Due diligence that goes above and beyond can often give you an edge that can yield large returns in the microcap space. Most astute investors read quarterly and annual financial statements, but I find very few go beneath this first layer of due diligence. In a four part series Sean, Neil, Jason, and I will give you a few recent examples of in-depth due diligence, and how it ultimately helped in making an investment decision. The company examples in each part are meant to help illustrate the DD and not meant to be stock recommendations. Here is the final part in The Power of Due Diligence Series:
Part 4: Alteva (ALTV)
by Jason Revland
We were initially attracted to Alteva Communications (ALTV) due to its position within the Unified Communications (UC) industry, which we believe is in the early stages of a multi-year bull market, as businesses of all sizes switch from using older technology to newer, much more powerful technology. Billions will be spent switching, and there are many flavors of UC that can be provided, from out of the box to fully customizable solutions. There will be many winners. UC will enable businesses to be much more productive, fully leverage the internet and cloud, and pay for mission-critical telecom services using a recurring leasing model, rather than a fixed, capital-intensive model. There is a dearth publicly traded pure plays in this space. Alteva has a compelling business model, and is already successfully exploiting the UC opportunity.
Our due diligence involved several phases, took about one month, and we purchased an initial starter position at $9.
Speaking with management is a non-negotiable requirement for investing. We walk away from companies that do not open their doors to us. Alteva has been outstanding in this regard. We first sat down with the CEO, CFO and Chief Technology Officer at their Philadelphia headquarters. We spent 2 hours speaking with them, and asked dozens of questions that we had prepared in advance. We also visited their hands-on technology center, where customers can experience their products and solutions. We left feeling more confident about the management team, their strategic vision, and their solutions and positioning in the marketplace.
We were fairly confident Alteva was in an industry with a very strong outlook for double-digit growth. This was supported by studies published by Gartner and IDC, which gave us additional confidence. A good friend worked for Siemens Business Solutions and Verizon Business Communications and provided a very good independent check on this industry growth. He provided industry affirmation, and was able to help outline the dominant technology providers, and how businesses were thinking about their various choices.
ShoreTel (SHOR), 8×8 (EGHT) and newly public RingCentral (RNG) are publicly traded comparables, leveraged to the UC opportunity, which compete with Alteva to varying degrees. We spoke to sell-side analysts who cover these companies to gain a better understanding of the competitive landscape, and we read published research on these companies from a variety of sources. UC is a large market, and can be delivered in many flavors, including out of the box and customized solutions. Alteva plays more in the customized, fully integrated space.
Unique Balance Sheet Asset
Dating from its days as a telecom company, Alteva owned a small interest in a wireless limited partnership, majority owned by Verizon (VZ). Alteva recently restructured this partnership agreement with Verizon, which effectively gave Alteva an ability to re-sell its interest to Verizon in April 2014, for $50M gross proceeds. This essentially created a very valuable put option that could be exercised European style, at the discretion of Alteva, based on different financial scenarios of how the partnership performed. We spent a considerable amount of time understanding the dynamics of this asset, and believed it would provide substantial downside protection to the investment.
Key Business Catalyst
Alteva has been in a well-telegraphed business transition, going from an old-school telecom company to a growth-focused UC company. The company has been paying a sizable dividend for years, and its shareholder base was primarily value oriented and yield sensitive. As new growth investors, however, we were highly confident that the company would, at some unknown point, reduce or eliminate the dividend, which would align the dividend policy with their new growth initiatives. In August, the company eliminated their dividend, causing a significant disruption in the shareholder base, and a significant price sell-off. We did not anticipate such a violent negative reaction, but were well prepared to act on it. Our conviction level to add shares in the $7 range was bolstered by the diligence we had performed around the put option. Our view was that the price would normalize once management began telling the story to a new subset of growth investors who would see the “value plus growth” opportunity, and take out the old value shareholders. We believe much of this shareholder transition is now complete.
Additional Research and Ongoing Diligence
We had an opportunity to attend their annual shareholder meeting around the time we were conducting diligence. This enabled us to meet additional board members, and some other shareholders, as well as deepen our relationship with management by showing our commitment to being actively involved shareholders.
We spoke to one of Alteva’s larger re-sellers to understand how they distribute Alteva’s offerings, and their general opinions of Alteva vs competitors.
Since due diligence is obviously an ongoing effort, we endeavor to speak with management at least quarterly. As such, we have had several follow up conversations with management.
Finally, we set up Google Alerts on all of our investments, which include key words relating to the company name, key products and the names of top management. This helps us stay in the information flow, and monitor the vast amount of information that is being published on virtually any topic.
Disclosure: Jason Revland is LONG ALTV
Further due diligence on Alteva and more than 170 other microcaps can be found in our MicroCapClub members forum. Here are the first three parts of The Power of Due Diligence Series.
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