In the 4th quarter we added one new mid-sized position. While we are largely small-cap, technology, value focused, it’s unusual for us to invest in a sub $30 million company – that’s small, even for us. However, in the 4th quarter we established a position in RMG Networks (RMGN).
Superficially, if you take a quick look at RMGN’s marketing materials they appear to be a video display company, but they neither manufacture nor install displays. They are actually a software company that provides enterprises real-time data on displays for a variety of use cases – call centers, logistics facilities, retail outlets, hospitality, etc. We think it’s unusual for a company of this size to have 70 of the Fortune 100 as customers, and equally importantly, to lack significant customer concentration.
We established our position at approximately $0.75 – the stock closed last Friday at $1.08. The company’s historic troubles stem from its former management team that spent excessively and was distracted because it was running its display business and an unrelated airplane advertising business – the former CEO’s expertise (which was divested in July).
Under the new CEO, Bob Michaelson, the company has reduced opex (which we expect to be down again sequentially in 4Q vs 3Q, to be reported on March 10th), grown sales and backlog, and for the first time in 5 years developed a new operating platform and added 6 new products. There’s now a very good reason to reengage with the company’s numerous Fortune 100 customers.
This is essentially a high margin software business (~53-59% gross margins) with 30-40% recurring revenue. We believe the company will approach breakeven in 4Q, versus the single sell-side estimate of a ($0.07) loss (equal to 3Q loss, despite likely lower op-ex and seasonally strong revenue). While 1H tends to trend lower from 4Q, we have modeled, and are confident, that by 3Q or 4Q 2016 the company will earn $0.04-0.05 per quarter, or a $0.16-$0.20 run-rate.
At a 20x multiple, that would imply a $3.20-$4.00 stock, or a 4x-5x return from our cost, and 3x-4x current prices (shares are now at $1.08). It’s worth pointing out that both the CEO and CFO made open-market share purchases post 3Q results (albeit relatively small open-market buys). In addition, the company has $6 million of net cash and in November secured a $7.5 million credit facility (at an attractive prime plus 1.25-2.25%, depending on conditions) from Silicon Valley Bank. We believe that SVB providing a low-cost credit facility to a historically money-losing nano-cap is strong evidence that far better times are ahead. In our experience, SVB does thorough due diligence, and would not provide such financing without extensively evaluating a company’s business plan and prospects. In our conversations with management it’s clear that the company has no need for any financing, and believes its new operating platform, several key sales hires, and additional products position the company for growth.
Again, at Dane we don’t typically spend lot of time on $30 million market cap companies, but ones that can return 4x-5x, with clean balance sheets, motivated managements, and that have been vetted by high quality banks (i.e. SVB) present what we believe are highly asymmetric risk/reward opportunities – and if 2H plays out as we expect, 2017 could be extremely interesting for RMGN as the digital signage market is expected to enjoy double-digit annual growth into the next decade.
This post has been excerpted from an investor letter of Dane Capital Management.