Guy-Gottfried-Glentel-Supremex

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					Needles in a Haystack:
More Small Cap Values

      Guy Gottfried, Rational Investment Group
    (647) 346-0464 guygottfried@rationalig.com
Investment Idea: GLENTEL Inc. (TSX: GLN)




          Mobile Phone Retailer
Snapshot

         Recent Price                                                  Shares

             $14.75*                                               22.4 million




          Market Cap                                                   Dividend

         $331 million*                                       $0.50* (3.4% yield)

*All financial figures pertaining to GLENTEL are in Canadian dollars
Business Background
   Retailer of wireless products and services with operations in:
       Canada (WirelessWave, Tbooth Wireless, Wireless etc)
       US (Diamond Wireless, Wireless Zone)
       Australia (Allphones)

   Largest multi-carrier retailer in Canada and Australia,
    second-largest Verizon retailer in US

   Generates bulk of profits not from sale of phones but from
    payments from wireless carriers for signing up subscribers
       Commissions for plan activations/renewals, residual payments,
        stretch bonuses for meeting pre-set activation targets
Why is GLENTEL Worth Your Attention?

   Valued at 7.5x free cash flow (FCF) despite significant
    growth
        Investors receiving 13.3% FCF yield for business with
         meaningful growth prospects

   Management aligned with shareholders: substantial “skin
    in the game”

   Impressive record of capital allocation

   3.4% dividend yield while you wait
        History of double-digit annual dividend increases
Why is It So Cheap?

True earning power of business obscured by numerous items


   Important acquisition (Wireless Zone) closed in December
    2012 – only contributing for half a year toward trailing results

   Certain divisions making no money now yet still have value

   Several non-recurring items, confusing accounting
Numerous Non-Recurring Items and
Other Adjustments

   Corporate acquisition costs
   Start-up costs, initial operating losses for Target business
   Gain on disposition, bargain purchase gain on acquisition
   Full year of results for acquired subsidiaries
   Full year of interest expense for debt assumed to execute
    above acquisitions

Bottom line: it’s complicated – difficult for investment community
 to accurately assess GLENTEL’s normalized earnings and FCF
Arcane Accounting

   GLENTEL allowed management of some acquired subsidiaries to
    retain equity interest; these interests subject to put-call provisions
   Because minority shareholders can put their stake to GLENTEL,
    Canadian accounting rules (IFRS) require future obligation to be
    booked as “redeemable financial instruments” (RFI) liability
   Company must continuously mark-to-market RFI using host of
    assumptions (future earnings, when put option will be exercised,
    discount rate) with all changes running through income statement
   Further complicating things, these changes replace “non-controlling
    interests” (NCI) line in income statement (representing portion of
    subsidiary earnings attributable to minority owners)
Arcane Accounting
   To summarize, income statement includes one item that is
    neither economic nor reliable (change in fair value of RFI)
    and excludes one that is both economic and reliable (NCI)
   To adjust for this, investors must:
        Remove change in fair value of RFI
        Estimate NCI based on earnings/FCF of applicable segments
         and percentage not owned by GLENTEL
        To estimate segment earnings/FCF, need to further adjust
         results for unallocated G&A, amortization of intangibles

Most investors either do not grasp or are too busy (or lazy) to
        bother with all of these rules and adjustments
Shareholder-Friendly Management


   CEO Thomas Skidmore and his family (incl. brother and
    director Alan) collectively own 46% of outstanding shares

   Skidmores took control of GLENTEL in 1989 when it
    was manufacturer of communication equipment

   Excellent record of shrewd acquisitions, new retail
    relationships
Tbooth Wireless: Acquired in May 2005

    Canadian mall-based retailer bought from IT company
     that viewed it as non-core asset
          Business breaking even at time of purchase

    GLENTEL has expanded Tbooth’s store base from 49 to
     109, dramatically boosted profitability

                           Acquisition Valuation: Tbooth*
                              Cost                $16.7
                              FCF                 $6.0
                             P/FCF                 2.8

    *Amounts in millions
Diamond Wireless: Acquired in October 2010


    Mall-based retailer in western US

    GLENTEL’s grown store base from 132 to 201, another 154
     on way through new agreement with BJ’s Wholesale


                              Acquisition Valuation: Diamond*
                                  Cost              $63.2
                                  FCF               $12.5
                                 P/FCF               5.0


    *Amounts in millions. Acquisition cost adjusted upward for NCI since NCI expense not included in FCF.
Wireless Zone: Acquired in December 2012

    Street level-based retailer in eastern US

    Very recent transaction; considerable potential from
     leveraging GLENTEL’s operational and financial strength
     to accelerate growth
          Same formula successfully applied to Tbooth and Diamond


                         Acquisition Valuation: Wireless Zone*
                               Cost                $86.9
                               FCF                 $11.2
                              P/FCF                 7.8

    *Amounts in millions. Acquisition cost adjusted upward for NCI since NCI expense not included in FCF.
AMT (Australian Operation): Acquired in Nov. 2012

   Business struggling due to recent loss of major customer
   Historically solidly profitable
   Allphones brand highly recognized in Australia
   Provides beachhead into Southeast Asia; recently entered
    agreement to open up to 250 stores in Philippines
       AMT run by former head of Nokia’s mobile phone business in
        Indonesia and Thailand – well connected with regional carriers


Too soon to predict how this transaction will materialize
Relationships with Big-Box Retailers

   In late 2005, Costco agreed to let GLENTEL operate wireless
    kiosks within Costco’s Canadian stores under multi-year contract
   Driven by success of this relationship, GLENTEL recently reached
    similar multi-year deals with:
        Target Canada (124 stores)
        BJ’s Wholesale (154 stores)

   These agreements not only provide incremental FCF, but also
    enhance company’s share of carriers’ business and thereby
    strengthen its competitive position
Substantial Growth Potential
   New relationships not yet contributing to results: Target, BJ’s, Philippines
   Sizeable opportunity in US
        Store openings: Diamond not in east, Wireless Zone not in west; banners would
         not cannibalize each other due to differing models
        Incremental acquisitions: tuck-ins of smaller competitors (e.g. acquired two
         retailers with 18 stores in 2012)

   AMT: normalization of results in Australia, entry into additional
    countries in Southeast Asia
   Even in absence of expansion activity, simply using cash on hand and
    ongoing FCF (net of dividends) for debt repayment will provide boost


    These initiatives will result in meaningful growth for years to come
Assets Generating No FCF

   AMT: now incurring small losses due to aforementioned problems
      In long run, even if only returns to half of historical cash flow levels,
       would still have material value
      Philippines and rest of SE Asia could become major business

   Business segment: legacy operation from company’s early days
      Breaking even, not attracting management’s attention
      GLENTEL has begun to monetize this division: agreed to sell tower
        assets this year, expected proceeds of $10 million to $12 million

         Need to adjust for these assets in valuation of company;
          presently not making money but valuable nonetheless
FCF Multiple
                       Pre-tax income                              $37.9
                       Amortization of intangibles                    7.1
                       Gain on sale of assets                       (3.1)
                       Corporate acquisition costs                    3.4
                       Adjustment for Wireless Zone, AMT              8.9
                       Adjustment for non-controlling interests     (3.8)
                       Other                                          2.0
                       Taxes                                       (15.0)
                       FCF                                         $37.3
                       Per share                                   $1.66

                       Stock price                                $14.75
                       Value of AMT and business segment           (2.23)
                       Price excl. AMT, business segment          $12.52

                       P/FCF                                         7.5

              Attractive multiple even for stable business, let alone
                    for fast-growing company like GLENTEL

*Amounts in millions
Conclusion: GLENTEL


    Strong management and capital allocation



         Considerable growth potential



              Depressed valuation
Investment Idea: Supremex Inc. (TSX: SXP)




          Envelope Manufacturer
Snapshot

         Recent Price                                                   Shares

               $1.60*                                               29.0 million




           Market Cap                                                   Dividend

          $46 million*                                        $0.12* (7.5% yield)

*All financial figures pertaining to Supremex are in Canadian dollars
Business Background


   Largest manufacturer of envelopes in Canada

   60% market share, only player with national presence
    (seven plants in six provinces)

   Declining industry – volumes expected to drop at mid-to-
    high single digit rate
       Offset in part by aggressive cost-cutting; FCF has actually risen
        this year due to dramatic reductions in pension costs
Why is Supremex Worth Your Attention?


   Trades at miniscule 3.1x FCF

   7.5% dividend yield despite payout ratio of just 23%

   Lead investor incentivized to boost shareholder value in
    short term

   Potential major catalyst
Why is It So Cheap?



   Small, illiquid stock

   No conference calls, sparse coverage by one sell-side analyst

   Cut dividend by 90% a few years ago; shares have languished
    ever since
       Remain 75% below pre-crisis levels
Recent History


   In March, Clarke Inc. (45% shareholder) made preliminary offer
    to acquire rest of Supremex at highly depressed price
   In response, Supremex set up special committee and began
    negotiations with Clarke
   Parties unable to agree on price, called off talks in August
   This experience reduces risk of Clarke taking over Supremex
    without offering satisfactory premium
Debt Reduction

       113             98
                     (-13%)
                                       80
                                     (-18%)
                                                       60
                                                     (-25%)            53
                                                                     (-12%)              46
                                                                                       (-14%)




    Q3 2008         Q3 2009        Q3 2010         Q3 2011         Q3 2012            Q2 2013


Cumulative reduction of 60% in less than five years – debt-to-EBITDA
        ratio (key metric for lenders) now at reasonable 1.5

*Amounts in millions. Percent reduction for Q2 2013 represents 18% annualized drop.
FCF Multiple

        EBITDA                                                $29.6
        Interest                                               (2.5)
        Capex                                                  (1.5)
        Pensions: excess of cash contributions over expense    (5.4)
        Other post-retirement benefits: cash vs. expense       (0.1)
        Taxes                                                  (5.2)
        FCF                                                   $14.9
        Per share                                             $0.51
        P/FCF                                                    3.1


   Anomalously low valuation for company not in financial distress

*Amounts in millions
Catalyst: Material Dividend Hike

   Declining    businesses    with     limited   reinvestment
    opportunities and decent balance sheets should distribute
    as much cash flow as possible to shareholders

   Supremex has payout ratio of just 23%

   Insiders uninterested in wasting capital on acquisitions or
    capital-intensive growth projects

    Supremex can double dividend, yield 15% at current share
        price and retain ample room for debt repayment
Catalyst: Material Dividend Hike

   Clarke and its controlling shareholder, Geosam, have penchant
    for substantially raising dividends at investee companies

   Have done so at three controlled companies in past year,
    leading to significant share price appreciation for each

   With its takeover attempt having failed, Clarke now
    incentivized to maximize shareholder value at Supremex, tap
    into cash flow stream for redeployment into other
    opportunities
Performance at Clarke and Geosam Investees
After Large Dividend Introductions/Increases


                               Date Introduced/ Total Return: Next Total Return
                               Raised Dividend 10 Trading Days       To Today
       TerraVest March 2013                                              29.8%                        37.2%
       Bonnett’s May 2013                                                20.2%                        45.9%
       Clarke* August 2012                                               33.0%                        49.5%


     Implementing sizeable dividends is clearly an important part of
       Clarke’s and Geosam’s strategy for maximizing shareholder
           value; Supremex an ideal candidate for such a move

*Clarke has raised its dividend twice since instituting it. Figure in Total Return: Next 10 Trading Days column represents sum
of total returns following each of the three dividend introductions or increases.
Scenario 1: Double Dividend to $0.24/Share
(Assuming 12% Annual FCF Decline)
  0.50
  0.45
  0.40
  0.35
  0.30
  0.25
  0.20
             0.45
                                   0.40                  0.35
  0.15                                                                           0.31          0.27
  0.10
  0.05              0.24                  0.24                   0.24                   0.24          0.24
  0.00
                 Year 1                Year 2                Year 3                Year 4        Year 5

                                                 FCF per share        Dividend

                                     Aggregate dividends                         $1.20
                                     Percent of current price*                    75%
                                     Exit FCF yield                              17.0%
                                     Debt reduction                               35%
                                     Exit debt/EBITDA                               2.2

             Can sustain double today’s dividend (15% yield) for five years before
              payout ratio crosses 90% even with double-digit FCF decline rate

*Percent of price recovered ignores taxes and compounding on reinvestment of dividends.
Scenario 2: Maintain Constant 65% Payout Ratio1
(Assuming 12% Annual FCF Decline)
0.50         18%                                                                                                   20%
0.45                       16%
0.40                                     14%
                                                       13%                                                         15%
0.35
                                                                     11%
0.30                                                                                10%
0.25                                                                                             9%                10%
        0.45                                                                                               8%
0.20                     0.40
                                       0.35          0.31
0.15                                                                0.27          0.24         0.21                5%
0.10                                                                                                     0.19
0.05           0.29          0.26          0.23          0.20           0.18          0.16        0.14      0.12
0.00                                                                                                               0%
             Year 1        Year 2        Year 3        Year 4        Year 5         Year 6      Year 7    Year 8

                                       FCF         Dividends          Yield on current price

                                        Aggregate dividends                      $1.57
                                        Percent of current price2                 98%
                                        Exit FCF yield                           11.6%
                                        Debt reduction                            54%
                                        Exit debt/EBITDA                            2.2


                      Can recover entire investment in eight years (sooner if include
                           reinvestment of dividends) while cutting debt in half
 1Amounts    in bars represent dollars per share
 2Percent   of price recovered ignores taxes and compounding on reinvestment of dividends.
Additional Catalyst: Sale-Leaseback

   Company owns two manufacturing facilities in Toronto and Montreal

   In each of past two MD&As, Supremex has stated: “The Company is
    considering the sale of its two properties to lease them back”

   Canadian commercial real estate market still strong

   Sale-leaseback of these properties would likely generate pre-tax
    proceeds of approx. $20 million


    Sale-leaseback would enable Supremex to reduce debt by 35% to
          40%, greatly enhancing its flexibility to boost dividends
Conclusion: Supremex


                Exceptionally cheap


    Insiders with heavy ownership and desire to
         optimize shareholder value quickly


  Strong likelihood of major catalyst in near future
Two Very Different Investments,
But More Similar Than They Look

   One a multi-national retailer, the other a local manufacturer – yet both
    simple businesses
   One has growing earnings and cash flow, the other in structural decline
    – yet both clearly cheap
   Insiders focused on building business over long run at one, short-term
    value maximization at the other – yet both aligned with shareholders
   One highly acquisitive, the other shunning M&A – yet both have sound
    capital allocation


Undervalued investments come in many shapes and sizes; need to
be flexible and open-minded to uncover compelling opportunities

				
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posted:9/26/2013
language:English
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