I like a chart moving up and to the right. But even better is when there is an obvious reason behind the move – a catalyst.
One of the best catalysts is a motivated activist. An activist investor takes a large position in the stock with the intent of influencing the decisions made by management in some way.
This can take the form of polite suggestions conveyed through meetings (soft-activism) or hard-nosed demands of board member appointments and whole-sale management changes through proxy-battles.
The biggest activist shareholders get a lot of press – they are on the front page of the Wall Street Journal (think Carl Icahn) or Financial Post (think FrontFour). But many smaller, under-the-radar activists are out there clamoring for change in tiny, little micro-caps that aren’t followed by anybody.
Activism can help out the retail investor a lot, especially where the activist investor has outlined a case for value and a path to realize it.
In the next series of two posts I am going to outline a couple of names I have found with activists involved.
Electromed — ELMD-NASD
The first firm is in a familiar sector. One of my bigger wins for subscribers, has been Viemed – which has been a 4-bagger. Viemed operates in the COPD space, and Electromed does as well.
Chronic Obstructive Pulmonary Disease (COPD) is an umbrella term used to describe progressive lung diseases–COPD treatment is almost always for long term smokers.
The firm Zenith Sterling Advisors took an activist position in Electromed beginning this May.
At last count Zenith Sterling Advisors owned 5.9% of the outstanding stock in Eletromed. They have been buying stock up to a price of $6.30.
As best I can tell Zenith Sterling is a small fund with less than $10 million under management.
I would describe the activism here as being on the “soft” side. Zenith Sterling is not clamoring for wholesale changes. These seem to commend management for their operational work.
They are simply looking to have the value realized a little faster.
Zenith Sterling made their position clear in a couple of letters disclosed through SEC filings.
They recommended that Electromed authorize the repurchase of at least $2 million worth of its shares in each of the next three years
In fact, they would like to see even more spent on buybacks. They outline $20 million that could be put toward the cause.
Their reasoning is simple. Electromed is generating plenty of free cash and has limited investment opportunities for that cash. Its shares are undervalued compared to its peer group and a buyback would help close that gap.
Electromed manufactures the Smartvest, which is an airway clearance product.
Smartvest helps move mucus through the respiratory tract. The vest delivers small pressure pulses, which squeeze and release the torso, causing the individual to have small coughs. These coughs remove mucus and clear the airway.
The vest is used by people with COPD, cystic fibrosis, and neuromuscular disorders that do not allow them to clear their airways naturally. Poor airway clearance increases the chance of respiratory infection.
The vest allows patients to live longer in their homes – 93% of patients require some form of home care and the devices are sold through physicians that are caring for the patients.
The direct-to-patient model, requiring no distributor, leads to high margins and lots of cash generation. Electromed had gross margins of 76% over the trailing twelve months.
Being geared towards elderly patients, about 52% of revenue comes from Medicare/Medicaid.
Electromed has consistently driven revenue higher year after year. They have done this by adding salespeople and, more recently, improving the productivity of those salespeople.
Source: Electromed Investor Presentation
It may not be an exciting business, but it has proven to be a dependable one.
There is room for further growth. The company puts the opportunity in COPD, where there are over 4 million total patients, at 630,000 patients that are suited for the Smartvest, where only 70,000 are being served with it or some equivalent therapy. With the aging population that number will increase.
Electromed generates a lot of cash and this is where the Zenith Sterling comes in.
The company generated over $2.6 million of operating cash flow last year, even while their working capital decreased by over $1 million. Capital expenditures were a bit high over the last few months as the complete a new building expansion in Prague Minnesota, but in the past, they have averaged around $600,000 per year.
It’s not a stretch to say the business can generate $3 million of free cash a year on a normalized basis–more if the growth continues.
The activist investor, Zenith Sterling Advisors, believes that free cash will expand to over $4 million in 2021 and $5 million by 2022.
Source: Sterling Advisors 13-D Filing
They also believe that the money should be used by management to buy back stock.
Combined with the $7.8 million of cash currently on Eletromed’s balance sheet, Zenith Sterling Advisors expects that Electromed will have “$20 million of cash to allocate through the end of fiscal 2022”.
If Electromed allocated $20 million to buybacks it would be equal to “38% of Electromed’s equity market value.” Obviously, such a move would put a strong floor under the stock.
One of the things I love about activists is they do my work for me. Zenith Sterling has been helpful in this regard by characterizing the undervalued nature of Electromed’s own shares:
Source: Sterling Advisors 13-D Filing
The stock has moved up in the last week and that number is now around 1.5x sales, but even at that level, Electromed is quite reasonably priced.
Electromed sits at a market capitalization of $60 million. With $7.8 million of net cash, the enterprise value is $52 million. This seems like a not-unreasonable price for a business capable of delivering over $4 million in free cash in a little over a year from now.
I’ll be watching the stock closely. The big issue is that liquidity is really tight; the stock doesn’t trade much. But Sterling Advisors has painted an attractive picture. It has popped over the last couple weeks, but the stock is volatile, and I am hoping a better opportunity will materialize.