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.

 

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.