Sham Gad has provided the following guest post on Paragon Technologies (OTCBB: PGNT), which Daniel Rudewicz of Furlong Samex also covered in January. Sham is the managing partner of Gad Capital Management, a value-focused investment firm modeled after the Buffett Partnerships based in Athens, Georgia. Gad is also the author of the recently released, “The Business of Value Investing: Six Essential Elements to Buying Companies Like Warren Buffett.” He earned his BBA and MBA at the University of Georgia.
Paragon Technologies: Catalyst to Unlock Shareholder Value
Paragon Technologies (OTCBB: PGNT) is a $3.7 million market cap company with $5.5 million in cash and $5.2 million in equity. It’s operating subsidiary, SI Systems, has a 50 year history as a quality provider of material handling systems for many of the world’s top corporations. Unfortunately over the past decade, current management has not succeeded in growing this company. Since 2001, sales have been on a steady decline and the company has generated positive operating income in only 3 of those years. Clearly management can not hide behind the veil of economic turmoil.
A Strategic Alternative
It’s obvious why value oriented investors may be attracted to Paragon. Shares trade for $2.40, there is $3.60 in cash per share, and tangible book value of $3.40 a share. As you can see, the vast majority of book value is cash, not inventory or other hard to sell assets. Yet this cash margin of safety has been eroding for the past couple of years as SI Systems deteriorating operations have consumed cash. Left unchecked, what cash cushion remains today will likely disappear under the current status quo. Since year end 2009, cash per share has declined from $4.15 to $3.60.
In the meantime, current management continues to sit still waiting for one of two things to happen:
1. A pick up in new material handling systems orders; or
2. A sale of the company
As I discuss below, here is why shareholders can not wait for this to happen.
New Order Demand
While there is no doubt that the recession has had a profound effect on the new order volume of Paragon, the company counts names like Caterpillar, Harley Davidson, and Honda Motor as previous customers. Clearly the company has (or at least had) the infrastructure to support Fortune 500 companies. These industrial giants expend hundreds of millions if not billions of dollars annually on cap ex. A mere basis point allocation of this cap ex would significantly impact Paragon which today does less than $10 million in annual sales. Yet somehow the company has not been able to find a way to achieve new orders for years. If you accept management’s argument that new orders lag an economic recovery, then any realistic uptick in new order won’t occur until 2012 based on the current economic data. With SG&A expenses now accounting for 50% of sales, I don’t think this company has the luxury of time.
Sale of the Company
This one is quite simple, yet management seems perplexed. Based on my conversations with the CEO, the only offers being made value the company for its cash. While I will agree that the industrial operations are indeed worth something, any buyer today is buying those operations generating losses not profits. So management waits, refusing cash offers, while allowing the cash to decline. According to the CEO, the company has been trying to sell itself for a couple of years. The offers back then were materially higher than today, yet management continues to wait it out.
An Elegant Solution
While management waits for better days, the only thing they have done is reduce expenses here and there. While I will be the first to applaud this effort, its clear those actions alone are no longer enough. More so, despite the reductions, the company overhead looks bloated given its size today. As the company’s largest shareholder, I have proposed the following 4 point solution in my efforts to salvage this company and unlock shareholder value. In one way or another I have discussed these alternatives with management that I would like to aggressively explore as a member of its Board:
1. Addressing the company’s current compensation package – until the company demonstrates substantial operational improvement, compensation needs to be reflective of the current reality. As of the most recent quarterly filing, SG&A expenses constituted over 50% of sales.
2. Review and analyze efforts to sell the company – for over a year, management has indicated its preference for selling Paragon. I want to work with the Board to ensure that all avenues are explored in order to determine if an attractive sale price exists.
3. Immediately work towards bringing SI Systems back to operational break even – Paragon has had positive operating income in only 3 of the past 10 years. Moreover, it’s only because of asset disposals that the company has been able to increase cash on the balance sheet. Clearly something needs to be done at the operating level.
4. Examine alternative strategies with the balance sheet – The current investment legitimacy and marketability of this company squarely hinges on the cash on the balance sheet. Over the past 2 years this has declined as the operating business has not been a provider of cash, but a user of it. Any future value of Paragon is significantly influenced by the amount of cash on the balance sheet. I believe current management has spent the past year or more looking for a buyer. If today’s economic reality is such that no buyer exists at a mutually attractive price, then the Board has a fiduciary duty to, at a basic minimum, explore alternative options which may include utilizing the cash to make investments unrelated to the current operations of Paragon. By not doing so, they are effectively allowing the cash to deteriorate, while they wait for a potential buyer to appear. Unfortunately, as each week, month, and quarter passes by, the cash declines bringing any potential sale price down with it.
Clearly this company is need of change. While the current Board may sincerely be working in the best interest of shareholders, they have not delivered over the past several years. More importantly, the fact that they refuse to consider alternative solutions suggests a lack of fiduciary responsibility. While economic turmoil has clearly been a weighing factor, one can not continue to hide behind such conditions permanently. I welcome any and all emails and question.
Disclosure: Long PGNT
Shareholders in PGNT may send any inquiries to shamgad@gmail.com.
No position.
Paragon Technologies (OTCBB: PGNT) is a $3.7 million market cap company with $5.5 million in cash and $5.2 million in equity. It’s operating subsidiary, SI Systems, has a 50 year history as a quality provider of material handling systems for many of the world’s top corporations. Unfortunately over the past decade, current management has not succeeded in growing this company. Since 2001, sales have been on a steady decline and the company has generated positive operating income in only 3 of those years. Clearly management can not hide behind the veil of economic turmoil.
2. A sale of the company
4. Examine alternative strategies with the balance sheet – The current investment legitimacy and marketability of this company squarely hinges on the cash on the balance sheet. Over the past 2 years this has declined as the operating business has not been a provider of cash, but a user of it. Any future value of Paragon is significantly influenced by the amount of cash on the balance sheet. I believe current management has spent the past year or more looking for a buyer. If today’s economic reality is such that no buyer exists at a mutually attractive price, then the Board has a fiduciary duty to, at a basic minimum, explore alternative options which may include utilizing the cash to make investments unrelated to the current operations of Paragon. By not doing so, they are effectively allowing the cash to deteriorate, while they wait for a potential buyer to appear. Unfortunately, as each week, month, and quarter passes by, the cash declines bringing any potential sale price down with it.
Clearly this company is need of change. While the current Board may sincerely be working in the best interest of shareholders, they have not delivered over the past several years. More importantly, the fact that they refuse to consider alternative solutions suggests a lack of fiduciary responsibility. While economic turmoil has clearly been a weighing factor, one can not continue to hide behind such conditions permanently. I welcome any and all emails and question.
Disclosure: Long PGNT
[…] fall in the maybe category. There may be value here, just maybe. Thanks to Whopper Investments (http://www.whopperinvestments.com/) for the feedback. Much appreciated. I originally wrote this up over a month […]
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[…] 7, 2010 by greenbackd Sham Gad has provided an update on his earlier guest post on Paragon Technologies (OTCBB: PGNT), which Daniel Rudewicz of Furlong Samex also covered in […]
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I’m not sure how having the compnay expend resources to hire “strategic advisors” makes any sense here…for the past two years, mgmt has worked w ibankers trying to find an alternative…it hasn’t worked….
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Agree with Shaun. There is a lot of risk here and the upside is diminishing. When Buffett got involved in these types of situations, he had a back-up plan to keep buying shares until he got control, if we was not unable to unlock value by working with management. Graham warned about getting into net-nets where there was a clear erosion of value, for example via high cash burn.
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Personally, I think I’d need to see some news of them hiring strategic advisers before I’d be interested in being long this stock. Otherwise management action shows no true incentive to unlock value here. If I were them I’d just do nothing and collect my egregious compensation till the company was gone.
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