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Laughing Water Capital 3Q17: FC, EZPW, REV, ITI, IESC

Laughing Water Capital 3Q17 Letter, October, 2017

“All man’s miseries stem from his inability to sit in a room alone and do nothing.” – Blaise Pascal, c/o Mohnish Pabrai

  • Returned 11.4% during 3Q17 vs. S&P 500 and Russell 2000 of 14.2% and 10.9%, respectively

Franklin Covey (FC)

  • In the business of performance improvement, with a strategy based on the ideas first laid out in the best-selling book, “The 7 Habits of Highly Effective People”
  • Insiders own 33% of the company
  • Crux of the thesis is based on stepping over what should be a very low hurdle: customers like getting more value for the same price
  • Historically customers have been able to order training materials a la carte, paying one price (~$200/employee) for training materials on a specific topic. Recently shifted gears and began offering access to training materials across all topics for one price vis their “All Access Pass”
    • Should represent value to existing customers and has already opened doors to new customers
  • Few wrinkles that have impaired recent results and caused stock to trade down:
    • Under the old model, FC was selling to HR managers who could make purchase decisions out of their existing budget, leading to a short sales cycle. Under the All Access Pass, customers must sign a 1 year contract, and thus longer sales cycle
    • GAAP accounting requires that revenue be recognized ratably over the course of the contract, while expenses are recognized during the period they are incurred
  • In the near term, as the launch of All Access Pass is lapped, deferred revenue will be recognized, which should catalyze shares by mid-2018
  • Longer term, company’s addressable market is enormous, the combination of secular growth and management team with proven affinity for rewarding shareholders through repurchasing shares is attractive, and there is potential to separate the company’s education business from its corporate business, which the market would likely reward

EZCorp (EZPW)

  • Recently announced a major acquisition in the form of 112 Latin American stores
  • Operationally a good use of cash but there are larger implications which I believe will play out in the months and years to come as market digests the news
  • For the last few years, narrative surrounding EZPW has been somewhere between “it is a disaster” and “they have a lot of changes to make”. As the company enters the final year of their 3-year plan with a cleaned up balance sheet and incredible operational improvements, narrative should shift to, “they are back on a growth track”
  • For the last few years, largest competitor, FirstCash, has been hoovering up large pawn operations throughout the western hemisphere without any competition. Believe it is likely that FirstCash will realize that their best move would be to buy EZPW
    • Would be able to realize massive synergies by eliminating virtually all of EZPW’s infrastructure
    • If they do not buy EZPW, FirstCash will be living in a world where all of their substantial growth ambitions will lead them to competitive bidding processes

Revlon (REV)

  • Wild ride continues with shares having traded hands below $16 in mid-September and above $27 in late-September
  • As a stock, Revlon is its own animal as controlling shareholder Ron Perelman and the largest independent shareholder, Mittleman Brothers, do battle through SEC filings that seek to influence the supposedly fiduciary minded board of directors
  • Mittleman asked for Perelman to agree to not squeeze out minority shareholders for a period of five years
  • Perelman agreed to not exceed 90% ownership for a one year period
  • Lower prices make Revlon an attractive candidate for tax loss selling, but Perelman’s 1 year standstill agreement had the curious side effect of emboldening short sellers who no longer have any reason to fear a buyout deal at a premium
  • Presently earning a ~15%+ yield lending our shares to those who are concerned with short term volatility while patiently waiting for long term value to develop

Iteris (ITI)

  • Recently hired Jim Chambers to run the agriculture/weather business
    • Previous companies where he was employed, four of them were acquired
    • Seems clear that management has positioned the agriculture business for eventual sale
  • Company has also registered a shelf which would allow them to raise capital in secondary offering
  • If the agriculture business was sold in the near term, it would be unlikely the company would need to raise additional cash, so the tea leaves are muddled
  • Company continues to execute at a very high level, and the traffic management business remains an undiscovered gem at the forefront of the future of intelligent transportation and autonomous vehicles

IES Holdings (IESC)

  • Conglomerate with business in 4 verticals – Commercial & Industrial, Communications, Residential, and Infrastructure
  • These businesses should benefit from both cyclical and secular tailwinds and are thus interesting in their own right but what makes an investment in IESC more interesting is that it is almost 60% controlled by Jeffrey Gendell, an excellent capital allocator
  • Gendell is the founder of Tontine Capital, where he previously compounded capital at ~40% a year for a decade
  • Company also has $400 million of NOLs

Image Source: Laughing Water Capital

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