Greystone Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. Greystone is a privately held investment company. The investment firm seeks to simplify and add value by identifying opportunities in good and bad markets. During the third quarter of 2020, returns for separate accounts managed by Greystone Capital ranged from +10.4% to +22.4%. The median account return was +15.8%. You should check out Greystone Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Greystone Capital highlighted a few stocks and Rimini Street Inc. (NASDAQ:RMNI) is one of them. Rimini Street Inc. (NASDAQ:RMNI) is a software company. Year-to-date, Rimini Street Inc. (NASDAQ:RMNI) stock lost 4.9% and on November 6th it had a closing price of $3.69. Here is what Greystone Capital said:
“Our position in Rimini Street has been essentially flat following our initial purchases nearly two years ago. I’ve added to the position here and there during periods of share price weakness, and have been watching from the sidelines as the company has improved operations, consistently grown the top line, made key salesforce hires, expanded into global geographies, and cleaned up the balance sheet.
While it’s possible that the original reasons for the mispricing still exist – SPAC structure, potential dilution in the form of warrants, low float, legal issue overhang – my attempts to study the software support industry and efforts to learn more about the business leave me feeling as though Rimini Street is a high quality business delivering a huge value proposition, and doing all of the right things from an operational and capital allocation standpoint, meaning its only a matter of time before the market notices and the share price catches up.
It’s during times like these – when the scoreboard (a moving stock price) has remained dim – it becomes important to remind myself of Greystone’s investment philosophy of long term thinking and multi-year holding periods, even if the trading prices of our positions are visible every day.
When I first started researching Rimini Street, it became clear to me that they were operating in a way that created win-win scenarios for both themselves and their customers. I later learned that this approach can be referred to as creating something called ‘non-zero sumness’. The idea is that when a company creates a large amount of value for their customers, which then also creates value for themselves, it ends up creating a large amount of this non-zero sumness. You might think that every business is in the habit of creating as much non-zero sumness as possible, but I’d argue there’s a large difference in customer delight between Amazon and Macy’s, Wealthfront and Wells Fargo, and Oracle and Rimini Street. In fact, the historical operating environment in the software maintenance industry has, for the largest businesses, typically been ‘I win, you have to deal with it’. This is partly what created the opportunity for disruption by Rimini Street.
So taking that a step further, when a company’s main focus is to create a large value proposition for their customers instead of just themselves in the form of say high prices, transaction friction, or locked in contracts, they can create even more positive win-win scenarios. It is precisely this focus on customers that has led Rimini Street to establish their current competitive position where they continue to step over the once-unbreachable moats of large incumbents such as Oracle and SAP. This value add still isn’t totally captured on the income statement, but RMNI figured out that the correct way to run their business (after seeing this momentum develop) would be to spend as much as possible acquiring customers, providing excellent support, and widening their reach within the software maintenance and support industry.
These types of investments – damaging to short term results, but part of a long-term strategy – are precisely the types of things I love to see management underwriting, and are business strategies that the market is terrible at incorporating into long-term valuations. Although there remains plenty of dilutive scenarios within the company’s capital structure, with a cleaned up balance sheet and nearly 100% recurring revenue, Rimini still trades at a valuation of less than 2x sales despite their top line growth and sticky product. Furthermore, modeling a draconian scenario for the business a few years from now including full dilution of convertible debt/warrants, slowed growth and higher than projected legal spend still gets me to a valuation over 100% higher than the current share price.
RMNI also has leverage within their business to pursue alternative courses of action in order to generate cash flow. I’d estimate even with slowed sales and marketing spend, and with gross margins unchanged from today, RMNI may be able to generate in the neighborhood of $100-150mm in EBIT by 2022. Significant for a company with a fully diluted enterprise value of less than $500mm.
RMNI was able to report very good results during the second quarter, with revenue growth of 12%, active customer count up 13%, and first half of the year free cash flow of around $44mm. This was all on the back of a 26% increase in operating expenses driven by higher sales and marketing spend, higher SG&A and lower litigation refunds received than in 2019. As RMNI continues to beef up their sales force (there were an additional nine hires made in the quarter), the company should see an inflection point where fully ramped sales capacity begins to show up on the income statement as increased revenue and bookings. There is quite a long onboarding and sales cycle for both new hires getting to full production as well as when Rimini enters a new geography where management estimates a nearly two year period before additional meaningful revenue starts to show up following new sales hires and additional business wins. As a result, Rimini has outlined a target of 100 sales hires by the end of 2020, and seems to be making steady progress. Management talks a lot about their multi-year view on things as well as what the business could look like in as far away as 2025. This is music to my ears as I feel as though management and the board have adopted a long-term strategy centered around doing what’s necessary to create positive business results over many years.
RMNI is on track to generate around $65mm in free cash flow this year, which would put the company valuation at under 8.0x free cash flow (using a fully diluted enterprise value and elevated legal cost assumptions). That seems like a fairly low multiple given high teens revenue and customer growth, intentionally elevated sales and marketing spend depressing GAAP earnings, and a cleaned up balance sheet. A look at the share price performance may reveal one thing, but a look at the business performance reveals another, more positive thing. I prefer to focus on the latter, as the share price will eventually catch up to the operating results.
Of note, RMNI issued a decent chunk of equity in August – seemingly out of nowhere – which the market did not like, sending the shares down significantly following the announcement. My understanding is that with nearly $50mm cash on the balance sheet, the raise, at a low valuation for nearly $30mm, will be utilized to take out the company’s preferred stock. If that happens it will only serve to simplify the story and clean up the capital structure.”
In Q1 2020, the number of bullish hedge fund positions on Rimini Street Inc. (NASDAQ:RMNI) stock decreased by about 22% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t believe in Rimini Street’s growth potential. Our calculations showed that Rimini Street Inc. (NASDAQ:RMNI) isn’t ranked among the 30 most popular stocks among hedge funds.
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