In this newsletter, I share the most intriguing investment ideas I've come across in the past week from a variety of sources, including Value Investors Club, various investing blogs, hedge fund letters, and more. I aim to present you with concise and easily digestible investment idea summaries that quickly capture the essence of the thesis.
This week's newsletter includes:
Purple Innovation (PRPL) - A bet on mattress industry recovery.
Alto Ingredients (ALTO) - Potential sale of ethanol producer.
Reckon (RKN:AX) - Potential liquidation of Australian SaaS company.
Solum (248070:KS) - Dominant electronic shelf label provider.
Marlowe (MRL:L) - Cheap safety and regulatory compliance services/software roll-up.
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Purple Innovation (PRPL, $183m) - A bet on mattress industry recovery
Purple Innovation, a manufacturer and distributor of mattresses, offers an interesting play on the mattress industry recovery. Following the Covid-driven demand spike in 2020-2021, the industry is currently experiencing its worst downturn ever. However, the pull-forward effect appears to have been fully unwound already as the number of mattresses sold from 2019 to 2022 is in line with the hypothetical sum of volumes assuming a normalized 1% growth rate from 2019 levels to 2022. Aside from the normalizing volumes, PRPL profitability going forward is likely to be boosted by the recent right-sizing of the cost structure, rationalized marketing spend and normalizing raw material costs, with gross margins already growing over the most recent three quarters. As earnings normalize, the company might generate $80m+ in normalized EBITDA - substantially above the $13m-$17m expected in 2023. PRPL currently looks very cheap trading at only <2x normalized EBITDA. Applying a 10x multiple to the normalized earnings would suggest a share price target north of $8/share. This would imply a potential multi-bagger upside. Full PRPL write-up on Value Investors Club (free guest account is required).
Alto Ingredients (ALTO, $332m) - Potential sale of ethanol producer
Alto Ingredients is a commodity ethanol producer that might get sold at a significant premium to the current share price levels in the near-term. Activist Raper Capital has recently sent a letter to the company, urging management to explore sale of the company. The activist’s push for the sale comes amid ALTO’s large ongoing transformation away from commodity ethanol towards higher-margin and value-added proteins and alcohols. ALTO’s management also intends to pursue carbon capture/storage initiatives in order to receive substantial subsidies outlined in the Inflation Reduction Act. Management anticipates these initiatives to result in $125m of incremental EBITDA by 2026 (vs $67-$77m in 2020-2021 and -$10m in 2022). The activist has argued that ALTO lacks the size/liquidity to pull off the ongoing transformation as a standalone company and could fetch a significant premium if sold to a better-capitalized industry player. Valuing ALTO’s production facilities in line with the recent industry transactions would result in $5.19-$6.54/share valuation in base-bull scenarios, implying a 20-50% upside. The downside seems partially protected by ALTO’s still depressed share price vs 2022 levels despite a much improved industry backdrop. Full ALTO write-up on Value Investors Club (free guest account is required).
Reckon (RKN:AX, A$67m) - Liquidation of Australian SaaS company
Reckon, a provider of accounting and legal software, appears likely to undergo liquidation within the next five years, with the potential liquidation proceeds expected to surpass the current market cap manifold. This outcome seems likely as Reckon has already divested two of its segments (in 2017 and 2022) and has used the proceeds to reduce debt and pay out special dividends. Reckon’s CEO appears to be strongly motivated to continue on the path of liquidation and divest the remaining businesses. Under a recently implemented incentive package, the executive will receive a payout only if shareholder distributions over the next six years reach A$150m, which is more than double the current market cap. This target appears to be attainable. Reckon’s Accounting Software segment (accounting for 3/4 of sales) generated A$12m in 2022 operating profit compared to RKN’s EV of A$67m. Given that Accounting Software is a capital-light, high-margin (20% operating margins), cash flow-generative and growing business, the current valuation seems to be too low. While Reckon's remaining Legal Software segment is unprofitable (-A$4m in operating income in 2022), management is highly motivated to either turn it around or sell the division. The primary reason for the extended liquidation timeline is the fact that the Accounting Software segment operates under a licensing agreement with Intuit, which retains a claim on Reckon's source code, preventing the sale of the business. To overcome this obstacle, Reckon has been migrating users to its own cloud-based platform, with the migration expected to be completed within the next 3-5 years. Full RKN:AX pitch on Overlooked and Undervalued blog.
Solum (248070:KS, ₩1.5T) - Dominant electronic shelf label provider
Solum is the world’s second largest provider of electronic shelf labels (ESL) which allow retail store managers to update product information remotely. The company is currently trading at 12x forward earnings - substantially below the 20-22x multiples for peers E-Ink Holdings and SES-imagotag. The discount is largely explained by the fact that Solum still generates two-thirds of its revenues from the mature and lower-margin electronic components segment. However, Solum shares are expected to gradually re-rate closer to peer multiples as the business mix continues to shift towards the higher-margin/growth ESL segment (two-thirds of Solum’s 2023E operating income). The ESL business seems to have plenty of growth runway as the recent partnership between SES-imagotag and Walmart is expected to increase ESL penetration substantially above the current 5%. The most penetrated market of France boasts a 50% rate, suggesting that the US penetration rate might reasonably reach 30% by 2027. Other growth levers include introduction of new ESL features (driving higher average selling prices) and opportunities to expand beyond retail, including component management for manufacturing. Given Solum’s dominant standing in the ESL space (30% market share globally) and steady 80%+ market share of the three largest players over the last decade, the company is well-positioned to capitalize on the increasing adoption of ESLs. Solum’s operating income is expected to growth at a 35% CAGR over the next three years which, along with the multiple re-rating, would imply 80%+ upside from current market prices. Full 248070:KS pitch from Apis Deep Value Fund.
Marlowe (MRL:L, £577m) - Cheap safety/regulatory compliance services and software roll-up
Marlowe is a high-quality recurring services/software roll-up available at a significant discount to its peers and intrinsic value. The company currently trades at 8x run-rate EBITDA compared to 15-20x peer multiples. The opportunity exists as MRL shares have significantly de-rated since 2022 due to concerns about leverage, continuing one-off restructuring costs and lack of free cash flow generation. The bears have argued that Marlowe’s one-off acquisition restructuring costs are recurring and that the company will not able to generate meaningful cash flows. However, both of these concerns are expected to be disproved in the near-term. Management has indicated that one-off and restructuring expenses have peaked and expects them to significantly decrease from £24m in FY23 to £10m-£12m in FY24 (compared to £7.5m in FY23 FCFE). This expectation seems reasonable since the business experienced an exceptional level of acquisitions in FY22 (>55% of the total acquisition spend to date) and M&A spending has decreased significantly since then. The expected reduction in one-off costs, coupled with increasing profitability due to economies of scale and healthy structural market growth, is anticipated to drive significant cash flow generation. The company is expected to record £30m in FY24 FCFE and £40m on a normalized basis (excluding any future acquisitions). These targets appear to be achievable given that Marlowe has already demonstrated its cash flow generation potential in H2’FY23 with £17m in FCFE or £30m when including restructuring costs. Valued at 20x FCF (at the lower end of peer multiples), MRL might be worth over £10 per share, implying a potential upside of more than 70%. Full MRL:L write-up on Value Investors Club (free guest account is required).
This has very quickly become my favorite newsletter. Keep up the good work.
Regarding Marlowe, it is intriguing for many reasons but client stickiness is a function of inertia rather than switching costs. If a customer cared to they could pretty easily find any number of contractors to handle inspections and service.