Tender Offer for Goodheart-Willcox Company (GWOX)

Textbook publisher Goodheart-Willcox is an Oddball that was written up on Oddball Stocks way back in October 2012 when shares were trading for about $72.
I ran across Goodheart-Willcox in the Walkers Manual, the numbers in the manual intrigued me, from 1998-2001 the company had earned anywhere between a 24% and 32% return on equity, and EPS had grown at 25% annually. I was even more impressed with the ROE when I noticed the company was debt free. I was curious about how they were doing now, so I picked up some shares and contacted the company for an annual report. I received a few years worth of reports and liked what I saw. In the years between 2001 and 2011 the company had continued to throw off excess cash, but with reinvestment opportunities limited cash just piled up on the balance sheet. The company had become what value investors affectionately call a "cash box". A cash heavy company with a business bolted on.

So what is the business of G-W you ask? They're a textbook publisher. Most readers will see the last line and think "no wonder they're a cash box, dying business, dying industry, and relies on government funding." That's the bear case in a nutshell, a bit more information might change some perceptions, but my guess is for 99% of my readers this stock is untouchable because of some preconceived negative bias. I understand that, I've wrote about this stock to a number of investor friends, and all of them came back with some variation of my above sentence. I've heard it said that courage of conviction, and patience are two skills investors need to succeed. Both of these traits are required in double doses for G-W.
The Oddball Stocks Newsletter also did an update on Goodheart-Willcox in November 2014 when it was trading for $81, which was right around book value at the time.

Along the way from 2012 until now, GWOX paid some healthy dividends - a total of $23 per share since the post back in October 2012. The last trade of the stock was in December 2018 for $107 per share. That made for an IRR of 10%... until today.

We received a notice today that the GWOX Employees' Profit Sharing and Stock Ownership Plan and Trust is offering $150 per share for up to 124,000 shares (which is 27.8% of the outstanding stock). That boosts the IRR to 15%... but it happened in "One Day".

At $150, the market capitalization of the company (with 445,725 shares outstanding) is $66.9 million.

The P&L for GWOX is "cyclical" because of the school book adoption cycle. To some, the business looked like it was in secular decline. If you look at the financials from back in 2012, it earned $5.6 million in 2006 (on $31 million of sales) but only $563,000 in 2012 (on $17 million of sales). Even from 2013 through 2017 it never earned more than $1.6 million, with two of those years being below $1 million. But then for the year ended April 30, 2018, it earned $8.3 million!

Is the tender offer worth taking? There's some juicy nuggets that bear on that in the tender offer document - we will be discussing in the upcoming Issue of Oddball Stocks Newsletter in June. Stay tuned!

On outsourcing and vertical integration

There is an interesting pattern happening in the business world at the moment.  It's the outsourcing of everything.  And it's interesting because there are leaders, followers, and my conclusion from watching what's happening is that this outsourcing shift is more than an outsourcing movement, it's actually a shift in intellectual capital from one sector to another.

I'm not sure when this started, but in my mind the current batch of outsourcing picked up steam in the 1990s with IT outsourcing.  As technology was a newer thing to companies they thought it might be easier to hire experts rather than develop their own in-house capabilities.

Of course outsourcing isn't new, companies have always relied on vendors to help them in their business.  Not every company that delivers parts owns a trucking or rail fleet.  Completely vertical integration isn't possible, and isn't necessary, but that's not what I want to talk about.

What's happening is a technical outsourcing on steroids.  Because companies were comfortable outsourcing initial IT support, or systems there has always been a comfort level to other types of technical outsourcing.

Executives have an idea that it's much easier to outsource an accounting system, rather than host their own customized accounting system.  Or to outsource sales verses building an in-house staff.  The rallying cry is "we don't want to be involved in things that aren't our core competency."

Of course that makes sense.  If a business is the best in the world at manufacturing widgets why would they want to get bogged down in the logistics of distributing those widgets to the world?  Or why would they want to waste time hiring people to manage facilities, or run a phone system?  Instead they should focus all of their energy on manufacturing widgets and let others do the rest.

The problem is most companies don't really have a core competency.  If you take a deep dive into a businesses' operations you'll find there really isn't much of a secret sauce.  It's just a group of people working together in a unique way to provide a solution.  And if you begin to abstract the pieces away like lego blocks you start to realize there isn't anything at the center that can't be replicated elsewhere.  The exception to a generalization like this would be companies that own infrastructure, or prized real estate that is truly one of a kind.

What's happened is these outsourced vendors begin to understand their client's business better than themselves.  And the vendor starts to think "why don't we just bolt on a few front office features too?"  Then suddenly the back office vendor becomes a vertically integrated company that is competing with their clients and doing it better than they could do it themselves.

In effect many companies have leadership teams that have bought into this outsourcing mentality so deeply that they're slowly disassembling their own companies and transferring their knowledge and skills to their vendors.  And those vendors are realizing that with their knowledge and expertise that they can replicate what their clients are doing better.

It's fascinating that the competitive advantage Carnegie had with his steel was that he fully integrated operations.  He owned coal mines, owned the path to the coaling and coking plants and eventually steel.  The great innovation was the fully assembly line from coal to steel was physically located in close proximity eliminating the distributed logistics gap that existed at the time.  It was an enormous factory made up of many smaller operations all lining the same river.

The end result of this outsourcing transformation is this "new economy" that we're experiencing.  Old main-line companies are willingly disassembling their businesses and re-incarnating as portions of multiple tech companies.

The implications of this are far ranging and wide, and I'm not sure this process can be stopped.  It's the pattern of the Innovators Dilemma on a much larger macro scale.


What's going on in the Oddball world?

I wanted to put together a quick update post of what's been going on for me (Nate) in the Oddball Stocks world.

As you've noticed my posting frequency has slowed to a crawl.  This has coincided with the acceleration of my software business, CompleteBankData.  As that's taken off I just haven't had as much time to write and muse on investment topics.

Our company was accepted early in 2019 into the AlphaLab start-up accelerator here in Pittsburgh and that's taken up even more time.  But I'm not lamenting the loss of time, the benefits far outweigh how crammed things are.  Here's an article about the current cohort of companies, ours included.

While being a part of an accelerator I've had the opportunity to greatly widen my network and meet a ton of entrepreneurs and successful executives.  As readers know I'm a value investor through and through.  Which is sort of a paradox in that I'm running a growth company, and the maxim of our company is that we help banks grow.  So how is it that I'm a value and growth person?  I think it all breaks down to the level of involvement.

A lot of investors and activists struggle to push a stagnant company to grow.  That's because growth isn't in their DNA, and for a lot of people growth means change, and it's hard to change.  When someone else is buying the dollar for $.30 and liquidating it I'm happy to take a ride.  But I'm not sure I'd want to be doing that liquidating myself.

On the other hand I really enjoy running a company.  I love talking to clients, love networking with prospects, and getting involved in client operations and helping them accelerate their growth.  But you can't do this if a company doesn't want to grow.

In the meantime my partner in crime at the Oddball Stocks Newsletter (and you really should subscribe if you haven't already) will be starting to post from time on this blog.

The posts I author have my name attached at the bottom, whereas the posts Colin authors have "Oddball Stocks Newsletter" attached.

I want to take a quick turn and talk about the newsletter for a minute.  Over the past year I brought Colin on board and he's taken the letter to a place that I didn't have the ability to take it.  We've dramatically increased our coverage universe of oddball stocks, while at the same time expanding the depth of coverage on each name.  If you're in the oddball investment space I'd highly recommend you take a look and consider a subscription.  There is a lot of content we put together that is simply not available anywhere else.

A parting word.  Lest you think I've lost the value gene, I'm still out hunting for bargains, although not always stocks.  I've been out in the real world finding bargains on hard goods and reselling them on eBay.  It helps me scratch the itch until the market is littered with similar bargains.


The first post ever on Oddball Stocks...

...was PC Connection back in September 2010 when it was trading at $6.85 a share.

The thesis was pretty simple. There was $6.70 per share in working capital (current assets - all liabilities).

Assuming a 10x multiple for the business at a $0.45 earnings level for the year would have valued the business at $4.50, so that ($4.50+$6.70) suggested a valuation of $11.20. Or, being more conservative and placing a 10x multiple on the then-current earnings (and assuming no growth for the year) resulted in a $2.70 value for the business and thus $9.40 for everything. So, back then the "conservative" estimate was a 40% upside from the trading price.

So what happened along the way? Well, note that in 2016, the company changed its name to "Connection" and the ticker symbol to CNXN. Names are trendy and subject to fads, so one thing that we find is that doing a retrospective can be more complicated than just typing in the ticker symbol.

But here is the stunner: the share price is now $36!

Starting in November 2011, the company paid a dividend of $0.40 and then has paid an annual end of year dividend of similar amounts since then, for a total of $2.98 of dividends. The dividends plus the share price appreciation have resulted in an IRR of 24% compounded for eight and a half years!

Let's look at what happened here. Revenue grew from $1.9 billion for the year ending at the time of the blog post to $2.7 billion for the year 2018. Gross margin grew from 11.6% to 15.2%. The result is that gross profit almost doubled (+88%). Meanwhile, SG&A only grew 70%, so operating income more than doubled.

The result is that earnings per share have grown and in 2018 they were $2.41 a share. (They were 85 cents a share for the full year of 2010.)

So, coming out of the recession you could buy this business for 15 cents a share because current assets covered almost the entire purchase price - and it ended up being a growth stock that had nice operating leverage.

We've been talking about this lately... price rules. Whenever a business sells for a really low price (e.g. for no price once you subtract current assets minus all liabilities, or for zero or negative enterprise value), the market is already acknowledging the problems people are worried about: a recession, a business that seems to be highly competitive and lacking a moat; or in other cases, bad management, bad capital allocation, unfriendly insiders.

Sometimes bad factors win out and a company goes to zero. Or a stock purchase can do really poorly even if they company survives when too high a price is paid. But when companies don't have much debt (and that's what a low or negative enterprise value is telling you), there is a lot more runway to try to improve things. So much more runway, in fact, that most shortsellers are not very interested in situations where there are not financial debts or other fixed liabilities to act as catalysts.

Oddball Stocks Newsletter: Small Bank Snapshot

Time to post another sample piece from the Oddball Stocks Newsletter. This is something we wrote about small banks in Issue 21 last August - just a "snapshot," if you will. A collection of small banks with market capitalizations almost all under $100 million, with P/Bs back then ranging from 52% to 199%!

The Oddball Stocks Newsletter has gotten longer and we now have more general commentary like these observations on the small bank equity market. You can subscribe here to the Newsletter, and we also have some a la carte samples of back issues available.

Also, on the last page of this sample you can see a little bit of our thoughts on Tesla. It is amazing that the market seems to have some extremely overvalued mega-cap companies, while on the small end a lot of Oddballs trade to a big discount to what their liquidation value would be.

For example, Bank of Utica (which we have been writing about) is overcapitalized and the nonvoting shares trade at a big discount to book value. It would make a ton of sense for the controlling shareholders to get moving buying everyone else out. But until they decide to allocate capital that way, it could continue to be a "one day" stock.