shareholders (other than ITEX executives) tendered just 17.4 % of their shares, raising their ITEX ownership to 42.7%. Having demonstrated that they are in no hurry to sell, I don't expect the remaining shareholders in this group to participate anytime soon in any buyback that does not involve a significant premium to the market price (e.g. a $5.50 offer if the stock is at $4.43).

Given the solid case that can be made for an $8 valuation, whatever stock that can be bought back at $5.50 (or even $6.50) would benefit ITEX and the shareholders who continue to hold on. In other words, if ITEX's stock is worth $8 and the company pays $5.50 each to buy back 100,000 shares, that is the equivalent of earning $250,000 tax free as far as ITEX and its remaining shareholders are concerned.

Valuation Summary

Valuation Based On Price/Earnings Multiple Of 10x: $8.02

Valuation Based On 2015 Buyback Price, Adjusted For Subsequent Operating Results: $9.68

Likely Buyback Price: $5.50-$6.50

Risks Faced By ITEX Stockholders

There are a variety of risks associated with owning ITEX stock. Among them are:

  • reliance upon the continued efforts of its broker network,
  • reliance on a small number of key employees, especially the CEO, Steven White, who is in his early 60's,
  • the possibility that revenues will continue to decline,
  • the possibility that new or existing competitors in the ecommerce space will lure business away from ITEX and/or cause its profit margins to decline,
  • the possibility that new regulations adverse to the barter industry will be adopted, and
  • the illiquid nature of ITEX stock, which is likely to result in large losses if investors seek to sell their positions quickly.

Disclosure: I am/we are long ITEX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: ITEX is a highly illiquid microcap. Anyone attempting to sell more than a few hundred shares at a time is likely to incur sizeable losses.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.