Liquidity Services: Ridiculously cheap and at an inflection point. Giant insider buying.

Disclaimer: I hold no position in mentioned securities but plan to or will own positions within the next quarter as I expect short term share price weakness due to covid19.

  1. Department Of Defense contract overhang awarded since 2016 is completed as of Q2-2020.
  2. Market Cap as of last reported quarter standing at $197 million. As of last report, the company exited Q2, 2020 w no debt, and with $51.8 million of cash, putting EV at $145.2‬m.
  3. GovDeals, one segment of the business is capital light and growing. Cash generated from this segment alone was is worth the enterprise value of the business. Other segments, we get for free.
  4. Counter-Cyclical business proposition is at an inflection point. Net income exploded from $12m to $24m between 2006-2010 during the last cycle.
  5. CEO Angrick William bought approx $5 million worth of shares on the open market. For a comparison, his compensation for FY19 was approx $2.3 million all in including stock based compensation. He also already owned 3.7 million shares.
  6. Business shutdown via covid19 is net negative since LQDT moves physical goods, but current economic conditions should drive medium-long term out performance.
  7. Long common shares. Company needs to address high SG&A costs through its new merged marketplace.

Overview

Per its 10k, the business is in the reverse supply chain industry. The idea is simple.

Businesses throughout lifetimes will have significant discharges in terms of material goods.

Some of them will be looking to sell and recover expenditures where possible. Others will be looking to buy and reduce spending where possible.

Liquidity Services helps both sides and everything else in between including marketing, logistics, merchandising & channel optimization (reducing fats from a business), etc cetera. Fees are taken on a consignment (piece of the pie), profit sharing, or outright purchase transaction model (I buy from you, I sell to someone else).

Historically speaking, the company’s net income has been dog shit. Actually, calling it dog shit might be generous. Take a look for yourself.

Seeking Alpha

SG&A has been consistently and disgustingly high. A large part of this can be blamed on the 2016 Department of Defense contract which has recently been completed as of Q2 2020.

Read that line again.

“Company will bear all of the costs for the sorting, merchandising, and sale of the property”.

It’s a good thing this contract has been completed or I wouldn’t be bothered. I’m not a fan of any partnership where the variable cost is borne by just one party while the other side holds a fixed profit rate. The income statement above also shows this to be true. In fact, ever since 2016, net income has been negative. The good thing is, the DOD contract overhang is now gone.

Valuation: GOVDEALS Segment Worth the entire EV of LQDT at $145m. Investors get the rest of the business for free.

As of writing, the company’s enterprise value stands at $145.2m.

Note the high margins. Now if only mgmt could lower SG&A costs…

To understand why I would make the proclamation that the GovDeals segment alone is worth the enterprise value of the business, you have to understand how the segment operates.

Per LQDT’s 2019 Annual Report, govdeals is self-directed.

The GovDeals segment is an automated, consignment/commission based platform that requires no handling of inventory per their consignment model for sellers.

So, we have a segment of the business that’s throwing off $30M in gross profits alongside marginal overheads costs since no inventory is taken into account, AND, this segment is actually growing. (DOD contracts were under CAG segment, this is organic growth, numbers thus not inflated, also, as an aside, I’d like to see competitors try to muscle 13k government agencies versus LQDT’s existing relationship, and have 13k town hall meetings just to get to where LQDT is. If you don’t call that a moat, I don’t know what else you would call it).

So where do we stand in terms of GovDeals? At these prices, you’re paying approx $145.2 for a high margin, cap light, sticky, well-defended moat-like business with 18% growth thrown in, and a total addressable market size in the billions. (research from Brightpearl (2018) has found that more than half of all retailers (51%) claim their margins are being squeezed by returns, yet 69% are not deploying any technology solutions to help process them. The reverse supply chain addresses the redeployment and remarketing of surplus and salvage assets. These assets generally consist of retail customer returns, overstock products and end-of-life goods or capital assets from both the corporate and government sectors. The market is large, as indicated by an Appriss Retail report in 2018 that shows $369 billion, or 10% of total sales, of merchandise is returned on an annual basis. Estimates based on Bureau of Economic Analysis (BEA), U.S. Census, and World Bank reports, the global used equipment market is valued at approximately $350 billion.)

You get the rest for free. Here’s a look at segment growth since FY17.

Source

What’s a capital light, high profit margin throwing off $30m a year worth to you? Is 15x profits too much? 10x? 5x? Even at 2x, the business is still worth approx $60m. Assuming horrendous operating margins of 50%, and even taking growth potential and growth rates with a cubic meter of salt, paying $145m for this segment seems a no brainer. Assuming normative growth rates and normal operating margins, we’ll see profits from year 4.

All of this is not baking in the fact that this is a counter-cyclical business model about to experience a strong upward tick in business from a covid19 induced economic fall out.

Insider Buying

CEO Angrick William has been buying up a ton of shares (how I found this company in the first place).

He’s bought approx 963,828 shares for approx $5m (go do the precise math yourself). For comparison, his FY19 compensation was approx $2.3m, approx $380k of which was cash. I’ll let you do the math.

Upcoming Catalysts

The three things I’m going to be looking at are as such;

First, an upward inflection in business as covid19’s effects trickle through the economy. The last time this happened, LQDT’s revenue and net income skyrocketed over the next 4 years. Take a look at how supplemental operating data and net income ballooned. (note, dod contract here contributed 31.3%, 32.8% and 29.9% of total revenue for the fiscal years ended September 30, 2008, 2009 and 2010, respectively.)

Second, improving profitability, we need to keep an eye on LQDT’s ability to bring down SG&A costs. That’s the whole point of the consolidated marketplace.

Third, I want to see improved operating margins and free cash flow. The past few years have been a hurdle – unsurprising considering this is a counter-cyclical business model. But if the thesis is right, LQDT from here on out, should see increased q-o-q volume, net income, reduced operating expenses and reduced SG&A.

If the company can do these various aspects right, I suspect we will be able to see a significant re-rating of the stock. I don’t exactly have a rule of thumb, but this used to trade between $40-60. That’s a 10-bagger or so from where share prices are now.

Negatives

Like it or not, LQDT will pay the price for being a physical mover of goods even if its trying to get new a software slant and that is reflected in the . I anticipate near term share price weakness once q3 results are out and I will be using that to try and get a position established.

Also, a quick check on Glassdoor shows a mixed rating. I’m confident customers are happy – they wouldn’t be seeing growth if they weren’t. But the company culture can be improved.

Final Note

$LQDT is cheap, has multiple ways to win, has solved all of its prior problems, and is on the verge of a significant turnaround. It also has a massive tailwind in its favor with a rather significant defensible position – handling bureaucracy is a bitch. CEO and co-founder (who started the business nearly 20 years ago!) is buying large chunks even recently.

Disclosure: I am long $LQDT. I expect Q3 to have abysmal reported earnings due to riots and covid19 induced business shutdowns, and will be adding shares whenever possible. I may choose to hedge my position in case I’m wrong. DYODD.

When I take a swing, I tend to swing hard. Sometimes I’ll miss and look like a damned fool. But if every dollar I risk is for ten more dollars, I only have to win 2 out of every 10 times to double my money. Even if I’m only right once, I make back all of my money and learned a lot more for it. My style of investing might not be suitable for most people. Consider yourself warned.

5 thoughts on “Liquidity Services: Ridiculously cheap and at an inflection point. Giant insider buying.”

  1. So you explained it but I don’t think I understood how the overall company becomes cash flow positive in future? Is it because dod contract is done and sg&a comes down?

    Does dod contract help them? Why did they do it ow?

    Like

    1. bcuz the dod contract has them covering all marketing and advertising related expenses, but profits are split at a set rate. if expenses climb, lqdt eats it and dod gets to profits. it was an anchor around their financial neck. prior years, mgmt have always been cashflow positive. see years pior 2016 when dod contract was renegotiated.

      Like

  2. What’s your estimate on the EBIT losses from the DoD contract each year from 2016-2019? What is your estimate on steady-state SG&A now that the contract has wound down?

    Like

    1. no real way to gauge. the most logical way is to calculate it by taking avg sg&a incurred over a weighted basis (gmv) and apply it to the gross volume moved under the DoD scrap contract. The remainder is the steady state sg&a. but note that this might go up or down as well since its not like the DOD contract moves set goods all the time. the items differ and if items differ sg&a definitely differs.

      imo, the coming 2 quarters will provide greater clarity just because there is a before/after and it will also provide clarity on the aggregrated website and also gives sufficient time for the delay from covid to catch up. hope tht helps.

      Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s