Nanocap on the Verge of a Buyout

In times of market uncertainty and extreme volatility I like to turn to special situations for alpha generation. Special situations like mergers and acquisitions, odd lot tenders, spin-offs, carve outs and tiny little nano-caps that trade by appointment. With market uncertainty and the looming doom of an all out global recession, investing in these tiny special situations is a great way to generate incremental upside without taking much market level risk.

One company that I have written about previously (mentioned first in by a member in the Telegram group) fits the bill of a special situation with little market level risk. The management team has successfully sold off two of their business units. There is one business unit left and the management team has hired tech bankers to market the segment for sale.

Even better, the valuation is cheap and I don’t think there is much downside. At the close on Friday the company has a market cap of $39.7 million. There is $20.7 million of cash on the balance sheet and no debt. The enterprise value is only $18.9 million.

The company recently reported fourth quarter 2022 results which is the first full quarter of only running one segment. Costs have come down considerably and the company generated $590k in EBITDA. The remaining business is firing on all cylinders with backlog up 25% from one year ago. Annualizing this EBITDA figure puts us at a full-year forward EBITDA of $2.4 million, or a forward EV/EBITDA ratio of 7.9x.

Comps trade at EBITDA multiples in the 20x range. This is a great business with gross margins of 60% and growing at high single digit to low double digit rates. A strategic buyer could easily pay 20x EBITDA, wipe out $5 million of corporate costs and turn that 20x acquisition multiple into a 5x multiple, from cost synergies alone. A larger strategic could then ramp up the selling and marketing and really grow this thing.

Guidance for 2023 seems strong regardless of a sale. The management team highlighted the business will generate positive cash from operations. Capex is minimal. If the company is not sold by the end of 2023, cash will continue to pile up on the balance sheet.

Based on the language in the earnings release, it seems like management is intent on selling the remaining segment and returning capital to shareholders. With a 15x EBITDA multiple there is close to 50% upside. Using comp multiples of 20x, you get close to 80% upside.

I added to my position yesterday and will continue to buy on any weakness. I don’t think there is much downside at the current valuation and the potential sale of the remaining business offers investors a strong rate of return.

Hope you enjoy the write-up!