HVS 3Q21: Idea for action from Bedford Park Capital – Converge Technology Solutions
The Hidden Value Stocks show for the third quarter ended September 30, 2021, with an interview with the President and CEO of Bedford Park Capital Corporation, Jordan Zinberg, in which he shares his idea for action, Converge Technology Solutions Corp ( TSE: CTS).
See parts 1 and 2 here.
Bedford Park Capital – Stock Idea One: Converge Technology Solutions Corp (CTS)
One of your favorite stocks is Converge Technological solutions. Can you start with giving us a brief overview of what this the company does?
Converge provides IT services across multiple verticals including data analytics, cloud migration, cybersecurity, digital infrastructure, and managed solutions. The company is growing rapidly and has just announced its first acquisition outside of North America with the purchase of 75% of Germany-based Rednet AG.
You mentioned that you came for the first time throughout the company in 2018. What did you think about the business then and what prevented you from pulling the trigger on the time?
I first met Converge CEO Shaun Maine in late 2018 and think the stock was around $ 0.80 at the time. At that meeting, Shaun presented a roadmap for $ 1 billion in revenue within 3 years. My initial impression was that the growth strategy was too aggressive and would be difficult to achieve. As a result, I decided to put the business in my database and track their progress but didn’t invest. After seeing that management was successfully executing their initial plan, we finally invested around two years later around the $ 2.00 level.
What is the management training, and do they have skin in the game?
The majority of the management team worked together in a public company called Pivot Technologies. I had been an investor in Pivot in the past and it was acquired by Computacenter PLC in 2020. Converge notably strengthened its capacities in Europe recently, with the addition of two high-level European technology leaders, including the one is now president of the table. According to Bloomberg, insiders currently own just under 10% of the company.
The company’s growth strategy is based on on acquisitions. He finished 22 transactions since 2017. Some companies that followed a similar roll-up strategy in the past eventually fell back to Earth. What makes you think Converge is different?
Given the focus of our fund on high growth companies, we invest and evaluate roll-up strategies very regularly. The mere fact that a company pursues a “roll-up strategy” is not unique and that fact alone does not make a company an attractive investment for us. Where these types of businesses typically fail is in their inability to research and close deals or buy mismatched businesses, get too much into debt, or fail to properly integrate acquired businesses.
Converge has proven its ability in all of the above areas and is not just pursuing valuation arbitrage. Converge buys low margin businesses that other players don’t want and turns them into higher margin businesses that generate a ton of cash flow. For any business that grows primarily through acquisition, we look at the types of businesses they are buying, the subsequent steps taken to optimize those businesses once acquired, and the potential repeatability of this process in a systematic way. Converge ticks all of these boxes.
The company uses an acquisition strategy model. Can you tell us about it approach?
CTS management has often cited the following acquisition model, which envisions the acquisition of a $ 100 million revenue company with an EBITDA margin of 3% that is acquired for 5 times EBITDA. This $ 15 million acquisition would generally be structured as $ 9 million upfront cash with an additional $ 6 million:
Can you explain the three steps to increase sales, profits and reduce costs after an acquisition?
The first step is cost reduction. After the acquisition, target companies qualify for Converge volume discounts with vendors, resulting in significant cost savings and increased gross profit margins. In addition, in functional areas where there is overlap (ie Accounting, HR, etc.), the company is able to rationalize the workforce, further reducing costs. In a short period of time, these initiatives can result in a decrease in the effective purchase multiple of the target company from 5x EBITDA to 2.5x EBITDA.
The second step is the optimization of working capital. Converge has obtained favorable payment terms with its suppliers. Before the acquisition, the payment terms in effect in the target companies are generally 45 days. After the acquisition, Converge may increase these times to 75 days, resulting in increased cash flow for the business. This optimization and extraction of working capital is then used to help offset the purchase price of the business. Notably, in the example above, you will see that $ 3 million of the original purchase price of $ 9 million is taken from the target company itself.
Finally, all of the synergies mentioned above are further enhanced by the third step: the cross-selling of existing products and managed services from Converge to customers of the target business. The ability to sell cross-managed services is a top priority for the management of CTS. Managed service revenues are higher margin and recurring in nature, which improves the profitability of the business while adding predictability and stability to its revenue.
Do you think there are any signs that the company is growing too fast?
Considering how quickly the business is growing, this is something I think about often, but currently see no areas of concern.
The interview continues.