|Shares Out. (in M):||21||P/E||0||0|
|Market Cap (in $M):||228||P/FCF||0||0|
|Net Debt (in $M):||90||EBIT||0||0|
|TEV (in $M):||318||TEV/EBIT||0||0|
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Volt Information Sciences (VISI) - $10.90
Volt was previously written up on VIC by archer610 who did a good job of laying out the overall thesis for why VISI was undervalued at the time. Despite an increase of ~50% from that write-up, we believe there is still material upside and recent developments make this a timely idea. We believe the stock has 50-100% upside over the next 12-18 months with a number of catalysts to unlock value.
Historically, a closely held family-run business. This is changing as the first non-family CEO was installed in 2012 and founder Jerry Shaw recently gave his voting rights to an activist investor
Management has been dealing with significant distractions, including but not limited to (i) an audit restatement and subsequent delisting and (ii) poorly performing non-core businesses
These issues are being taken care of by (i) selling off (giving away) the under-performing businesses, (ii) completing the restatement, and (iii) relisting on the NYSE
The staffing business suffers from the worst margins across its peers stemming from years of unprofitable contracts, taken in order to grow revenue
Preliminary steps have been taken to address the staffing segment’s margins; however a significant amount remains to be done and may significantly increase the value of the staffing business
There are obvious additional costs that can be taken out of the business (headquarters on Avenue of the Americas rather than a more frugal location)
There are a number of hidden assets, including an owned building in Orange County, that we estimate are worth over $50M
Activists are starting to really move including Glacier Peak Capital and Livermore Partners and we expect a newly constituted board after the annual shareholder meeting.
The archer610 write up provides more background on the company so we will only summarize it here:
VISI was founded by Bill and Jerome Shaw in 1950 and became the first temporary staffing company to come public in 1957. The Shaw family still currently holds over 30% of the shares. Over the decades, Volt was built into a large staffing franchise servicing a number of Fortune 500 companies including Microsoft, Boeing, Apple and Google. Through the years, the company acquired a number of unrelated businesses to diversify the cyclicality of the temporary staffing industry. In 2009, the company began a 4 year long restatement process that ultimately cost the company $147M (That is not a typo… $147M vs. a current market cap of ~$230M). The restatement was focused on revenue recognition of multiple-element arrangements, and ultimately proved to have zero effect on the company’s cash earnings. In 2012, in the middle of the restatement process the board brought in a new CEO and CFO (more on them below) to finish/fix the restatement. The new CEO/CFO have embarked on a restructuring plan, but it has been too slow, in our opinion. In 2014, the company finally became present with its filings and relisted on the NYSE.
Transition to a Pure Play Staffing Company
VISI has historically operated three segments (i) Staffing, (ii) Computer Systems and (iii) Other. The revenue and operating income breakdown for 2013 is as follows:
As one can see from the above, VISI is primarily a temporary staffing company and staffing is really the only source of any meaningful operating profits. Since finishing the restatement, management has been “cleansing” the company by shedding non-core assets to become a pure play staffing company so it can focus on its core business and the Street can begin to value it in line with peers.
Recent Sale of the Computer Systems Business is a Major Catalyst for Unlocking Value
The Computer Systems business included a 411 call center business, IT service solutions, and OnDemand SaaS business. This segment had been the largest source of pain for the company. It had been seeing significant revenue declines, mounting operating losses and was the primary source of the large restatement. To make matters worse, management had been reinvesting in this business over the last few years to try and stabilize its decline.
On 12/3/2014, the company announced they were selling this business to NewNet Communications Technologies: http://www.volt.com/template_vis_investors.aspx?id=42949673060
In effect, they paid NewNet $4M to take the business in return for a $10M note at 0.5% interest that is convertible in four years into 20% of NewNet. We will not attempt to place a value on that potential NewNet stake, if it turns out to be valuable, that will be icing on the cake.
The press release and financials show that divesting this business will save the company >$20M in cash per year. For back of napkin purposes and to drive home the point, putting a 10x multiple on that cash flow savings represents $200M of value creation (on a market cap of just over $230M).
In addition to the Computer Systems divestiture, the company has made additional divestitures in the last year to simplify the business with the intent of becoming a pure play staffing company. (See VMS Software and ProcureStaff Technologies divestiture: http://www.volt.com/template_vis_news.aspx?id=15032386878)
As can been seen below, these divestitures have significantly improved the profitability of the overall business.
We expect the company to continue down this path of simplifying the business and focusing on its core staffing business. To do this, we expect within the next year for the company to divest a number of its non-core businesses within the Other segment, such as the Uruguay publishing business, Telecom infrastructure business, and IT infrastructure business.
The company also has meaningful real estate holdings we expect it to sell. This is discussed more below.
Examining the Core Staffing Segment
If we are going to be left with the staffing business, we need to get comfortable with that business and understand if it undervalued. Below is a look at the Staffing segment financials over the last three years.
Critics will quickly point out that revenues have been decreasing fairly rapidly. Note, however, how gross margins have actually been increasing. This is not an accident. Previous management had compensation structures for sales reps and middle management that was tied solely to revenue growth, not profitability. As one would expect, over the years this led to the company entering into unprofitable contracts to grow the top line and earn commissions/bonuses.
Under the new management team, the company has been focused on eliminating contracts where it cannot earn a reasonable return. Furthermore, the segment has actually been restructured to be organized by customer industry rather than geography (before, if Microsoft needed a specialty IT skill and someone with the right skillset lived in Dallas and was willing to relocate to Seattle, this person would rarely have been considered for the role because the various geographies didn’t communicate with each other. Now all IT related jobs and personnel fall under the same division). Enterprise customers that span multiple geographies will now be serviced by the national accounts team rather than by their local geographies, providing a more streamlined service to those customers.
Based on the conference calls, conversations with other shareholders and management, we believe this decline in revenues will persist for 2-3 more quarters before the top line can start growing again. As we’ll show below, we don’t believe this business needs to start growing again to support a materially higher stock price. What the company needs to do, is to expand its operating margins on the business it currently has.
Let’s start by looking at gross margins. When comparing VISI gross margins to industry peers, it is obvious that the company operates at much lower margins. The reason for this is twofold: 1) customers tend to be much larger customers with long-term procurement contracts that have negotiating power as they plan to bring on a large number of temps, leading to lower direct margins for VISI, and 2) previous salesforce was compensated based on revenues rather than operating income. As seen above, gross margins have been trending higher as a result of management rationalizing contracts. Given the change in compensation structure, we are hopeful that in this cycle the company will be able to expand to margins above where they were near the top of the previous cycle (~16.5%), however, to be conservative we model these are 16%.
Below is a look at VISI compared to a group of peers:
When looking at Opex as a % of revenues, one would think that VISI operates fairly lean from an SG&A perspective. However, given the pass-through COGS nature of this business, the most appropriate way to look at Opex is as a percentage of gross profit. From the above comp table, one can see the scalable nature of this business as the larger players operate at over ten percentage points lower, as a percentage of gross profit, than the smaller players. We think management has levers to pull here to reduce SG&A and expand operating margins.
As seen in the three year financials above, SG&A as a percentage of gross profit has decreased from 93% in 2012 to ~88% in the TTM period. We think management can decrease this by another ~4% to be in line with peer group by:
Continuing to move enterprise customers to national account servicers and reduce local staff
Moving into office space that is more suitable for a company this size
Remove redundant positions (most likely accomplished by a new CEO without long-term relationships at the company)
Rationalize the budget of every department by starting from zero and layering on only necessary and justified expenses
Perform a business entity rationalization (the company has a lot of legal entities that all require costs to maintain, these can probably be consolidated)
Improving SG&A as a percentage of gross profit by ~4 percentage points would generate roughly $10M of additional operating income, which would increase operating margins to 2.50% on $1.5B of revenues.
Management has guided to 2-4% operating margins on their conference calls. That is an extremely wide range for a company with this operating leverage. Instead, we get comfortable with this operating margin by looking at how the company has performed historically when managed by a family member pushing a compensation structure focused on revenues rather than operating profits. As shown below, in the strong parts of the cycle, the company has reached 3% operating margins under this old structure. Therefore, going forward under new leadership and structure, we believe this should be an achievable target. However, to be conservative we are using 2.5% as our base case.
Though best in class margins of ASGN and RHI are materially higher, we view those levels as very unlikely given the nature of VISI’s business being geared more towards enterprise customers than retail.
Board Changes Will Accelerate Transformation
While the management team has made a number of changes over the last few years as they have wrapped up the restatement, relisted the company and divested the Computer Systems segment, shareholders are very frustrated at the slow pace of change.
On October 21,2014 the largest holder of VISI, Glacier Peak Capital LLC (GPC) switched their 13G filing to a 13D noting they intended to influence management. On October 28th, Jerome Shaw, one of the founders of Volt, filed a 13D noting he was handing over his voting rights to GPC. This increased GPC’s voting rights to roughly 22% of the shares outstanding. On December 9th GPC filed a proxy statement noting that it intended to elect four new board members at the company’s annual meeting in April 2015.
Given the overall performance of the company and mix of shareholders we expect GPC to receive majority support from shareholders and win the board seats. Once this is completed, we expect the new board members to hold management’s feet to the fire to unlock value and potentially even sell the company. The current CFO, James Whitney, appears to have smelled the writing on the wall and resigned before the new board is elected (Hiring of a new CFO, Paul Tomkins, from the Reader’s Digest announced March 25, 2015).
The CEO, Ron Kochman has been with the company since 1987. Some might say his mentality and vision is too ingrained within the corporate culture to be able to change the culture. Being at the company for that long, we expect he has built a number of relationships with people whose jobs may need to be rationalized. This is an incredibly challenging task for anyone to do if you have a 20+ year personal relationship with the person. We believe a new CEO with strong industry operational experience would be able to come into Volt, improve the cost consciousness of the culture and improve the overall operations of the company. As with any CEO with a new board, Mr. Kochman will certainly be on the hot seat to improve operations quickly.
Value of the Staffing Business – It’s all about the margin
We think the best way to value a staffing business is to look at it on a multiple of free cash flow. We always want to keep in mind absolute valuations, as we don’t typically like to rely solely on relative valuations. However, we think looking at the valuations of the peer group gives us a feel for what other investors in the market are paying for these companies.
We used a Median rather than an Average due to some extreme outliers. The median valuation for these peers is about 17x FCF. In our base case for valuing VISI’s staffing business we will use 12x.
*Pro-forma share count is being calculated assuming the company buys back all 1.5M shares it currently is authorized to repurchase. We expect the company to be aggressive on this front and for the new board to authorize additional repurchases once the current authorization is used up, assuming the stock stays at these levels.
Note that Corporate expense has been inflated due to transaction/restructuring costs. Corp cost, ex-restatement in 2011 was $8.5M, 2012 was $10.7. We use $10M.
Estimated Downside is Likely Only 20-30% in Reality: One can collapse the margins of the company and assume revenues continue to keep falling indefinitely and model a valuation around $5/shr. However, even in 2011, when the company did not have up to date financials, was delisted, had a Computer Systems business hemorraging cash, and was only generating $15M of staffing operating income, the stock bottomed out in the $6-7 range. The company is in a much healthier, more focused position now, and has support from a number of value funds (Glacier Peak Capital, Cooper Creek, etc.) that we believe will be buyers on pullbacks, supporting the limited float of the stock that is out there.
Upside From Base Case (100%+): One can quickly see the operating leverage here from increased margins. If the company is able to return to revenue growth (which management said it expects to do by the second half of fiscal 2015) and expand operating margins into the midpoint of the 2-4% guided range the company has provided, we could be looking at a value for the company in the high 20s. This target quickly moves higher if the company is able to get into the upper end of the range of their guidance.
Other Hidden Value Not Included in Valuation Above:
OC Commercial RE: VISI owns a building in Orange County, CA with 200,000 square feet of office space. We have discussed the property with multiple real estate experts in the area and believe the property could be worth about $200-250/sf, which equates to $40-50M. The company’s remaining mortgage on the building is $8M. Therefore, we think there is potential to unlock approximately $32-42M of value for shareholders upon the sale of this building. We don’t believe the current board will consider this option, however we do believe the new board that should be elected in April will have this high on the priority list of items to consider to unlock shareholder value.
Based on our checks, the Class A office space in OC is leasing for about $30/sf. We think it is reasonable the company could (i) perform a sale-leaseback and (ii) downsize to 100K sf, leading to a $3M annual rent charge.
Uruguay Commercial RE: The company also owns 93,000 square feet of office space in Montevideo, Uruguay. Based on very high level research conducted via real estate websites in Uruguay, we estimate this space could be worth ~$8M. We don’t have a lot of confidence around that number and it is not all that material to the thesis, so we don’t include this number in our valuation.
Other Segment: During the last conference call, management noted there are both profitable and unprofitable businesses within the Other segment. If the company can divest or shut down a few of the unprofitable businesses within this segment, management noted the segment can and will be turning a profit. There is very poor disclosure around this segment so we have no way of quantifying how material that profit would be to the overall company. But we note that if this segment ends up being able to turn a profit of a couple million, this could be meaningful.
Deferred Tax Asset: The company has over $121M of gross deferred tax assets on its books as a result of significant net operating loss carryforwards. $109M of the DTA is reserved with a valuation allowance and therefore not fully reflected on the balance sheet. These NOLs will shield the company from paying taxes for a number of years to come and proving out the profitability of the business to the auditors could, at some point, result in a valuation allowance reversal.
The temporary staffing industry is extremely segregated in terms of market share due to the vast number of companies involved in this space (many much smaller than Volt). The reason for the segregation is because the barrier to entry is fairly low, and it is largely a relationship driven business. Sell side industry reports have argued we are seeing a secular increase in temporary staffing as a result of the Great Recession. Companies want more flexibility in hiring/firing their workforce so they can adapt to changing environments quicker.
As a result of these market dynamics, there has been a significant amount of consolidation in recent years. Staffing Industry Analysts published a brief on January 30, 2015 (http://www.staffingindustry.com/site/Research-Publications/Research-Topics/North-America/North-American-Staffing-Mergers-and-Acquisitions-2014) noting there were 70 publicly announced staffing firm acquisitions in North America in 2014.
Once the new board is assembled after the next annual meeting in April, we believe the likelihood increases materially that the company could put itself up for sale over the next few years. If a strategic buyer assesses the company and decides it is able to wipe out the majority of the corporate G&A and potentially find synergies within the staffing segment, the savings are likely worth at least $100M.
As mentioned above, the company has $121M in DTA that it would likely have to forfeit in a sale as a result of the section 382 limitation. We believe the new board will take this into consideration when structuring a deal to determine the most appropriate course of action for shareholders.
Obvious Levers for New Board
Help management figure out the best way to communicate the Volt transformation and valuation to the Street (at a minimum through a slide presentation)
Push management to conduct road shows to tell the story since it is only covered by one small sell side shop
Focus on the effectiveness of the new operating structure and what can still be changed to improve margins
Institute “zero cost budgeting” to make every department justify every expense
Conduct a Dutch tender offer for shares to accelerate buyback and get around liquidity restrictions
Authorize additional buyback with cash generated throughout FY15
Divest the Uruguay business and related real estate
Evaluate if monetization of the OC RE is accretive to shareholders
Evaluate what else within the “Other” segment needs to be divested
Evaluate whether the management team is right for the role
***The author was previously employed by one of the activist funds currently involved with VISI. All information included is publicly available
Activists replacing four board members
Short-term (6-12 months):
Divestiture of Uruguay business
Sale of Orange County building for $40M+ of pre-tax net proceeds
Improvement in operating margins to 2.5%
Management team improvements
Long-term (12-24 months):
Improvements in operating margins to 3-4%
Sale of the company to a larger competitor
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