May 23, 2013
The news on Wednesday 5/22 that our 7th largest client holding, Multiband Corp. (MBND), would be acquired at a significant premium was welcome news. MBND was perhaps our least favorite portfolio name and, truth be told, we had begun selling a few shares just in the past week to fund what we thought to be superior investment ideas. We had been modestly underwater on the position; the takeout price of $3.25 per share brings our MBND investment well into profitability. And we think the likelihood of a superior bid emerging over the next 45 days is not zero; it’s more like 30%. So given that the all-cash buyout offer on the table is definitive and not conditional on financing, holding MBND shares now represents a free option on a higher bid.
We wrote in our Q1 2013 investor letter that our patience with MBND was running low. The reasons were several; we’ll try to summarize. The company’s CEO is a likable guy but he is an empire-builder who aspired to a company with $1 billion in sales (from about $300 million in 2012). Nothing wrong with growth ambitions, you might say, but we were very skeptical of his M&A skills (he had badly bungled a deal prior to our investment and, as seen below was bungling an announced deal) and we were not supportive of his aggressive push into the MDU video and broadband business. We preferred that MBND stick to its core business of providing contract field services to DirecTV, cable operators, telcos, energy companies and the like. There is a reason, we told him, why the MDU business is fragmented and unreceptive to small, less sophisticated participants: it is a complex and capital-intensive business with competition from much better capitalized players (e.g., the cable and satellite providers). The CEO disagreed with our view, saying that many buildings offered exclusivity to the MDU provider, though he failed to mention that the trade-off is a substantial cut to the building owner/landlord. In short, we thought that management should be laser-focused on growing the contract services business and expanding its very low operating margins (~3%).
Further, MBND was woefully undercapitalized to embark on an MDU strategy. In early 2013, the company was finally able to refinance a $30 million seller note relating to an acquisition several years ago, with conventional bank financing at a market rate, no less. Prior to this financing arrangement, MBND funded working capital needs with a hodgepodge of short-term insider loans and several tranches of preferred stock. In March 2013, the company filed an S-1 to raise $20 million of “renewable unsecured subordinated notes.” To say that the company’s capitalization was laughably amateurish would be an understatement.
And yet the MBND CEO was doggedly pursuing an acquisition of certain assets of a barely solvent MDU provider in New York and New Jersey called MDU Communications (symbol MDTV, market cap: $6 million). First announced in early July 2012, the deal terms were apparently still being negotiated. On May 15, 2013 MBND noted in its Q1 release that it was “continuing due diligence and activities related to its previously announced acquisition of MDU Communications”. Continuing due diligence more than ten months after the announcement of the transaction?
So, to recap, MBND’s capitalization is a mess, its core field services business is very low margin, its customer concentration is too reliant on DirecTV (75% of revenue), the MDU business is complex and too capital intensive to become a core segment, the CEO has destroyed value with prior acquisitions and he’s pursuing another deal outside of its core Midwest and southern geography in the MDU space.
Why, you might ask, in light of this unflattering profile of MBND, are we investors? First, the stock was very inexpensive at about 0.25x revenue and less than 5x EBITDA even without an accounting treatment adjustment for its vehicle fleet that could have cut the EBITDA multiple in half. Second was the presence of not one, but two activist investors who had gotten involved since last summer. One 7% shareholder was able to shake up MBND’s sleepy board with its chosen representative and the other investor, with a 13% stake was urging the board to sell the company and like us, disapproved of the MDU business initiatives. Our thinking was that something favorable was almost certain to happen due to the engagement of the activist shareholders: improved profitability, new management, new board or a sale of the company. We felt that a sale of the company was the least likely outcome at this time because of the low stock price and the CEO’s empire-building tendencies were incompatible with a sale of the company.
Happily, we were wrong. Sometimes it’s better to be lucky than good.
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