Brief TREC Update
We will get to the ATTO update shortly, but for those who are following the TREC story, I wanted to draw attention to the recent buyback announcement. I was incorrect in my initial assessment, the large 792k share block last week was actually bought by the Company, and not by the activist parties. The press release is linked below:
I think this is a great development, because not only is it very accretive to buy back shares at low $8s, it also shows that management is presumably feeling the heat, and likely did this to placate angry shareholders. We could also view this as anecdotal evidence that mgmt. is likely “playing ball” with holders who are pushing for strategic alternatives. Of course as a public side investor I cannot say any of this with certainty, all of this is my own personal speculation. In any case I unequivocally see this as a step in the right direction, and added modestly to my TREC position at current prices.
ATTO reported 3Q’21 results yesterday after market close. Given that ATTO is my top position which I pitched in length in my prior writeup and on a public interview with Andrew Walker on the YAVP channel (linked here), I believe that subscribers deserve to know my thinking on a real-time basis, hence this speedy update.
Bottom line, I think the quarter was generally fine, with the only disappointment being on the revenue growth side of the equation. After a strong 1H’21 topline performance, I expected 3Q revenue growth rate to be closer to high single digits (vs. 4.1% reported, on a constant-currency basis). It appears that this “miss” was largely intentional, as the Company shed lower margin business rather than renewing the contracts to preserve the topline optics (good move in the long-term in my view). In any case, the official guidance was always for “mid-single digits” of organic growth this year, so it is likely that management set that bar for themselves knowing that there were some planned contract exits for 3Q which caused this sequential QoQ decline.
After reviewing the press release and listening to the earnings call, I think the fundamental thesis is intact, for the following reasons:
· Margin progression is well on its way, with 3Q EBITDA margin at 13.9%
· Higher margin US business ramping nicely, with further evidence of less profitable contracts being pruned elsewhere in the portfolio
· Despite 3Q revenue growth disappointing expectations, +4.1% organic growth YoY is still quite solid and certainly not a disaster
· 2021 guidance and 2022 targets reaffirmed
· Company has insurance for the cyber attack impact, which was confirmed as immaterial in the first place (in terms of impact on guidance)
What’s Up with the Volatility?
Let’s address this topic head on. There was some stomach churning volatility today, with the stock falling from $28 (yesterday’s close) to $22.74 at the lows (19% decline). Now, I could just say that illiquid, small cap stocks can always experience violent swings on the earnings date, but I think this is too lazy of an answer.
Here’s my best attempt at an explanation of what happened – the few days leading up to earnings attracted a number of “fast-money” speculators on a reasonably strong volume, who were just playing for a blockbuster quarter and planning to punt out for a 5-10% gain. When they saw that it was generally an in-line quarter with initial negative stock reaction on the open, they all scrambled for the exits when buyers presumably had their bids pulled to re-evaluate after the earnings call. After the call ended, the market realized that nothing really changed for the fundamental thesis, and bought the dip aggressively, sending the stock back from ~$22.7 to ~$26-27 within minutes. Full disclosure, I also tried to buy some at the lows but was unsuccessful, and did not make any further attempts to trade today.
Event Driven Path
Astute readers may recall that the 2nd half of my ATTO thesis was predicated on the likelihood of strategic alternatives in the not too distant future. I am a public side investor, so all of the following is my own personal speculation, but I believe there were several interesting clues:
First, the Company decided to postpone the Investor Day, after publicly guiding to a date in November this year – mgmt. said this during the 2Q earnings call, and have confirmed the same during 1x1 investor meetings to the best of my knowledge, so my alarm bells immediately started going off when they announced that the Investor Day was going to be postponed to April next year:
This naturally begs the question of why they decided to do this, and I believe the answer from the CEO during the 3Q call this morning was quite telling. I think it would have been extremely easy for him to blame this on COVID, that they do not expect many shareholders to travel, and they prefer to host the Investor Day in 2022, when hopefully COVID is more firmly in the rear-view mirror. However he decided not to use this convenient excuse and fumbled through the response that they had “too much going on” right now.
I actually think mgmt. may be telling the truth – there is a very logical explanation of the Company currently being involved in, or about to begin, a process to sell the business. If there is a line of sight towards announcing a deal towards year end or early next year, it absolutely does not make sense to host an Investor Day in November, which would be a huge time suck when management needs to focus their attention on strategic alternatives. Initially I believed it was a 50/50 shot between an innocuous COVID-related delay vs. a process, but assessing how management handled the question today, I now assign a higher probability to the latter.
Further, there is also the corroborating evidence of departures from the Company. I would note that at least two members of the IR team left the Company in recent periods (to respect their privacy I will not name them, but you can probably google your way through to confirm this). Of course there may be a million reasons for quitting your job, but one likely reason in this context is that they probably saw the writing on the wall, and decided to leave on their own terms before the inevitable – to state the obvious, the IR function probably does not need to exist if ATTO is acquired.
I will close this section with the caveat that I could definitely be wrong here with these speculations, but nonetheless wanted to bring them to light.
Involvement of Kyma Capital
Before we close, I also wanted to bring to your attention the involvement of Kyma Capital. They are a large public-side shareholder of ATTO, and recently released a very curious letter:
Full disclosure, I have no idea what their proposal is, and I do not want to go on a wild goose chase of speculation, given that they have explicitly said further disclosure is coming in short order.
However, I will say that I have previously spoken to the people at Kyma Capital, and have found them to be very sophisticated investors, with deep knowledge of the Company and the business model. I believe their continued involvement, and their willingness to voice concerns in the public domain can only mean good things, as their incentives are fully aligned with any other public side shareholder. I will be keenly waiting for further developments on this front.
Plum Capital is long ATTO common stock, TREC common stock and TREC call options