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We’re back with another edition of Elevator Pitches.
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In this week’s issue, we're happy to share five ideas, including:
A microcap provider of educational content and resources
An international powerhouse in engineering and defense
An influential entity in asset management and infrastructure, with a strategic focus on renewable energy and sustainable growth
A leading facilitator in the energy sector, known for its pivotal role in energy transfer and commitment to environmental stewardship.
A niche manufacturer in the specialty chemicals industry, renowned for its bespoke products and dedication to quality and innovation
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Let’s get to it.
Smoak Capital walked through thesis on microcap educational products company, Goodheart-Willcox (GWOX) in their latest letter. We include it below.
Goodheart-Willcox (OTC:GWOX)
Goodheart-Willcox is the previously unnamed position I discussed in my mid-year letter. Goodheart-Willcox is an educational products provider that specializes in Career & Technical, Health, and Physical Education, notably outside of the more competitive mass market textbook subjects (Math, Language Arts, Science, etc.). They have strong customer relationships and market share across a number of CTE subjects and most recently have had success winning new customers for both their Health Education and Financial Literacy products. It has historically been a pretty good business with operating margins around 10-15% and a growing but lumpy top line. In recent years though, the business has undergone a significant transformation that I believe is greatly underappreciated. The company’s digital revenues started to gain significant traction in 2018 and have only accelerated further post-pandemic, now making up almost 40% of revenues and still growing 35%+ per year. Operating Margins are now 30% and climbing and cash is quickly piling up, despite paying a large special dividend at the end of 2021 (33% of the market cap at the time) and paying out a majority of net income as a dividend.
The underlying reason for the excellent performance of the business is very simple. The pandemic and distance learning accelerated technology usage in and out of the classroom and now nearly every middle and high school student has a school provided laptop. This creates a strong and obvious incentive to purchase digital content in and out of the classroom. The educational content providers that have adapted quickly providing high quality, relevant digital content have been big beneficiaries of this demand wave. Interestingly, this hasn’t turned into much cannibalization at all on the legacy print textbook sales either, most buyers prefer to bundle and get the print textbook and digital content together. Importantly, this digital revenue is sold through all their pre-existing customer relationships and sales staff, so given digital gross margins are so high (I estimate 90%+), the incremental margins on these digital sales is extremely high and drops straight to the bottom line. It’s also important to note that there is a large divergence between reported Net Income and FCF. This is because most of their digital revenue is LT, typically 6-7 year licenses, and they receive all the cash up front with relatively minimal ongoing costs over the remainder of the contract. Because of the LT nature of the license, GAAP only recognizes revenue ratably over the 6-7 year contract term.
So, the big takeaways are true economic earnings are much better than presented by GAAP, and true economic liabilities are a far cry from what is presented on the balance sheet. I estimate they have around $85M of cash right now, well over half the market cap, and nearly all of that is excess cash given the ongoing profitability and growth of the business and their limited capital needs. This also means billings related to the digital licenses are growing even faster, albeit much lumpier, and much larger than reported revenues.
Despite this transformation, shares trade at only 3x EV/FCF and yield 6-7%, far below comps of 12x FCF or higher (most notable comp is HMHC which sold to Veritas for 12x FCF in 2021, which many holders understandably thought was criminally low), which would value the business at over $760/sh. One of the primary reasons HMHC holders were against selling at 12x FCF was HMHC’s incredible opportunity to create significant shareholder value by capitalizing on the accelerated shift towards digital learning. Goodheart-Willcox has fully taken advantage of this ongoing secular shift yet trades at a fraction of its true value.
Four more ideas below are reserved for our paid subscribers.