CWL.TO - Caldwell Partners International

[matts]

Hi All,

 

I just posted a thesis on this company on SA. Would appreciate any feedback.

 

https://seekingalpha.com/article/4218710-caldwell-partners-underfollowed-5_7-percent-dividend-payer-short-term-catalyst

 

 

Thanks

 

 

[flesh]

Nicely done. I'll look into it over time, don't have the bandwidth to get it in before earnings. Good luck.

[matts]

Thanks Flesh. Not easy to digest a new idea and make a decision with only a couple of days before earnings. The editorial process at SA took 2 days longer than i anticipated, probably because it was my first submission.

[writser]

fwiw it was also written up on a blog a while ago (maybe it's yours): https://pettycash.blog/2018/08/03/caldwell-partners-tse-cwl/ . Will put your article on the to-read stack :P .

[matts]

fwiw it was also written up on a blog a while ago (maybe it's yours): https://pettycash.blog/2018/08/03/caldwell-partners-tse-cwl/ . Will put your article on the to-read stack :P .

 

I was not aware of the blog post. I'll check it out. Thanks!

[Guest Schwab711]

Nice summary writeup matts.

 

Do you know why does the opportunity exist? On a quick review, it looks like they increased business in Europe in FY2016 and lost quite a bit of money. It looks like they always take some losses in Europe to help broaden their search horizon but 2016 was a particularly bad year. They seem to have pulled back from expanding in to Europe, which helped the stock. Is this roughly what happened? Do you know of any other background on the company?

 

It looks like they are roughly 50% undervalued with low risk. It's an interesting idea and I like the business.

[matts]

Nice summary writeup matts.

 

Do you know why does the opportunity exist? On a quick review, it looks like they increased business in Europe in FY2016 and lost quite a bit of money. It looks like they always take some losses in Europe to help broaden their search horizon but 2016 was a particularly bad year. They seem to have pulled back from expanding in to Europe, which helped the stock. Is this roughly what happened? Do you know of any other background on the company?

 

It looks like they are roughly 50% undervalued with low risk. It's an interesting idea and I like the business.

 

Thank you for your feedback.

 

Yes, you have the story right. They stumbled in Europe, but as you point out, it's a great business model. It's capital light, so they can easily expand or contract in any given region by hiring/firing search partners. The losses are there, but at least it's quick and clean without assets and capital being trapped.

 

I believe the biggest reason the opportunity exists is liquidity. It's terrible on the OTC and just adequate for a small investor on the TSX. Market cap is 30 million whereas direct competitors are 700MM and 3 billion.

 

Finally, I think the whole sector is cheap because it is cyclical and we are late into a very long cycle. Slow down in the economy does mean a slowdown in business. No doubt about that. I believe I have enough experience to spot a significant downturn in order to go out with a loss from the peak, but with good returns overall.

 

 

[matts]

Oh, I should also point out that under the founder, Mr. Caldwell, the company was never a very good capital allocator and he paid himself a ton. To the point that there was a shareholder revolt and activism in 2009.

 

So ya, those with long memories are turned off by the historical track record.

 

He has now left and has no role other than a 10% stake. I'm sure he's just happy to live off the dividends.

 

[Guest Schwab711]

That would make sense that CWL was especially punished in 2016 because major US brokers started to shut down grey market trading around that time. It certainly became harder to access a market in their stock right as they are printing bad numbers. Who knows, but that at least partially addresses the problem of why is the opportunity available.

 

The comments on Mr. Caldwell helps explain the past. In a lot of ways, this reminds me of PACI. There was a long history of sideways to down price movement, but under the hood there was substantial corporate governance improvement (single class of stock) and aligning of incentives (like the private placement to key employees). All of the changes in aggregate eventually made a minority investment attractive for PACI and it looks to be the case here.

 

You don't seem to mind the size of competition gap, which I agree with. I think this is one type of business where only modest scale is necessary to succeed. From there, it should be relationships. They seem to be able to expand those relationships so they must provide a decent service. It's not the greatest business ever and capital-lite comes with earnings volatility. Good managers should be able to use that to their advantage to try to expand and leave when it doesn't work. I think the financials show that's how they've treated Europe. I like the financial history in that sense.

 

I agree on the cyclicality. I think something like 6x EBITDA, with the assumption that some day CWL can distribute most of the excess cash to today's investor. Is anything near today's EBITDA the cycle average? That's a big question. I think we are more than compensated for the risk that it's not.

 

Maybe 100% upside is too aggressive (from a multiple expansion perspective) and 50%-67% upside is more realistic. That has a very good shot of happening with further earnings stabilization or growth. Either way, that still gets us to 15%-18% returns, assuming excess cash is distributed (or the market at least credits them for the cash during the holding period). That's all before considering anything above minimal growth, which also seems possible. There's definitely a holding period requirement since we are relying on multiple expansion. I'm not sure what a deeper dive will show, but 15% expected returns, with a right-tail skew, feels roughly right.

[matts]

Great points.

 

I agree on the scale. You need a bit of it to have a brand, but after that, it's all about the relationship between partners and clients. That leads to a risk of your partners being poached. Works both ways however. From reading all their communications, their pitch to partners is that it's a smaller company, only a couple partners in each market, more dynamic than the big guys etc. So far, they have been able to add partners if you account for the Europe retreat.

 

One little tidbit I did not include in the article: Caldwell actually announces major search successes on their LinkedIn page

 

https://www.linkedin.com/company/the-caldwell-partners/

 

It's not enough to build a model or anything, but the number of announcements has definitely ticked up in recent months. I was able to tally them up monthly going back 12 months. Before that Linkedin just dates the post as "1 year ago" and it gets messy.

 

 

[matts]

Looks like they won't report today as the TSX indicated. Last year they reported after close Nov 9th so I'm not concerned.

 

 

[matts]

Company reported last night. As I predicted, revenues were up around the 20% mark. Operating revenue was strong. They also raised their dividend by 12.5%. They did take a sizable charge against their US tax assets due to the Trump tax cut. Because of their weird August year-end, they did not make the adjustments at the end of Dec 2017 like everyone else. My oversight. Still, it's a one-time and non-cash charge to IFRS earnings and since there is no analyst coverage there is nothing to miss.

 

Still very cheap with a well-covered 6% yield

SA update submitted for publication with all the details.

 

 

[matts]

My follow-up was posted on SA this morning

 

https://seekingalpha.com/article/4222650-caldwell-partners-follow-strong-results-predicted-plus-big-increase-dividend

 

 

Sorry to be adding to your reading stacks :)

 

Stock has gone from 1.40 to 1.65 since my first article just over a week ago. Still a cheap stock with a 6% yield.

 

 

 

[writser]

Thanks for writing these articles. I'm a bit skeptical regarding the usefulness of your EV/EBITDA calculation.  Operating cash flow is mainly very high this year because of a 3.5m increase in compensation payable. If you ignore that then sure, the EV/EBITDA ratio is great but I don't think the 6m is a proxy for real earnings / cash generating power. I actually think that the income statement provides a more realistic view of the earning power of this company.  This year ~4m for an EV / EBIT of ~6. Still cheap but is this year part of a trend or just an exceptionally good year? Probably a bit of both.

 

This might be a bit of a pessimistic view but I'd say that with a company such as this one the 'quality of earnings' isn't great. Basically the partners make or break the company, will take the lion's share of profits and will not have a shareholder-friendly spirit. The shareholders will only get residual profits. That, combined with the cyclical nature of the business will ensure that profits will be volatile and can drop like a rock in a bad year.

 

On the other hand, I'm probably being too pessimistic. They've grown revenue at a nice clip the past decade while paying out a juicy dividend, have a conservative balance sheet and generated a decent ROE the past 5 years. If the growth continues you'll probably do fine (but what I'm wondering is: will you do great?). It's cheap, but I'm not sure if it is cheap enough for me. I haven't made up my mind yet.

 

Regarding your articles: one thing I'm missing is: what is your estimate of fair value and how did you arrive at it?

[matts]

Thanks for writing these articles. I'm a bit skeptical regarding the usefulness of your EV/EBITDA calculation.  Operating cash flow is mainly very high this year because of a 3.5m increase in compensation payable. If you ignore that then sure, the EV/EBITDA ratio is great but I don't think the 6m is a proxy for real earnings/cash generating power. I actually think that the income statement provides a more realistic view of the earning power of this company.  This year ~4m for an EV / EBIT of ~6. Still cheap but is this year part of a trend or just an exceptionally good year? Probably a bit of both.

 

This might be a bit of a pessimistic view but I'd say that with a company such as this one the 'quality of earnings' isn't great. Basically the partners make or break the company, will take the lion's share of profits and will not have a shareholder-friendly spirit. The shareholders will only get residual profits. That, combined with the cyclical nature of the business will ensure that profits will be volatile and can drop like a rock in a bad year.

 

On the other hand, I'm probably being too pessimistic. They've grown revenue at a nice clip the past decade while paying out a juicy dividend, have a conservative balance sheet and generated a decent ROE the past 5 years. If the growth continues you'll probably do fine (but what I'm wondering is: will you do great?). It's cheap, but I'm not sure if it is cheap enough for me. I haven't made up my mind yet.

 

Regarding your articles: one thing I'm missing is: what is your estimate of fair value and how did you arrive at it?

 

Strong arguments.

 

You're right, OCF isn't a great metric here, but I wanted to use a standard valuation metric for the SA articles and Net Income was just too messy the last couple of years. The company's own metric, Operating Income, is much better. All share-based comp is cash based an expensed immediately so it's a very fair approximation, but you do have to adjust for taxes. LTM Op Income was 4MM so we agree that's a good starting point. Now, I think they can grow that at least 10% a year in the current environment by hiring more partners and the fees naturally increasing due to executive compensation inflation.

 

Quality of earnings: This is a relationship business and your assets work out the door every night, no doubt about it. They take the lion's share of the profits because they are the assets. Same with investment bankers and that was still a great business to own for a very long time. The high dividend they have committed to restricts their ability to push their own pay to an extreme. This is evidenced by fairly steady net margins over the recent period. Can the partners leave? Sure. But reading the bigger competitors calls and materials, HSII and KFY, they seem very focused on developing auxiliary services to boost growth. Only Caldwell is talking about focusing on increasing partner counts. That gives me some comfort that there won't be a "comp war" that pulls partners from Caldwell. Other than compensation packages, I don't know what would make a slew of Caldwell partner run to a competitor. The company already has the scale to provide all the support the partners need, without the big corporate culture.

 

That's why I think they can modestly grow partner count to grow revenues/op profits at least 10% barring a slowdown in the overall economy. They should get small margin increases with scale, but let's ignore that. I don't have a price target because I know my opinion will change based on changing dynamics and macro. I just know that 6x EV/Op income is cheap enough for me. I could make up a number and say it's worth 2.50, but if tomorrow Korn/Ferry updates guidance that's going to change. I'll hold it as long as I feel it's cheap and in the meantime collect my 6% dividend.

 

Oh, one more thing that popped into my head to mention as I typed this. The share-based comp is expensed quarterly dollar for dollar but their PSUs cliff vest after 3 years so there is an interesting dynamic that if the stock does fall, it will boost their earnings as the accruals are reversed. They can't sell to lock in gains like fast vesting options. A small, but nice little counterweight. Sure, it means that when the stock is up their earnings fall, but I care less about that  :P

 

Thanks for your feedback, much appreciated.

 

 

 

 

 

 

[zuokk]

Any thoughts on potential buybacks as a possibility with all that cash?

 

 

[matts]

Any thoughts on potential buybacks as a possibility with all that cash?

 

Thanks for reading. I think buybacks are unlikely. At 30M market cap, the company is just too small to think about getting smaller. even though in the mathematical sense it might be a good capital allocation decision. They have hinted at growing partner count the next couple of years. If they hire individual partners, they will need cash to staff up, pay initial comp etc. They might also buy a smaller firm with several partners already operating. I think that is a risk to the stock, as they could easily overpay for a firm that doesn't end up performing (that's what happened in London in 2016). I would much prefer them to hire partners individually with smaller initial investments.

 

 

[hell0dude]

Any thoughts on this stock now that it is down 14% due to slower than anticipated growth. Since economic uncertainty was quoted as the main driver, do you guys think it could be a good entry point as trade talks between US and China progresses? Majority of professional fees is generated from the US.