Most of the investment opportunities in the microcap space are net-nets. Not Advant-e. It is a company with moats with consistent ROE in the 25-35% range.
Advant-e is a pink-sheet microcap with a market cap of $15M. It has 2 subsidaries: Edict and Merkur. Edict provides EDI web services. Merkur is an integrator specialised in providing e-document connectivity for enterprise-level CRMs and ERPs like Oracle and Peoplesoft. 80% of ADVC's revenue is derived from Edict.
Edict was founded by the current CEO Jason Wadzinski. It has been in EDI business for 20 years and in web-based EDI for 10 years. In late 1990s, when the internet started taking over everything, Edict struggled to survive with its desktop-based EDI connector business. Wadzinski bet on web-based EDI and spent all the money to implement its own web-based EDI solution. When he ran out of money, he backlisted Edict in 2000 to raise capital via shares, unsecured notes and bank loans. The listing vehicle is now Advant-e.
Edict's Business Model
Edict has found a niche in the grocery EDI market. 80-90% of Edict's revenue comes from grocery EDI. It is trying to grow in the automotive EDI market and also other vertical markets like chemicals.
What's special about Edict is its business model, what Wadzinski called the "hub-and-spoke". ADVC basically gives away EDI services (with direct system integration) to big grocery retailers for free. Revenues come from the small grocery suppliers who need to trade with the retailers. Because they are small, they don't have the IT resource nor budget to do full-blown integrated automated systems. And also because they are small, the market is ignored by bigger players like IBM and Sterling Commerce. So, Edict is able to run a profitable business by providing them a web-based solution -- or in the current lingo, "cloud-based". They are charged by trade volumes. Grocery suppliers on average pay $100 per month. The amount isn't really that material with respect to their business expenses. An electricity bill can easily eclipse it.
(Evidence it patchy here. But I believe ADVC runs Kroger's backbone. And Wal-Mart is directly connected on ADVC's EDI. It appears Wal-Mart ditched VAN and implemented their own internet-based EDI using iSoft in early 2000's and ADVC has partnered with iSoft. I suppose what it mean is Wal-Mart's EDI is connected to ADVC's EDI. By doing so, small suppliers can trade with Wal-Mart via ADVC's webapp interface and Wal-Mart doesn't need to spend any money on getting them connected.)
It's as good as an electronic toll booth! ADVC is clipping toll tickets whenever the grocery suppliers are trading. As far as I can see, this business has pretty strong moats. Big retailers have no incentive to leave. It's free. Small suppliers also have no incentive to leave because the costs aren't substantial and there is a degree of lock-in. It's the same kind of pain you have when you want to move from, say, Yahoo Mail to GMail. It can be done. But there is a huge baggage of stuff (i.e. your archive) on the server which is tedious to migrate. Not to mention you have your practices and processes that you've adopted for that particular service.
Due to the nature of grocery, revenue is very stable and pretty much recession proof. As in 2009, Edict has 4000 grocery suppliers. (This is the most recent data I could find.) So, there isn't much concentration risk. And it is very profitable. Operating profit margin is at mid-20% and ROA is mid-60%. Edict has been growing its revenue and profit since it became profitable in 2003.
EDI is an entrenched technology. It may evolve slowly but is unlikely to become obsolete. One risk I can think of is what if a grocery retailer goes bankrupt. In 2003 (I think), Edict reported they had over 100 grocery retailers on board and majority of the revenue came from 25 of them. That was long time ago. So again, the concentration isn't high enough to by worrying.
Merkur is a different story. A large portion of Merkur's revenue comes from maintenance contracts. Merkur's business is cyclical, sensitive to IT spending, of lower margin, and with much less moats. Wadzinski acquired Merkur in 2007 from his brother. This fact alone isn't very comforting. But it appears there is some synergy between the 2 subsidiaries. In the past years, Merkur provided software to connect mainstream ERPs and CRMs to Edict's EDI backbone. Also, it seems Wadzinski is able to bring its operating profit margin from 8% in 2007 to a respectable 22% last year by cost control.
Since Merkur constitutes only 20% of ADVC, it's not too critical. It's a mild distraction to the management, I would say.
Wadzinski owns 54% of the company. There is no doubt it's his company. My impression is he knows the industry and he knows how to manage software projects.
More importantly he seems to be shareholder friendly. He draws a lowly $160,000 salary in 2010, which is actually less than his 2009 pay. Substantial dividends have been paid in the past 3 years yielding around 8-10%. Although future dividends aren't guaranteed, this at least shows he's willing share half of the fortune built up in the company with his fellow shareholders. In 2009 he also did a 10 for 1 split in order to increase the liquidity of the shares.
The company also bought back $270k worth of shares between 2007-2009. Not very material. But again, all these are shareholder friendly and helps to release the value.
Valuation and Growth
ADVC has $4M cash and no debt. Like most software business, it's not capital intensive. Valuing the balance sheet doesn't tell you much. Its most valuable asset isn't on the balance sheet -- its customer relationship. So it's only meaningful to value it on earning basis.
Since it's not capital intensive and the requirement on working capitals is very stable, its earnings track its free cashflows pretty closely. A pure cash business. Business can't be any simpler than this. At the current price of $0.23, P/E is at 9.5x That translates to a cash earning yield of 10.5%. This by itself looks cheap for a quality business. No growth is priced in. Given its stable business and moats, it's like receiving a bond coupon at 10.5%.
But ADVC does grow. In the last 5 years, its revenue grows 5.5% p.a. and profit 15%. And ADVC has been improving its operating margin in the last 5 years.
Profit growth comes in many areas:
- Steady increase in trade volume on grocery EDI
- New suppliers signed on
- Expansion in automotive EDI and other vertical markets; both are still a very smaller part of Edict. (Edict signed up Honda in 2009. I won't be surprised this is their only client at the moment.)
- Cost cutting
- Price increase. (They increased price in 2010, when US was still considered to be in recession. That shows it has some pricing power.)
So here we are looking at a 10-20% p.a. return and minimal downside. ADVC is a cash machine. Each time when I researched another company, I would ask myself why not buy more ADVC.