Wednesday, March 22, 2017

Transcat Can Double in 3-5 Years

Transcat (TRNS) distributes, services, and calibrates equipment for a variety of industries, particularly highly regulated industries such as life sciences. Transcat serves as a one stop shop to make sure the equipment are working properly, without customers having to schedule with each and every OEM. The link here shows the instrument types they can calibrate.

I will try to provide the outline of a long thesis as succinctly as I can. Someone has a more thorough write-up here (paywall).

Thesis Sketch

Transcat can double its EBITDA in 3-5 years, and the stock can double as well. The reasons are below:

  • The company has 2 segments, one growing and one declining/stabilizing. Revenue growth is set to accelerate because the growing segment is now outpacing the declining one.
  • Growth is further enhanced by a roll-up strategy in its services segment (in addition to organic growth) 
  • Margins will benefit from mix (Services segment has higher margin), as well as operating leverage.

As a bonus - I'm not counting on this - the company pays 30-40% tax. A corporate tax cut to 20% would immediately boost earnings by 14-33%

Mix Shift Toward Higher Growth and Higher Margin Segment

The company has 2 segments: Services and Distribution. Right now they contribute about 50/50 in terms of revenue. The Services segment has been a steady grower (both organic and via acquisition). Distribution segment revenue declined the past few years due to the oil and gas industry downturn, but seems to have stabilized in the past few quarters.

Going forward, the growth in Services will outpace the decline in Distribution. Since Services enjoys a higher EBITDA margin (low double digits vs mid-single digits), EBITDA will grow faster than revenue.

The slide below shows the revenue and profitability crossover.

Transcat revenue and operating income

Roll-Up Strategy

The Services segment is also a rollup story, supported by reasonable debt levels (~2x Debt/EBITDA). The company is a disciplined acquirer, typically paying 4-6x EBITDA with IRR hurdle of 15%.

Calibration services is an $1bn market, split 40%/35%/25% between 3rd party services providers, in-house labs, and OEMs. Within ~the $400mm market for the 3rd party services provider, Transcat is the 2nd largest with behind Tektronix (18% share versus 22% share).

Notably, almost 40% of 3rd party providers market is serviced by smaller regional and local players. That’s a ~$160mm space that Transcat has been, and will continue to be consolidating.

I believe the company can improve its share of that 3rd party market from 18% to low 20%’s, providing a tailwind for revenue and margins.


With TRNS stock trading at $12.4/share, the company has $89mm of market cap and ~$115mm of enterprise value.

Management is targeting $175-200mm of revenue and double digit EBITDA margin in 4-5 years. Using the midpoint of $187.5mm revenue and a 12% margin gets you to $22.5mm EBITDA. With a 10x EV/EBITDA and you have $225mm of enterprise value – almost a double from the current $115mm EV.

That is in 4-5 years. But as markets are forward looking, I expect the stock to double sooner.

Here’s my rough model on 1) how revenue and EBITDA might progress over the next few years to FY2021, and 2) what they look like if management’s goals are met.

The 2 are fairly close so I think management’s goals are reasonable. Recent financial results suggest they are well on their way.

Transcat model

Friday, March 10, 2017

Week ending 3/10/2017: Losing Streak

From red hot to ice cold. My major stock holdings have drifted lower. My small, speculative positions have blown up and given back their gains. In the past months I twice sold stocks (Fortress and Nimble Storage) days before they get acquired at huge premiums. Even currency trades, a barometer with which I judge my understanding of the world, went from positive to negative.

It’s a combination of bad shots and bad luck. What do you do when you keep shooting bricks and air balls? Do you keep shooting? Or do you bench yourself?

For now it’s the latter. I have cut back on losers and winners alike. Despite having a plethora of stock ideas, I’m putting them on hold until I can figure out what’s going on.

Major Stock Positions

Fidelity National Financial (FNF). Spinoffs coming 2H16 to unlock value. The core title insurance business is cheap at about 10-12x PE. This is a great business and we may be on the cusp of a wave of millennials buying their first homes.

Beijing Enterprises Holdings (0392.HK). Just too cheap.

Sallie Mae (SLM). A play on deregulation, tax cut, and higher interest rates.

Aetna (AET) and United Health (UNH). Insurers have the best bargaining power in healthcare.

Medtronics (MDT). SURTAVI trial results coming March 17th. A good read could boost the market size of TAVR heart valves and MDT’s market share.

Vipshop (VIPS). Incredibly cheap for a company with 20%+ revenue growth. The market should come around to it one day.

Most of these have done well the past 2 months but are now showing weakness. I’m actually praying for FNF, SLM, and VIPS to go lower so I can buy more. Beijing Enterprises had a nice run the past month but looks about to be beaten down again. The negative sentiment in Chinese stocks persists (this applies to Beijing Enterprises as well as VIPS) and I think part of it is the market assigning a steady decline in Chinese Yuan.

Inotek and Negative Enterprise Value Situations

2017 will be an interesting year in biotech. When “clinical stage” biotechs fail their trials and still have cash left, what do they do? These stocks can trade at below value of cash on balance sheet, so the market is basically saying management will entrench themselves and burn away cash. There’s a bunch of these companies in the market right now. Ovascience, Inotek, Ophthotech…etc. Merrimack is another one that could have negative EV soon.

I replaced my OvaScience position with another negative EV play, Inotek. This company develops eye drugs. It has one more phase 3 trial result coming up, and no more pipelines after that.

In this way Inotek is superior to OvaScience, which has multiple years of pipeline (thus excuses to burn cash and destroy shareholder value). If the trial fails, Inotek would still be sitting on cash of $2-2.5/share and no debt. The company trades at 1.6 when I bought (up to 1.8 today).

It’s hard to say what management will do. Ideally they just return cash to shareholders. But they could try to acquire some product pipeline. Or they could refuse to admit defeat and do another phase 3 trial on the same failed molecule. In short, anything to keep paying themselves.

So this is potentially an activist situation. But I’m not sure how much good that can do. The board has no investor representation and only one director is up for election in 2017.

Ophthotech is another eye drug company with negative enterprise value. They have already said they will not return cash, but will look to acquire. So Inotek could be a target.

On “M&A Valuation”

What are these “plethora of ideas” that I’m holding back from? I have one general observation about the whole IT/medtech space.

I’m seeing lots of companies like this: revenue growing fast – say 20%+ or even 100%+ a year. Stock trades at 2-4 times EV/revenue. Big net cash positions. GAAP losses but approaching cash flows break even (because of stock based comp and D&A). High gross margins. The biggest expenses tend to be sales/marketing /G&A.

From the perspective of a strategic acquirer, you can synergize and cut down SG&A by half or even more. If you do that, most of these companies are essentially valued at <10x EV/forward EBIT, maybe lower.

So if you start modeling “acquirer perspective”, they all look like slam dunks. On a standalone basis though, most of them will never be profitable (unless you literally project growth like 10 years out).

Off the top of my head, Novocure (NVCR), Atricure (ATRC), Nutanix (NTNX) are just a few that fits in this category. The list is long.

The megacaps are sitting on huge cash piles. Tax reform could add to that by allowing big tech companies to repatriate cash. This all bodes well for M&A. Of course, not every company will be bought out, but increasingly market valuations are based on perceived M&A potential.