JDP Interviews Jess Ravich, Chairman of ALJ
Jeremy Deal interviews Jess Ravich about the unique private equity-like structure and culture of his ALJ Regional Holdings (NASDAQ:ALJJ). JDP, December 2015
Full Interview Transcription
Jeremy Deal, JDP Capital:
Okay, thank you for agreeing to this interview, Jess. Today is December 23, 2015 and I am Jeremy Deal, Managing Partner of JDP Capital Management. This interview is being recorded and is part of JDP’s presentation for the 2016 Manual of Ideas ‘Best Ideas’ conference.
ALJ is a holding company with three primary operating subsidiaries – Faneuil, an operator of electronic and manual tollbooths, Carpets ‘n’ More, a retailer of flooring and home furnishings in Las Vegas and, most recently, Phoenix Color, a manufacturer of book components and educational materials.
Jess Ravich is the Chairman of ALJ and the company’s largest shareholder. Jess is also Group Managing Director at TCW, a large investment manager and is on several other public company boards. To provide some background, JDP invested in ALJ in April of 2014 through a private placement that helped fund the acquisition of Carpets ‘n’ More.
We paid $1.60 per share, around five times what we estimated (run rate) EBITDA to be. The multiple was attractive because the subsidiaries had virtually no maintenance CAPEX and they were also being shielded from federal tax due to massive NOLs. The effect was that EBITDA was more or less equal to cash flow, and we thought the market would recognize it sooner or later.
But the transformation and value creation happening at ALJ was not totally visible in the income statement and it took a bit of instinct and confidence in you, Jess, to ultimately justify our investment because it was very large for our fund at the time. Since then, the stock is up roughly 200% and in my view, still undervalued considering the Phoenix acquisition is not yet being reflected in the stock.
But the ALJ story is much bigger and more interesting than a valuation gap. For the purpose of this interview, I thought we’d talk more broadly about what makes ALJ so unique because these characteristics are key to our thesis on why we think the company will continue to compound value well into the future, and why ALJJ is still one of our fund’s core holdings.
Of course, a lot of ALJ’s uniqueness starts with you, Jess, so I thought we’d start with maybe your background, then a history of ALJ, its NOLs, how you view capital allocation and buying companies, and maybe finish by talking about your charitable foundation, Tia’s Hope. With that said, let’s get started. Jess, where did you get your start in business?
I started in the mid-1980s at Drexel as an attorney practicing in Los Angeles. I was fortunate enough to meet some people who were working at Drexel at the time who I went to business school with, who introduced me to Mike Milken. I moved over there in 1985 and it was an amazing time.
We were young men and women with all the energy of young people, but we were getting literally eight times the experience of our peers on Wall Street because we were doing eight times as many deals. When you combine the wisdom and the ability to have seen those deals over and over with a young person’s just general entrepreneurship, that’s what made Drexel so great.
How did that experience shape your perspective on how to value companies?
In two ways. I was a trader and I remember that one of the best days of trading would be the Friday after Thanksgiving. When nobody was around and somebody needed to sell, it was an opportunistic time to buy or vice versa and that attitude has continued through to ALJ.
At ALJ, we are not a call center company or we’re not a steel mill company, but we are opportunistic buyers. The best calls we get are from friends or bankers who say, “This is a fairly small company within a larger portfolio and the seller is winding down their fund. It’s at its normal end of life and they need to sell it or want to sell it.” Actually, all three of our current companies we purchased that way.
The original Faneuil was a division of Hartland Clarke, a subsidiary of Macandrews and Forbes (Ron Perelman holding company). It was a very small piece of their business; it was not relevant to what they wanted. We met with management who felt that without that constraint (of the parent), they could do a lot more. We wanted to expand them into other verticals and as far as the valuation went, we were not the top bidder, but Ron Perelman sold to us anyway because he wanted to take back some of this purchase price in stock because he believed in our vision and it worked out very well for him, obviously.
How did you get involved with ALJ initially as a company and what was it before it was the current ALJ?
When I was running Libra Securities, we were hired by a company called Network Entertainment – it later became Ustream Media –they needed to raise money for their business, preferred stock. Their business was basically when we were involved with them, was that they would prescreen movies, digitally downloaded at the time to college campuses to get buzz going for those movies.
They were paid by the colleges to present the entertainment and they were paid by the movie studios to start word-of-mouth. We raised a small $17 million in a convertible (note) at first. The stock took off. During the internet bubble, they went out and bought a company called 6 Degrees, which was sort of like an early Facebook—idea being that everybody’s connected six degrees to someone else.
We didn’t the raise money for that, but Credit Suisse raised $250 million for them. At one point, the stock had over a billion dollar market cap and then it all went away. When the dust settled, I still followed the company even though we didn’t have an investment in it. They had a stock that was trading in pennies, they had about a million dollars in cash on the books, and they still had the outstanding convertible note, that was basically owned by people who had purchased the convert and shorted the stock.
They made a fortune shorting the stock and really didn’t care what they got for their debt (convertible note), so I bought up all that debt and converted it into controlling interest in the company. When we took it over, they had a negative net worth of $13 million.
I vaguely remember something about it started with roughly $300 million in NOLs.
Can you describe what is an NOL (Net Operating Loss) to the people listening and how do they add value to ALJ?
Through the raising of funds from the Credit Suisse offering, they went out and bought other companies and those investments turned out not to be worth anything. Then through the internal revenue code, losses can be carried forward as net operating losses. The company earned, in essence, those losses, loss of money and it could be used to offset future gains, but there are restrictions on the ability to use that going forward because there can’t be changes of ownership. In essence, the people that loss the money have to now find a way to make money themselves. They can’t sell that NOL to another profitable company, so it’s basically a 50% change of ownership over any three-year period and you have to make sure you follow all those rules and don’t violate any. Otherwise, you could lose it for use or even eliminate the use of the NOL.
How far along are you in using these NOLs?
The most current public statement, the NOLs are down to $154 million.
Once these NOLs are used up, is it possible for ALJ to benefit from partnerships with other NOLheavy companies?
It’s not really a partnership. Again, because you can have a change of ownership of 50% every three years, if you have a long-term vision, you can make investments in companies that may have NOLs and no real operation and slowly buildup your ownership so that over a three-plus year period, you could have control of that company and those NOLs.
Obviously, NOLs always occur – certain companies generate them – at times of tremendous strife like the dotcom bubble and this last recessions. Those things, lots of companies generate NOLs and so we have been actively looking at other companies that we can start to make investments with.
Eventually, we think we have a way of using those NOLs for the benefit of our shareholders, but it wouldn’t be something that could take place, again, at least for three years and a day.
Switching gears a little bit, I wanted to talk about capital allocation. Today, what are you looking for in an acquisition and how do you find it?
Going back to my roots of being a trader, we’re looking for values that because it’s either too small or doesn’t fit, people need to get out, whatever the reason is, and we are there to stand up and say, “Here’s our bid, we’re willing to buy it.” It may not be the best bid, and we loose a lot, but we’re very disciplined.
What we’re looking for is, I was around when net income was a number and then EBIT, EBITD and EBITDA and then EBITDAM. Essentially, people kept adding add back to get to positive numbers in order to get ratios, in order to give metrics, in order to put in their company. I still like to follow cash.
I like to understand how much cash a company generates and our board has the same view. We look at buying companies roughly four to five times cash flow. The inverse of that is they get either 20% or 25% cash on cash return.
Most of the companies we’ve bought have been low CAPEX businesses. We enjoy running them and then at the right time, for example, the steel mill, we got a call from a banker who said, “My client is a Ukrainian conglomerate. They really need to buy KES, and this is their plan. They have looked and this is the company they want to buy.” I said, “That might be the worse opening line I’ve ever heard from somebody who wants to buy a company,” because it just immediately changed the price value.
We weren’t shopping it at the time and we sold it. The KES story is part of the ALJ story because we bought a steel mill that was closed. Nobody cared about it, the banks didn’t want it. We renegotiated the deal with the unions, we reopened. All told, we spent probably $10 million refurbishing the steel mill and at the end of the day, we sold KES for $114 million.
It’s about finding what people don’t want, and understanding that they may not want it, and we may agree with them that it’s not a good business, but the businesses that we put together now, we’re very comfortable with.
They have long runs, they are large players within their niche and each one of them, using a dough analogy, our goal is to increase their revenue and the profitability within their basic business, their fairway. But we want them to still look into the rough.
Faneuil started out as tolls. They’ve added utilities, they added health care. We’re adding government 311/511, so the same basic skill set that they had, we can now find other verticals and that’s really how you grow your business.
You seem to find a value in orphan corporate divestitures. Maybe mention how does this happen? How does a company become orphaned and why do they have more value as part of an ALJ subsidiary versus where they had come from originally?
It gets back a little bit to the motivation of management. We buy things, we do our diligence. Of course, we’ll hire outside experts to help us, but the final check of the businesses we’ve bought, it’s only been four, but in the case of all four businesses, the management writes a check (in an amount) that is significant to them, to be our partner in owning the business because we don’t bring in our own management, we don’t go and fire everybody and start anew. To make sure that there are no ghosts out there, skeletons in the closet, we want management who’s lived with the business to be part of it. When they own a piece they’re always motivated, but as owners, they look at things a little differently and they talk about, “Hey, we could expand here,” or “We really need to cut back here,” and that’s what we want. I have weekly or bi-weekly calls with each of the management teams and we talk about it as a partnership.
Yeah, that’s very interesting because it gets us into the next thing I wanted to talk about, which was you mentioned Faneuil a number of times. It’s the first acquisition as far as when we got started with ALJ that we were able to observe, but we heard you at a couple of shareholder meetings ago praise Faneuil’s CEO, Anna Van Buren, and we think that part of her success is aligned with the compensation plan that lets her earn a percentage of the company’s EBITDA above a stated threshold.
It goes back to what you were taking a bit about earlier. Your subsidiary CEOs are almost compensated like fund managers. Can you talk a little bit about how you view compensation and how to best align everybody’s interest?
We are an entrepreneurial company. We are either victims or heroes of our path. I grew up in the investment world and understand how fund managers and investment managers are compensated. We brought that over to our subsidiaries. Each of our management teams of the subsidiaries are compensated the same way Anna is, which is we determine a baseline, and they get a percent above that.
John Scheel and his management team, that was the same thing at KES. It’s been that way for all four of our companies and there’s no cap to it. I hope that they all become super wealthy because that means all of our shareholders become super wealthy.
We want them looking even as they go from $10 million to $15 million of EBITDA to not rest on their laurels, but understand if I go from 15 to 20, I’m still going to make more money as opposed to, “I’m in an industry where X million dollars is the most I’ll ever get paid”.
There’s no limit, just like there isn’t for a fund manager. A fund manager who’s got, in the old days, a 2 and 20 or a 1 in 15 (comp structure), there’s no cap to what that 15 (15% of profit) could be. The LPs are very happy paying them that much when they do well, so we brought that culture over.
ALJ has a very unique, low-cost corporate overhead structure that we love and I think it’s misunderstood, but from what I understand, the structure is really nimble and the team is essentially you, your CFO, Rob Christ and your legal team in Palo Alto.
You also save substantial costs by trading only on OTC and not listing on NASDAQ. Can you maybe talk a little bit about why this nimble infrastructure is such a competitive advantage for ALJ shareholders and even into the future as you grow?
There’s two parts to this. The first is, at the holding company level, we have nine directors, we have two employees, and we take advantage of everybody’s expertise on the board to filter down and look at different businesses. Whoever has the expertise will help in making those acquisitions.
At the time we are looking at something, we’ll hire expert bankers to help us, but we don’t need a very bloated system up at the parent because it’s really a roll-up of the various subs. With regard to trying to keep our cost down, as you mentioned at the beginning, I’m a large shareholder of the company. I look at this company as I hope every CEO would look at it is that we’re trying to save money for our shareholders as we generate cash.
If there’s something for us to do with it, we’ll invest it. If there isn’t, we’ll give it back to our shareholders. When the day comes that our investing IRR is less than what our shareholders can get, we’ll distribute it out. For a lot of years we’ve been on the pinks (pink sheets).
A lot of shareholders have wanted us to up list, and we’re always looking at that. We’re probably at the level now where that might make sense. We’re larger now, we have other acquisitions we may want to make, and having a listed (major exchange) currency may be helpful. That part may change in the future, but again, we’ll look at it as it pops up and around.
Speaking along that line and ALJ’s board, you guys have really transitioned nicely. It wasn’t too long ago that you were somewhat of an unknown, illiquid nano-cap cash box and now you’re roughly a $260 million enterprise-value company.
You guys have done a great job of transitioning the board and the oversight throughout that process. How do you think about governance and the evolution of your board over such a short period of time?
It’s a balance between having people that have a history with the company and people that could come in with a new view. We like to have the CEOs of our main subsidiaries on board. John Scheel was a board member, we no longer at KES, but John has tremendous manufacturing experience and can help us look at companies in that arena.
We added a gentleman, Mike Marofsky, who comes with a finance and legal background. We just recently added Maggie Hernandez. As we add people to the niche we want them to fill, still being cognizant at all times, that the duty is to all the shareholders, not just to the largest shareholders.
You’ve been to our shareholder’s meeting. This is an unusual event. I’ve been to shareholder’s meeting of companies with billions and billions of market cap, and nobody asks a question, and then it’s basically over. We sit around for an hour-plus, talking to our shareholders, having our management available (for Q&A).
We want them (shareholders) to understand what we’re doing. So far, it’s been working well. Someday, it may not work that well, but if you stick to what you do and you don’t drift, and your shareholders know what you’re trying to accomplish, they’ll be supportive even during times when the economy is not so (supportive).
Lastly, I just wanted to maybe talk about Tia’s Hope, your foundation and the work that I believe you are doing. It’s for children and their families who are forced to stay in hospitals for an extended period of time. Can you tell us a little bit about that?
Unfortunately, my wife passed on March 29, 2012 after spending 11 years in and out of the hospital dealing with non-Hodgkin’s lymphoma. My four daughters and I wanted to do something to honor her. She always had a thing, she would hug the girls or talk to me and say, “We’re creating a memory moment, something that will always be remembered.”
We wanted to carry that through, so we started Tia’s Hope and the first year we associated with one hospital, City of Hope out in Duarte, California and got involved with 500 families, giving them gifts and having holiday parties. We expanded so that in three short years we’re up to eight hospitals in Texas, Nevada, New York, Louisiana, California.
This year, we’re dealing with over 4,000 families. We, again, throw parties at all the hospitals and give financial gifts. Some use the gifts to pay for food, some use it to buy clothing, some use it to buy gifts. This year, we’ve added another thing where we’re taking children from the hospital to sporting events.
Madison Square Garden has become our partner as well as UFC, as well as The Cave, and the Buffalo Sabres, to help these kids make memory moments by going to a locker room, or by going on to the field. It’s been an amazing ride and we hope to someday have Tia’s Hope in every state in the country, so we’re moving that forward at a fairly brisk rate.
That’s a great story. On that note, let’s wrap this up. Thank you so much for your time and have a happy New Year and I look forward to seeing you at the next shareholder meeting.
Sound good and to you as well. Thank you.