The Caldwell Partners

The Caldwell Partners is a company that I’ve been familiar with for quite a while, and which I avoided for a number of years. The company, which specializes in executive search, was essentially controlled by the founder (Douglas Caldwell) via a dual share structure. This meant that holders of the B Class voting shares could dictate how the company operated, despite the fact that they controlled the minority of the total shares outstanding. Not surprisingly, other institutional investors finally got annoyed and proceeded to litigate. When the dust settled, there was only one class of shares, and Caldwell embarked on a new (and less complex) path. However, even after that, it took a while before I regained my interest in the company, but I did eventually commit capital to it. I believed it was attractive before COVID, and I believe that the impact of COVID, while understandable, has caused its valuation to fall into territory that presents an interesting opportunity for the patient investor. For the sake of highlighting factors that are bullish, neutral, or bearish, I use my standard format of using the colors green, amber, or red.

What does the Caldwell chart say ? As repeat visitors know, I tend to start with the “visual” representation of what makes a company attractive (or not), and this case is no different. The Caldwell chart (see below) prior to COVID was in a bit of a holding pattern – not bad and not great at the same time. However, once COVID hit, all bets were off, and the shares hit a new bottom. Normally, price movement like this is reserved for major restatements of earnings or other company specific issues. However, as any investor knows, all companies were hit by COVID, some more than others. As Caldwell is a smaller firm, and most investors (during times of crisis) tend to flock to larger companies, the valuation of Caldwell will remain compressed for a while, which is exactly what this chart is telling us. So, while we would normally regard this chart as negative, in the context of COVID, we view it as neutral.

The balance sheet is solid and cash rich. As one can see from the most recent balance sheet (as of May 31, 2020), things are pretty tidy. Caldwell is still sitting on a significant amount of cash – amounting to no less than $0.73/share. Add to this the fact that there is no long term debt, and overall liabilities are only marginally higher, despite the fact that Caldwell now carries a “Paycheck Protection Program” loan (which is eligible for loan forgiveness) and was also required to include lease liabilities, due to recent IFRS changes. Were those not included, overall liabilities would actually be significantly lower than they were a year ago. In any case, while we expect that the path forward for Caldwell won’t be all sunshine & rainbows, the balance sheet indicates that they can weather the storm.

Cash flow from operations is positive. The cash flow up to May 31st 2020 only captures the impacts of COVID for a few months, but the fact is that Caldwell created $0.15/share of cash (before changes in working capital), or $0.03/share (after changes in working capital). Depending on which of those you prefer, those numbers look either great or simply ok, but the fact is that Caldwell is creating a cash surplus from operations during a fairly difficult period, which is what we like to see.

Revenues are down – but so are costs. Falling revenues are never a good thing, but even worse are falling revenues and no ability (or will) to manage costs. In this case, we can see that Caldwell is taking a revenue hit from the COVID induced economic compression, but COGS also fell (which is to be expected) and Caldwell also took a hard look at G&A, reducing it by 50% year over year. The income statement is telling us is that the company is managing the situation as best it can by not allowing G&A costs to simply “carry on” as usual. Falling revenues are definitely bad, but prudent management is always favorable, hence the neutral stance on this.

Insider & significant shareholders continue to hold Caldwell. Insiders and significant shareholders hold about 41% of the outstanding shares, and have not sold throughout the entire COVID downturn. This suggests that they have a long time horizon, and that they have faith in the current management team. The breakdown of these shareholders is shown below.

• Darcy Morris (Board member) – owns 3.8 MM shares (18.6%), and is the founder of Ewing Morris Investment partners, so he is arguably a knowledgeable investor.
• C. Douglas Caldwell (founder, former Director) – owns 2.77 MM shares (13.6%). Given that Caldwell is his “baby”, he will likely continue to hold for the longer term.
• J.C. Clark Ltd. – another sophisticated investment firm, owns 1.86 MM shares (9.1%). Clark has a very long time horizon and has held Caldwell shares for many years.

The key takeaway here is two-fold. First, these insiders, given their insight into the firm, would have sold if they truly believed that the future for Caldwell (post COVID) was bleak. Secondly, given their propensity to hold through this period, it would seem unlikely these insiders will engage in a wave of selling anytime soon, so further price compression is unlikely.

At the current price, the valuation is attractive. Although there are “many ways to skin a cat” we’ve detailed four key metrics that we tend to focus on when looking at a potential investment.

• Book value: Caldwell has traditionally traded at multiples of 1.96 (low), 2.46 (average) , and 2.97 (high) times book value. As of October 8th, at a price of $0.73, Caldwell is trading at 1.12 times book value. Even if this simply reverts back to the low multiple (1.96 x book value of $0.65), this suggests upside of ~ 75%.
• PE multiple: With negative earnings for the latest quarter, purists would suggest this is bearish. However, this has to be viewed in the context of COVID, so I’m not certain we can attach that much weight to the PE multiple in isolation. At any rate, if viewed as a function earnings, Caldwell is either trading at a high multiple or negative multiple, depending on how one believes the full year will play out.
• EV/EBITDA multiple: The combination of a depressed share price and the significant amount of cash on the balance sheet means that Caldwell has an enterprise value of a paltry $2.22 MM, and that value is that high because of the inclusion of a forgivable government loan of $2.22 MM. Excluding this loan, the enterprise value of Caldwell is only $22,000. In turn, even with compressed EBITDA of $3.28 MM (for only 9 months) , this multiple falls to 0.68 ($2.22 MM / $3.28 MM). To put this into context, Caldwell’s EV/EBITDA multiple has ranged from a low of 1.1x EBITDA to a high of 10.6x EBITDA, suggesting there is ample room for the share price to move upwards.
• Cash flow yield: As noted previously, this depends on how one tends to view cash flow, either before or after changes in working capital. If one prefers cash flow prior to working capital changes, then over the 9 months the yield is 20%, if one prefers cash flow after working capital changes, this falls to 4%.

The dividend has been cancelled. I suspect that last sentence will cause people to read it twice, as a cancelled dividend is rarely viewed positively. However, bear in mind that a purchaser of Caldwell today is purchasing a company where there is little (or no) expectation of a dividend at all. With that in mind, companies that have a history of paying dividends (like Caldwell) realize that their market value is, to some degree, dependent on perception. While not a “dividend aristocrat”, Caldwell did have a history of paying shareholders, as that was part of the appeal. A shareholder in Caldwell was holding it for some capital appreciation, and some income. When COVID reared its head, the management at Caldwell made the prudent decision to immediately eliminate the dividend to preserve capital. Like the rest of us, they couldn’t predict the future, and simply “hoped for the best, but planned for the worst”.

So, while there is no dividend today, there is the distinct possibility that the dividend will be reinstated. In the event that the dividend is reinstated (even at a reduced level), some of those investors seeking income that once sold Caldwell will return, and that increased buying could cause a significant move in share price. A good example of this is another Canadian company, none other than Boston Pizza. When COVID hit, Boston Pizza, like Caldwell, eliminated its dividend and paid nothing for the bulk of 2020. However, it recently re-instated the dividend at a level almost 50% lower than it’s pre-COVID dividend. The reinstatement of this reduced dividend caused the shares to jump 60% within the week. So, given its history of paying a dividend, it would not be unheard of for Caldwell to bring it back, as the world is slowly getting back to normal. And with that in mind, the shares in Caldwell could jump significantly as well.

The final word.  In essence, the opportunity in Caldwell boils down to the following:

• Bad news is baked into the share price: The share price has already been punished, and unless there is another COVID like pandemic waiting in the wings, a further fall is unlikely. Businesses have started to adjust to the “new normal”, and cannot shut down forever. Executives still have to be sought out and hired – even if they end up working from a home office.
• The shares are trading at cash value: Rarely can one purchase an operating business, with a significant history, for the value of the cash on the balance sheet. While it is true that the balance sheet is a “frozen snapshot of time”, even with that in mind, it is rare to find an operating company priced at such a discount.
• Bankruptcy is a non-issue: This is a common theme in the companies I tend to look at, and this is no different – unless the future is very, very bleak, in which case we all have bigger issues to worry about.
• Reinstatement of the dividend will move the price: When this happens, Caldwell shares will enjoy a significant move upwards, and investors who bought in when there is no dividend will enjoy a reasonable income stream even if the reinstated dividend is significantly lower.
• Keep an eye on insider sentiment: Current insiders have remained steadfast in their resolve to hold Caldwell through this very difficult time. We believe this will continue to be the case, but we will also keep an eye on insider activity.
• If you are a buyer, buy in small portions: The shares do not trade on huge volume, so if one is anticipating a purchase, use smaller bid lots in order to not move the price too significantly.

As I indicated previously, I am already long on Caldwell, and have bought more at the current price ( ~ $0.75 CAD). Many of my investments are made when the future is murky, which is what keeps many investors away – and also creates price inefficiency, especially in smaller companies.

As always, these are only my thoughts & opinions, and it will take some time for this thesis to bear fruit (or not). If you have questions or comments, I can always be reached at mark@grey-swan.com.