Old School Value

Previously we looked at the business valuation of Mastech Holdings (MHH). To summarize, MHH is an IT staffing company in a competitive yet profitable industry. The macro environment has punished all staffing companies to the floor as companies continue to lay off people. MHH is a spinoff, a contrarian pick and a cheap stock all in one.

View the first stock analysis post on MHH. This post is all about analyzing numbers and valuation.

Spider Graph and Business Valuation Overview

Some opinions on the graph above

• Low risk: With a strong and healthy balance sheet, the risk of MHH going bankrupt and investors losing their money is very small. Current national unemployment rate is at 9.4% and I believe the jobless rate will decline more than it will increase in the future. Note that I did not say in a couple of months or this year. I’m talking over 1 year to be safe.
• High growth: Growth is dependent on the economy. Growth of job rates is the max it will be able to grow.
• Undervalued: Big margin of safety from different valuations. Continue reading.
• Well managed: In operation since 1986. Plenty of experience with the founders still running the company.
• Good financial health: Very healthy. Strong balance sheet.
• Strong moat: Shallow moat. Lots of competition. Anyone can enter the industry.

Financial Statement Analysis

Balance Sheet Analysis

• Mastech has a healthy balance sheet
• $1.55 in cash per share. i.e. 53% of share price is cash.
• No intangibles (WOW! I like)
• No long term debt
• Current debt not a problem. Current ratio of 2.51
• Net net value is $1.80 which means the company has lots of tangible assets making up the stock price
• No drastic changes in cash, accounts receivables or other balance sheet items from the past 5 quarters to set off any alarms.

Income Statement Analysis

• Gross profit margins in the 19% range. Good for a staffing company.
• Cost of Goods Sold (COGS) is very high at 80+% but other competitors around the same size is also in this range. Obviously has to spend to attract employees and earn business. Visa processing and legal fees obviously costs a substantial amount per employee.
• Small net profit margin of less than 4% average and 2.4% in the latest quarter makes it tough in bad economies.
• No new issuance of shares

Statement of Cash Flows Analysis

• Cash flow statement is clean
• Has a bad debt of $258k from not being able to collect receivables. Some of its financial clients went bankrupt.
• Generates positive cash from its operations. No need for debt. (Excellent)
• Organically creates FCF. No need to use EBITDA to try and inflate their numbers (Excellent)

Overall the financial statements are very clean, the business looks to be running smoothly without risk of going bankrupt in this tough environment.

Fair Value Calculations

Discounted Cash Flow (DCF) Fair Value

First using the discounted cash flow method. We see that MHH has been able to generate FCF for the first time as a standalone company in one of the worst years ever. Their history also shows how they have been able to generate cash while being a wholly owned subsidiary of iGate. With this, I’m confident that they will be able to generate more FCF in the future as well.

So to make some assumptions, I’ll use my FCF value of $3.8 million, assume 0% growth rate for the next 10 years and then a terminal rate of 3%. These are very conservative figures. Apply a 15% discount rate, I could use 20% as well but I don’t need to fiddle with the numbers.

• The DCF method gives me a fair intrinsic value of $9.40.
• 50% margin of safety means the buy price is $4.70
• 69% discount to current price of $2.90

Benjamin Graham’s Formula Valuation

This formula uses normalized earnings and with a 0% earnings growth rate, Ben Graham tells me that MHH is worth $3.77. If I were to apply a growth rate of 3.5%, which is basically the 10 year treasury rate;

• the fair value would be $6.21
• 53% discount to current price of $2.90

Net Net Working Capital Valuation

As I mentioned above, the net net value is $1.80.

When I calculate the net net value, I ignore property and all other assets except 100% cash, 75% of accounts receivables and 50% of inventories.

Multiples Valuation and Competitor Comparison

Competitors I am comparing that were mentioned in the annual reports:

• Analysts International Corporation (ANLY)
• Computer Task Group (CTGX)
• TSR Inc (TSRI)

Other value and Magic Formula staffing companies:

• Barrett Business Services (BBSI)
• Manpower (MAN)

Looking at all these companies side by side, I can’t help but see how much better MHH is.

• MHH PE is is at 3.6 while the average is 18
• Price to cash flow is a low 3.26 compared to average of 12
• Price to FCF is 1.86 compared to average of 5
• EV/Revenue (TTM) is 0.06 compared to average of 0.13
• Less of a decline in growth compared to all its competitors except CTGX
• Financially stronger than most
• Profitability is in line with competitors but profit margins are the best
• Excellent ROA, ROE, ROIC. Much better than competition

On ALL counts MHH performs and executes better than its competitors yet it is trading at a PE of 3.6 and this is even after it ran up 50% or so following its 1st quarter results.

If I was to assume a multiple of 10, which is still conservative, the fair value comes out to $8. Note that I am using their latest EPS with this multiple. I didn’t even bother factoring in how their earnings will definitely increase.

Also, the spinoff price was at $9 which is in line with everything I’ve written here.

See all the numbers for yourself in the spreadsheet below.
MHH Competitor Comparison Spreadsheet

Summary

No brainer.

Disclosure

I hold MHH at the time of writing.

I first mentioned Mastech Holdings (MHH) when I updated the results of the negative enterprise value screen. Mastech is not a net net value stock but after briefly analyzing the financial statements, I believe it to be within my circle of competence and margin of safety. There is also a limit to the downside. In other words, this is a cheap value stock idea.

Nevertheless, all fundamental analysis requires more reading and analysis to come up with a conclusion and fair value estimate. Like previous stock analyses, it will be broken to two parts. This one looking at the business, industry, risks and advantages and the second post will go over the various numbers.

I’ll start with a quick overview.

Spider Graph Overview

Business Summary

Mastech Holdings, Inc (MHH) is a provider of IT and brokerage operations staffing and consulting services to Fortune 1000 companies.

Mastech delivers a broad range of services within business intelligence / data warehousing, service oriented architecture, web services, enterprise resource planning & customer resource management and eBusiness solutions segments.

Mastech was established in 1986, has more than 2o years of operating history and was a wholly-owned subsidiary of iGATE but spun off from its parent on September 30, 2008.

The company managed to survive the dot com bust and retooled its recruiting model to focus on the recruitment of U.S. based IT talent which has allowed the company to access to a larger and differentiated recruiting pool compared to many of their competitors.

Growth Strategy and Competitive Advantage

The staffing industry as a whole is very fragmented with low barriers of entry and high competition. This means that there is no clear leader dominating the industry like Cola and Pepsi. The pie is big enough for everyone i.e. everyone has the potential to profit and stay in business although a moat does not exist.

In this type of industry, regardless of size, a company can steal or lose market share.

As for growth, I see it being dependent on a couple of things.

1. Stealing market share and contracts - Staffing is a service. It isn’t a product that can be sold internationally. An H1-B visa is useless outside the United States and a US staffing company isn’t likely to send their contractors to other countries.
2. Growth is entirely dependent on the economy - This is an investment that should be monitored along with the economy. When the economy is good, companies increase their business which will require additional employees whether they be permanent or temporary. With the nationwide unemployment rate being 10% at the moment, it is safe to say that the probability of economic growth is  higher than a depression.
3. Acquisition of companies - MHH has a healthy balance sheet and has the ability to acquire other companies.

One competitive advantage that MHH states in their 10-K is the following:

“Unlike most staffing firms that have a high concentration of either H1-B workers or W-2 hourly U.S. citizens, we have approximately a 50/50 composition of H1-B and W-2 hourly employees. As such, this balanced mix allows us to tap a broad candidate pool.”

I’m not quite sure how much of an advantage this is, since it should be easily replicated.

However, if you look at the numbers that I will go through later, MHH compares to a company 4-5 times its size. Their margins and profitability are higher than a number of their competitors which does prove they have an advantage. I just can’t see or pinpoint it.

Sales and Marketing

Mastech focuses their marketing primarily on large businesses with spending power and recurring staffing and software development needs.

MHH tends to spend “much of our marketing efforts are focused on increasing business with our existing accounts.” As you can see already, MHH is not a growth company.

The company does business through two business channels - wholesale and retail with most of the strategic relationships in this channel are established vice presidents and sales director.

“Wholesale channel consists of system integrators and other IT staffing firm customers …  Revenues from this channel represented 48% of total revenues in 2008.

IT retail channel focuses on customers that are end-users of IT staffing services.

Within the retail channel, many end-users of IT staffing services have retained a third party to provide vendor management services to centralize the consultant hiring process. Under this arrangement, the third-party managed service provider (“MSP”) retains control of the vendor selection and vendor evaluation process, which acts to weaken the relationship built with client contacts.”

Risks

1. Concentrated customers

IBM, Tek Systems and Wachovia Securities are the top three clients representing 14.9%, 12.7% and 10.7% of total 2008 revenues, respectively. If they lose even one of these clients, MHH will suffer huge setbacks.

However, with their history, expertise, broad talent pool and client relationship, this possibility seems to be small.

2. No Pricing Power

Because the industry is highly fragmented, MHH do not have the luxury of increasing prices without jeopardizing their business.

3. Immigration law

Immigration law is also another issue. There is a quota limit to how many H1-B visa’s can be issued each year and it fills up very rapidly. The good thing is that Mastech focuses on employing people in the US already with a H1-B visa.

4. Dependent on Economy

Mastech’s business is directly correlated to the economy. i.e. buy the stock when the economy is bad and sell when things are doing well.

5. Margins and profits will suffer if the trend towards Managed Service Providers (MSP) continues. Managed Service Providers are employed by bigger companies and act as the middle man to handle the negotiation and hiring of contractors. More companies have been using this business model which means that a direct and close relationship will be hard to maintain.

6. MHH also operates internationally to recruit talent which introduces currency risk.

7. Mastech hold several “preferred vendor” contracts which provides business volume although the margins are smaller. If they were to lose their preferred status, they would see a drop is revenue.

8. Co-founders of iGate, Sunil Wadhwani and Ashok Trivedi, hold 57% of MHH common stock. If they are shareholder orientated, great, if not, even an wolf activist Bill Ackman won’t be able to do anything.

To be continued

The next post will focus on the financial statements, fair value calculations and other number discussions. Stay tuned.

Disclosure

I hold MHH at the time of writing.

ValueVision Media Inc (VVTV) released their Q1 results on the 19th after hours and the conference call was held today on Wed May 20th. There was a lot going on with VVTV this quarter and my previous overly pessimistic attitude about its retail business has now changed. As VVTV starts or continues to turnaround, this cheap company really is one of the best stocks under $1.

VVTV Spider Graph Quick Overview

First Quarter Highlights

All the highlights and operation results can be read from the original press release.

GE Preferred Stock

The big obvious ones worth mentioning was that VVTV managed to negotiate its preferred stock with GE.

Negotiated with GE to restructure and extend the majority of its payment obligation of $44.3 million Series A preferred stock by five years. This extension provides the company with the time, flexibility and financial resources to execute the turnaround of its business. The impact of this transaction on the financial statements for the quarter include a $3.4 million cash payment of principal, interest expense of $743,000, and the newly issued Series B preferred stock with a valuation of $10 million on the balance sheet.

This was not that good of a deal for VVTV but they needed the extra time which is what they got. When I reflect a few months back regarding the restructuring of preferred stock, I realize the short term may not be so good, but the long term is much better with the deal rather than no deal and having to pay out a large cash redemption.

Cable and Satellite Distribution

The company stated that it expects to preserve 100% of its footprint [72 million homes], and with regard to negotiations completed to date, it expects to realize a 33% rate reduction. This is expected to result in a cost savings in the range of $22 million to $25 million in fiscal 2009.

A 33% rate reduction is a huge drop from its current levels. It isn’t enough to suddenly make VVTV profitable or ultra competitive, but it does allow VVTV to test new products.

Although VVTV will not be FCF positive anytime soon, the decrease in $22-25 million will make a big difference once it starts to take effect.

Insider Buying and Share Buy Backs

VVTV bought back 1.6 million shares for $900,000 at an average price of $0.58 per share which is around the price I first started buying. Although $900,000 isn’t a large sum, it’s finally good to see them increasing shareholder value.

The CEO insider buying has also been very positive with buyback prices ranging from the $0.20’s to $0.70’s.

Conference Call Notes and Thoughts

On a side note, a hunch I have about this CEO is that he is determined to see the company turn around. Although he was reading off a prepared statement, I felt that he knew what had to be done and how it was going to be done in a cool and collected manner.

Here are my thoughts on specific topics I was keen on.

Margins Increase Strategy

• Current gross margins creeped over 30% this quarter but management is not satisfied. They are working towards a consistent gross margin of mid to high 30’s [35%-38% ish?]
• Shifting product mix around. When I first started following VVTV it was all about the asset play. I was skeptical about its strategy to change up its product portfolio but they have shown, with numbers, that the strategy is beginning to work.
• Margins will slowly move up as Q3 and Q4 approaches as predictable sales increase.

Re-order Business, Predictability of Sales and Product Mix

• VVTV is trying to increase repeat sales. A strategy of getting the consumer to re-order items rather than selling one time high price products such as consumer electronics where the margins are only in the mid 20% range.
• Additionally, an improved re-order business will provide some predictability in revenue with fewer markdowns since they do not have to test which products sell well or not. This should also reduce operating costs driving up the margins higher.
• Electronics are low margin one time purchases so VVTV is trying to diversify into more predictable products.
• The problem with the current model is having to introduce new products constantly to generate sales. This introduces risk since the products have to be either returned or marked down and sold if it doesn’t sell well. These non selling products also take up airtime which could be better used for popular products.

Inventory

• I was surprised that VVTV used drop shipping method to store inventory. Drop shipping is where the retailer does not keep stock but transfers the order details to the wholesaler or manufacturer. The good thing with this supply chain management technique is that it will keep inventory low but to truly maintain a healthy and reputable retailing business, I believe drop shipping isn’t the answer.
• VVTV will now keep inventory in their warehouse rather than drop shipping now. (Good!) This move should turn out to be efficient and cut some additional costs.
• They also mentioned that their current inventory levels are at their 6 year low so in the next quarter, they will be doubling the amount of inventory to keep up with sales and to transfer to the inventoried supply chain management technique. With their inventory turnover slightly above 7, VVTV is doing an excellent job of churning inventory.
• VVTV has also informed their suppliers that they will  be extending payment due dates by 15 days.

In the beginning of my investment with VVTV, I placed no hope on the retailer, but with new leadership and direction, it seems like the strategy VVTV is implementing is working. Strong insider buying, stock buy backs at cheap prices and numbers showing that their new strategy and focus is working keeps VVTV as the best stock under $1 in my books.

Disclosure

I hold VVTV at the time of writing.

On April 29, iGo Inc (IGOI) announced earnings that were better than I expected considering they had previously lost their biggest customer, Targus. However, earnings wasn’t the number I was focusing on. It’s the assets I care about the most because this is a deep value stock investment.

For people new to iGo Inc, you can refer to the first stock analysis of this very interesting idea. The 10-Q hasn’t been filed on Edgar yet so I am basing my thoughts on the 8-K (the press release).

Quick View Business Valuation

(click to enlarge)

With the latest numbers entered into the free net net investing spreadsheet above, the liquidation value of IGOI remains at $0.96. The close price today was $0.74 (ignore the $0.65 price on the image, it was created last night…) leaving a 23% discount to its liquidating price. With operations generating cash, the downside is very limited.

Brief Income Statement Analysis

• Revenue and gross profit down from last year but this was expected and the numbers are not that bad.
• SG&A far too high for my liking at 40% of revenues.
• Didn’t receive any other income from litigation or from interest which is good. This way I can good indication of how profitable it can be.
• If the other income is ignored from the 2008 income statement, the total net loss is very similar to this years result. Not bad considering everyone else is losing money down the drain.

Brief Balance Sheet Analysis

• Increased cash: great
• decrease in short term investments by about 50%. Either they lost it or converted it back to  cash for operations. (only bad point I see at the moment)
• Accounts receivables slight increase.
• Slight increase. Not by much so inventory management is steady.
• Overall, a very slight decrease in assets due to the drop in short term investments.

Brief Statement of Cash Flows Analysis

• The 10-Q isn’t available yet so no comment for now.

Overall, nothing alarming jumps out like the way other net nets burn through cash and the way the conference call went was also encouraging. It seems like management is planning some moves to try and increase shareholder value. I’ll have to listen to the conference call again to get a better indication of management trustoworthiness.

See the pdf below to compare the past 5 Q1 financial statements, excluding this quarter.

IGO Inc IOGI Q1 past 5 year quarterly statement Numbers

Summary

• IGOI has done remarkably well considering the huge hurdle it faces in attracting new customers to overcome the Targus loss.
• By valuing the assets of the business, the liquidation price still remains at $0.96. i.e. This is the minimum price it ought to be selling for.
• Strong balance sheet
• Cheap!

Disclosure

I own shares of IGOI at time of writing

The DISK merger has been terminated again but before the announcement, a reader, PlanMaestro, left a very detailed analysis of the company as a standalone and I felt it was a waste to leave it in the comments. If you follow his calculations, you’ll get an understanding that the company is cheap.

[Regarding DISK] Up to this point, I wish I had been just a spectator of this circus; instead I have been one of the company clowns. Well, here are my thoughts, including an amateur try to valuate Image Entertainment:

1. Probability of Closing: This deal is almost a perfect example of Knight’s uncertainty so I won’t dare to throw a guesstimate. It could be anything. However, uncertainty is our friend because it scares momentum players and arbitrageurs. I would say that at this moment most of the big shots are long gone.

And what weapon do we have small players have against this uncertainty? Klarman’s golden glove to catch falling knives: margin of safety

2. Margin of Safety: Most people buying DISK do not even know what they are buying. They just see recent sell-offs and use that as a proxy for downside risk.

Since when we value investors trust Mr. Market? Especially since film libraries are assets that time and again are being underestimated by our bipolar partner. P/E ratios lack accounting of the heavy non-cash depreciation and amortization expenses, And M/B ratios usually undervalue the library because it is not marked to market.

At the same time the library has some particularly favorable economics:

• Growth potential across formats and internationally with marginal investments
• Low maintenance CAPEX
• Steady royalty cash flows

In other words, they are the perfect LBO or acquisition target. The only problem is the risky film production. But once you have the rights, no sweat! Buffet likes, or used to like, newspapers. I like film libraries.

I prefer to use equity free cash flow and in this case, EBITDA is a good proxy for FCF because of the low maintenance CAPEX. And because of the steady cash flow, compared to real estate for example, a multiple of EBITDA is a good estimate of asset value.

VALUATION Q3 2008

I used Q3 numbers because the company has changed for good in a hostile financial environment.

• Expand theatrical distribution rights to higher-profile feature films.
• Conservative prints and advertising expenditures to cap risk in the event of theatrical failure and greater focus on the rental marketplace
• Acquire “direct-to-video” content and distribution opportunities from the closing of the independent and specialty divisions of major studios
• Reduced distribution expenses through agreement with Arvato for replicating, warehousing and fulfilling retail orders

I did not include working capital in the valuation because it was very volatile quarter to quarter. If someone has insights into that, they are very welcomed

Earnings from Operation: 2.0 million
Amortization and Depreciation: 1.8 million
Interest Expense 0.9 million
- Taxes 0.0 million
Other Expenses: 0.8 million (just in case, mainly $561,000 M&A)
EBITDA: 3.9 million per quarter, 15.6 million annually

4x EBITDA 62.4 million (a low multiple even for industrials)
-  Debt: 20.3 million

Value Standalone: 42.1 million
Market Cap: 31 million
Margin of Safety 27%

Another way of thinking about this is trying to estimate the rate of return for the un-levered firm. For that I am going to assume a conservative 30% tax rate given they NOL carryforwards.:

EBITDA 15.6
After tax free cash flow 10.9
Enterprise value (Market Cap + Debt) 51.3
FCF / EV yield 21.2%

That is right, a wide moat business with an un-levered 21.2% annual rate of return after taxes. And consider that international and digital is less than 4% of current sales, 2.5 M USD in cash from the escrow release, no value added from potentially being acquired player with global distribution, and short term catalyst at twice its current price.

In my opinion it looks very compelling even if the deal does not close … if it would survive maturities, covenants, capital requirements to finance working capital and a blundering management.

One point that PlanMaestro and a few of us have discussed over twitter is the lack of interest and enthusiasm shown by Wall Street for media companies. Note that it took Seth Klarman’s big stake in RHIE to drive the price up.

It’s also possible to compare business models of Disney with DISK. They both own exclusive rights to movie titles which doesn’t require any capital expenditure to maintain. Receiving royalties for its assets is also an excellent source of revenue and we can see how they have a consistent stream of revenue. Although Disney is on a different scale, you get the idea of the business.

What surprised me more today was that I was fully expecting it to drop to the mid to low 80c range but it rose back up to end the day above $1. I think it’s because people are speculating that Nyx will return to the table or another company will come along with an offer.

In the meantime, I will continue to study the company and update my thoughts throughout the comments and twitter.

Disclosure

I own shares of DISK at time of writing

Todd Sullivan of Value Plays recently posted some retail numbers and discussed Sears internet presence. However, I noticed it included numbers for ValueVision’s (VVTV) competitors QVC and HSN so I went to the source of data to try and find some more information.

From the list we can see that QVC.com is 7th and HSN.com is 13th. To my disappointment, VVTV i.e. ShopNBC.com is not on the list. Considering all three businesses have similar product mixes, cable channels close to each other and websites looking and feeling similar, I am curious as to why shopnbc.com didn’t break the top 20 list.

When I first wrote about VVTV, I mentioned that retail is a tough business and I didn’t really feel their shopping website was as valuable as it seemed. I wasn’t taken in with the whole concept of “shop as you watch a video presentation” experience since it is distracting, time consuming and difficult with a slow internet connection. So when I checked back in to the ShopNBC shopping website today after a few months, I was glad to see the site redesigned. No more bandwidth hogging, time consuming and dominating videos. It now looks very similar to the other websites.

For VVTV, it is just a matter of gaining some online retail presence to support its home shopping business. If VVTV can market its way into the top 20, that’s when I’ll start getting excited about future aspects. We’ll also have to wait and see whether the negotiation in carriage contracts with the cable companies will improve margins in the home shopping side.

An obvious point at this time is that there is no way anyone can dethrone Amazon from its dominating number 1 position for now. I’m not hoping VVTV becomes number 1. I’m just hoping it can somehow break the top 20 online retailers.

Disclosure

I own shares of VVTV at time of writing