Update No. 151 – 22/02/14

I mentioned last week that we have recently some buying and selling. My promise to investors is that although I will not always discuss in depth what we own, I will tell you a little about our holdings when we sell.

Our sales last week were of a holding I had mentioned in the blog previously, Dicker Data. In the linked blog, I posited a valuation of $1.13 about 6 months ago. Dicker is a company that is doing a good job of growing intrinsic valuation as it uses its recently expanded warehouses to add to its ‘box-shifting’ capacity. Major deals are getting done with important clients, including a recent deal with Microsoft.

Bearing all this in mind, intrinsic valuation is perhaps higher now than when the original post was made, I await the 4D to make an assessment, but perhaps $1.20 or thereabouts would be close to the mark all else being equal.

When I originally purchased our Dicker stock, I bought a stake of 175,000 shares at an average price in the 40c range. We have, as mentioned recently disposed some stock (we sold last week at an average price of $1.28); we now hold only 130,000 shares.

My reasons for the sale were twofold. Firstly, I believe the price we achieved at the sale was higher than the assessed intrinsic valuation. I did not sell our whole stake, however, as the business has excellent prospects, I will not go into too much detail here, but speak to anyone with even a tangential knowledge of the industry in which Dicker operate and you will conclude there are very good reasons why Dicker are steadily eating up market share. The first driver of the sale is simple portfolio management, the stake has grown larger than intended (a nice problem to have) and trimming the stake makes risk management sense.

The second reason is the primary cause of the rise in price that led to the sale. Dicker recently announced they will acquire Express Data, for $65.5m in cash, funded entirely from a new line of credit with Westpac. Unfortunately, the detail Dicker has provided to the market is sparse to say the least. The first release announcing the sale didn’t even mention the price. The second release gave up the price, but no financial metrics. Dicker is already easily the most leveraged business EGP own. Depending on your view, the fact they have chosen to acquire entirely using debt could be a good idea or a bad one.

EGP mostly own Micro-Cap businesses. Virtually all of the Micro-Caps we own have massive insider ownership – usually founding managers that have massive stakes. I view it as a substantial protection that a founder’s ego and net-worth are on the line with our capital.

The positive view of the decision by Dicker to buy Express Data entirely with debt likely indicates that Dave Dicker and Fiona Brown, the founders (and holders of 93.98% of the outstanding stock) were reluctant to issue equity and dilute their stake in order to do the deal. This is the view I am most inclined to take, they have built a large successful business from nothing because they understand the industry well, and they would be very familiar with Express Data’s operations.

The negative view is that the business has traditionally primarily grown organically, has minimal experience in substantial acquisitions and is now hyper-leveraged. When you are hyper-leveraged, mistakes only need to be fairly small to cause big problems.

On the whole, despite my disappointment that more detail regarding the intent of the acquisition has not been released, I expect owners whose interests are aligned with ours have more likely than not made a step-change in the per share earning capacity of the business. Dicker is already a business with good operating leverage, provided there are no substantial integration problems, and the additional cashflows are used to eliminate the debt quickly, the deal will probably work out well. I hope to be extremely upset with last week’s sale decision a year or two hence – Tony Hansen 22/02/2014

EGP Fund No. 1 Pty Ltd. Up by 0.60%, trailing the benchmark by 1.36% since January 1^st. Since inception, EGP Fund No. 1 Pty Ltd is Up by 65.29%, leading the benchmark by 37.57% all-time (April 1^st 2011).

^{*1 after 31May 2013 dividend of 2.333 cents per share plus 1 cent per share Franking Credit}

^{*2 calculated based on dividends reinvested}