Creston, a smaller holding, was bought out by its largest shareholder in November. While we were cautious of this shareholder’s intentions, we had been comforted by the presence of unrelated large shareholders, whom we believed would counter such an offer. That comfort proved to be without merit. The 27% premium to the three-month average share price was much too low in our opinion—representing a valuation of approximately 10x free cash flow (which we believed to be below the firm’s earnings power). We voted against the offer. The total internal rate of return (IRR) since the inception of the idea in 2012 (prior to the Boyles launch) was 7.9%; without the impact of currency, the IRR was 14.4%. The modest outcome was impacted by the severe decline in the British Pound; the modest early outcome of an acquisition the company made; mediocre management which, while changed, was unable to generate organic growth; and as mentioned, the modest exit multiple.
Electronic Data Processing
We noted earlier in 2016 that the company was considering strategic alternatives. While we had expected a resolution prior to the end of the year, the process remains ongoing. We hope to hear of a resolution to that process in Q1 2017. Results released in December showed soft revenue with beneficial ongoing cost management efforts. Importantly, the company was able to finally dispose of a property that had been difficult to sell over the years. We believe this was a necessary precursor to a sale of the company.
Current operating results have been poor due to the overall macro conditions in the marine, oil and gas, and construction industries. Crucially, the company has noted its intention to spin off a cluster of start-up investments that have been cultivated during the last five years. While progress on these investments has been frustratingly slow so far, there are early signs of significant commercial progress in several of the businesses. The company has targeted a spinoff during the next 12 to 18 months. Shares remain quite cheap in relation to tangible book value.
Shares performed quite well in 2016, contributing significantly to our performance during the year. The decline in the British Pound during the year provides a tailwind to reported performance, given that a substantial portion of the business is outside the UK. Growth, beyond currency impacts, also seems to have accelerated. Importantly, the company’s launch of an advertising agency called System1 Agency in 2016 seems to have progressed well. The company is adding meaningful talent investment in this business. Any success with System1 Agency would provide significant upside well beyond the base case that continues to drive our thesis, and supports the current portfolio allocation.
Echelon Financial Holdings
Shares performed poorly during 2016, as it became evident that the company’s expansion in Europe was indeed foolish. Our, and others, calls to moderate this expansion over the years we’ve owned the shares went unheeded. The sale of that business (announced during the summer) at a large discount to book remains subject only to local government approvals. Echelon shares continue to trade at a discount to tangible book value. Upside is dependent on the performance of new management in the company’s core business, and is acceptable, given that downside protection is quite formidable at recent share prices.
This post has been excerpted from the Boyles Asset Management Q4 2016 Letter to Partners.