The Caldwell Partners issued their Q1 financials on January 14th, and despite COVID, fractured politics (in the US), and a generally questionable business landscape, their numbers gave an investor something to feel good about. If you were fortunate enough to have picked up some Caldwell shares in the latter part of 2020, you have probably done quite well. That being said, Caldwell was also busy expanding, and their acquisition of IQTalent partners means that the Q1 financials, while good, must really be viewed through a “post acquisition” lens. This is what we will be aiming to do, using our usual green, amber and red format to indicate areas which are thought to be bullish, neutral, or bearish. When titles display mixed colors, this indicates that a situation may be improving (or getting worse) as compared to our assessment from a prior post.

What a difference a quarter makes. Readers who checked in for our year end update on Caldwell (here) will recall that we viewed the chart at that time (late November of 2020) with cautious optimism, as it was just showing signs of recovery, with recent price action suggesting strength. Well, where we once indicated that the MAVGs seem to be converging, today it is a foregone conclusion. The Caldwell chart that was once “showing signs of recovery” is now in full recovery mode. The long and short term MAVGs have crossed over, which suggests that we are (hopefully) at the beginning of a longer rally. With that in mind, we should clarify that while we regard this chart as bullish, the strength of the shares is cold comfort for someone who has been waiting on the sidelines, as the “cover charge” to join has increased substantially.

Caldwell layered on an acquisition – but the balance sheet is still solid. With the acquisition of IQTalent Partners, we felt that it would make little sense to view Q1 results through the lens of the “old” balance sheet, so we have taken the liberty of representing the acquisition impacts on a “new” balance sheet. As per the MD&A, details of the acquisition are as follows:

What the acquisition does is increase the total share count by ~ 25%, reduce the cash balance, increase goodwill (or intangible assets) and layer on some short and long term liabilities. The “post-acquisition” balance sheet (with impacted areas highlighted in yellow) could look something like this (see below). Readers are cautioned that this is a representation of what we believe the balance sheet could look like, not the actual balance sheet as released by Caldwell on January 14th. For the sake of simplicity, US dollar amounts have been expressed at the average 2020 US-CAD FX rate of $1.34 CAD to $1.00 USD. Additionally, the entire purchase price is assumed to be captured as Goodwill or Intangible asset.

What is clear is that while Caldwell has traditionally had little or no “soft assets” and no debt, it now will have a larger intangible asset base and will also have some “longer” term liabilities due to the acquisition. However, unlike bank debt, these liabilities are not interest bearing, nor is there an ability for anyone to “call the debt”. In fact, unlike the share issuance and cash payment of $3.0 MM US, the remaining liabilities are all contingent on various factors, such as employees remaining with IQTalent and profitability. This suggests that some of these liabilities may actually be less, although how much less is unknown. Additionally, we are showing these liabilities at an FX rate of $1.34 CAD to $1.00 USD, which is on the higher side of the 10 year FX history. At such time that the liabilities are discharged, the FX rate may actually be lower.

So, while the Caldwell balance sheet isn’t quite as pristine as it once was, it now must contend with a larger “soft” asset base, whose value will only prove out over time. Overall, Caldwell is still sitting on a significant cash balance ($0.60/share), and the liability impacts are likely less onerous than bank debt. While we never like to see large Goodwill balances, we recognize that these must be viewed in the context of income and cash generating ability. Which brings us to the Q1 Income Statement….

The balance sheet might be a bit worse off – but earnings aren’t. After adjusting for the increased share count, Caldwell quarterly EPS would be up by 43% at $0.033/share vs $0.023 a year ago – pretty good for a year when companies are still dealing with a global pandemic. While the topline was essentially flat, the difference was primarily a combination of reductions in reimbursed expenses, G&A, and the offsetting impact of $110K of residual Government COVID grants. With that in mind, the previously quoted EPS amount of $0.033/share takes this stimulus into account, and the $0.033/share value reflects the removal of this.

What these numbers obviously do not reflect are any impacts of the IQTalent acquisition, the inclusion of which should theoretically boost topline revenues, but would also increase costs as well. At this point, we cannot make any useful projections, as to do so would simply be conjecture. What we can say is that Caldwell is starting out 2021 on the right foot. If it continues to execute at a similar level, it would be on track for full year EPS of roughly $0.13 – $0.14/share for the full year, suggesting a 10x earnings multiple as of today – not dirt cheap anymore, but not a stratospheric valuation either.

Like earnings, cash flow is solid. Any way you decide to look at it, cash flow is better on a YoY basis, both before and after changes in working capital. If one uses the post acquisition share count of 25.5 MM shares, Caldwell generated $0.065/share in cash before WC changes, or $0.216/share after WC changes. It is too early to tell whether or not Caldwell can continue to generate cash flow like this for the next three quarters, but if they can, the company is seriously undervalued at the current price of ~ $1.25 – $1.30. If one extrapolates both quarterly cash flow values over the course of a year, it suggests a cash flow yield of somewhere between 20% (($0.065 x 4) / $1.30) and 66% (($0.216 x 4) / $1.30). Both of those values are respectable, and one of them raises eyebrows. For all intents & purposes, the cash flow statement validates what the income statement was already saying – that Caldwell seems to be going in the right direction, and at a good clip.

The Insider story has changed, but is still supportive. There has been no selling activity by insiders, but the post acquisition insider picture is slightly different. With the issuance of new shares, there is now a new group of insiders (the former IQTalent management & directors) who hold shares that are subject to a three year hold period. While there is never a guarantee that an acquisition will go well, a three year hold period is strong incentive to make it work.

The price has strengthened, and the valuation has now left the “easy money” stage. Since our November post, Caldwell shares have gained approximately 60%, so anyone that bought in during Q4 of 2020 has done well. However, the easy money is now gone, and the valuation is now contingent upon execution. If the IQTalent acquisition proves to be accretive, and Caldwell can continue to execute at the same level, then the shares remain attractively priced. On the other hand, if Caldwell has “bitten off more than it can chew”, the shares may stumble. That being said, while past results do not necessarily predict future results, they do provide validation that the company has at least managed to navigate through a very challenging 2020 with solid results. Readers should note that the valuation parameters discussed below are all viewed in a “post acquisition” context, using the new number of shares outstanding and taking into account balance sheet impacts.

  • Book value: With the increase in total shares and the (likely) layering on of soft assets, Caldwell is trading well beyond its traditional price/book multiple. However, it should also be noted that the price/book multiple for a company such as Caldwell should be used to identify when the shares are mispriced at the low end, and not necessarily as determination when to sell.
  • PE multiple: The PE multiple currently sits on the edge of “still cheap”. If Caldwell continues to execute at similar levels, then today’s multiple is a reasonable 9x – 10x, depending on whether one includes or excludes the Government stimulus. However, as stated previously, this is contingent on the company continuing to execute at the same level. One could also argue that if Caldwell comes out with similar results for Q2, then it is quite possible that the market assigns the company a higher multiple, which would suggest today’s prices is still “cheap”.
  • EV/EBITDA multiple: At a current EV/EBITDA multiple of approximately 2.1, Caldwell is no longer in bargain basement territory (as it was in Q4 of 2020), but it is well below its historical average of around 4x.
  • Cash flow yield: As previously noted, if Caldwell continue to execute at around the same levels, it will be generating somewhere between a 20% and 66% cash flow yield for the year. Even at the lower level of 20%, this is well below the long term average for Caldwell, which is closer to 9%.

The dividend may not come back – or it might. In our November post, we suggested that Caldwell had the financial wherewithal to reinstate the dividend. However, with the IQTalent acquisition now in the rear view mirror, it has demonstrated that Caldwell has expansion plans beyond the traditional executive search function. Regardless, investors are ultimately rewarded when a company performs well. If Caldwell continues to execute well (without a dividend), the market should eventually award it higher valuation metrics. If the company executes well and reinstates the dividend, that would be the proverbial icing on the cake. Assuming Caldwell continues to execute well, we will continue to hold Caldwell, with or without a dividend.

In closing, we believe current shareholders (and potential new investors) should keep the following in mind:

  • The share price is much improved: Yes, the “ticket to entry” is much more expensive, but the argument is that the results speak for themselves. This is always the classic conundrum – buy early and suffer “dead money risk” or buy later and take on more price risk.
  • The new shares are locked up: If one does buy at today’s price, there is security in knowing that the newly issued shares aren’t being sold anytime soon, and insiders continue to hold.
  • Bankruptcy is still a non-issue: It might sound repetitive, but acquisitions sometimes come with lots of debt. Caldwell has managed to avoid this trap.
  • If it happens, reinstatement of the dividend will move the price even more: As mentioned, there is no guarantee of this, but if it happens, it will further juice the share price.
  • Insider sentiment is likely to remain positive: With Q1 results like these, it is highly unlikely that there will be any insider selling (by pre-acquisition shareholders) that could sink the price.
  • Caldwell may be reinventing how it is perceived: An analyst once stated that Caldwell “paid a good dividend, but the small size implies risk, and we don’t see the upside.” All of that may be changing – which could mean that Caldwell may command a higher valuation in the future.

We purchased more Caldwell in Q4 of last year, and continue to hold. Questions or comments can be sent to mark@grey-swan.com.

 

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