A money printing machine flying under the radar

I’ve been looking around for good qualitybusinesses that I think, over the long term, stand to compound their earningsand make their shareholders look very wise. I would like to think that I’vefound an example in HiTech. What will follow is a short analysis I’ve writtenthat should highlight some areas of strength, weakness, and provide a company comparisonto highlight the quality of senior management.

As always, I hope you enjoy and get somethingout of it. Please feel free to disagree with any single part, or the entirety.As always, these views are my own and do not constitute financial advice. Mindyou, who the hell takes financial advice from stranger keyboard warriorsanyway?!

HiTech Group (ASX:HIT)

The standard stuff:

HiTech is a listed company that specialisesin placing IT professionals with clients, headhunting new recruits on behalf ofclients or sending out consultants to client offices.

Started life in 1993 and listed on the ASXin 2000. Ugh, mid tech-wreck can’t have been fun for them.

The CEO and Chairman have been with thecompany from day one (26 years). Chairman Ray has 45.86% of the company. CEOElias has 17.94%. The top 20 shareholders have 81.76% of the company.

HiTech have paid a dividend for the last threeyears. Prior to this it was very lean with only one, half cent, dividend in2013. We need to go back to 2002 until we see dividends again.

The good:

Has a list of “ICT Professionals” that is370,000 people long.

Has over 490 clients across technologycompanies, banking and the Fed Gov.

They make decent gross margins. Each yearfor the last 4 they have sat at around 20% gross margin.

The net margin after tax has been steady at10% of total revenues for 4 years.

Revenue increased 10% from last year, netprofit increased 13%. Net profit has increased in jumps of 15%, 6%, 11% and 13%year on year since 2016.

The business has slowly worked out how muchcash it needs to keep on hand. It has increased the dividend and decreased theretained earnings to a stead state. Current year saw $1.6m retained and $3.6mpaid out in dividends.

The business has $7.6m of cash on hand, ormore than 13% of the value of the company. The stated purpose is a buyout of acompetitor. The payout ratio (63% of cash earnings) indicates they are churningout money at a decent rate.

There is zero debt.

The software they use has been depreciatedso heavily over the last 4 years that their total ‘intangible’ assets comes to$0, down from an eye-watering $859 last year.

They are ‘capital light’. There total plantand equipment comes to $222k. The overwhelming majority of their revenue comesfrom sales, not physical plant.

They have 2.7 times more current assetsthan current liabilities.

Cash flows can be increased with new salescontracts. No need for heavy amounts of capital.

Insiders hold the vast majority of theshares.

Total ‘key personnel’ pay came to $1m.Pretty good going for a $57m company.

With the entire company still worth lessthan $60m a lot of people are not paying attention to this little gem. If theycan buy a competitor and/or increase their government contracts there is a lotmore upside to this company.

The Bad:

Heavily reliant on salespeople

Heavily reliant on growth in the IT sector.A lull in demand would crush this firm.

No sign that margins are increasing.

Increasing cash balance indicates they; 1.Can’t find businesses to buy or 2. They don’t have enough money to buy them.Both could be true.

Most cash flow is paid out (63% as of thelast full year)

The verdict:

The current share price is $1.51. Thisgives a P/E of 17.36.

Now for my favourite part; math. If I canlook at a growth rate calculator I can see where the ‘mean-reversion’ of themarket might take HiTech over the next 10 years. In order to do this you needto have the current share price ($1.51), the current earnings per share($0.087), the current Price to Earnings ratio (17.36 – i.e. $1.51 / $0.087 =17.36). Now we need to ask ourselves; what is the market likely to pay,expressed as a P/E ratio, for HiTech in 10 years’ time? This future P/E is putinto a formula (hang on, I’ll share it with you in a moment) to work out whatthe earnings (the big E in the P/E) growth rate is expected to be in order forus to reach that P/E in 10 years’ time. In the end, the ‘baked in’ earningsgrowth rate is 5.67% p.a. The math looks like this: (17.36/10)^(1/10)-1 =0.0567 or 5.67%.

This is a decent growth rate and wouldrequire HiTech to go out and find a lot of new business. The upside of this isthe recent history of them doing exactly that! The last three years have seenthem eclipse the 5.67% growth rate, with this year coming in over 13%.

If they can spend that $5.9m and buythemselves some inorganic growth, they will hit this number without a doubt.

This is now a highly "relationshipdependent" company with a P/E of 17 so it isn't exactly cheap, but... aP/E of 17 is way safer than the infinite P/E of, say, AfterPay (ASX:APT)...

The bet here is that revenue and profitgrowth will continue to drive up the share price and insulate current investorsfrom any future share price shocks.

This last part is especially true giventhose sweet, sweet dividend cheques.

Ultimately, this very tightly held companydoes not have a lot of shares available to buy at any one time. This lack ofliquidity could see a single buyer forcing up the price. This would be evenmore noticeable than another personal favourite of mine Regional Express, whichis three times the size.

There are very favourable signs here.

OK, you want a bit of a rage story?

I would like to take a look at a study bycontrast. The two firms we will peak at are the high performing (at leastrecently) HiTech (ASX:HIT) and my all-time favourite leech, shit bag, no hope,borderline rip-off company… Nuheara (ASX:NUH).

So, I pointed out earlier that HiTech iskicking goals and making money with which they mostly do three things:

1. Reinvesting in the business. This iscash flow based growth (a good sign).

2. They are putting more cash in the bank.Now at over $7.6m. (also a good sign).

3. They are paying out dividends toshareholders. The latest declared dividend means a grossed up yield of 8.68% fromtoday’s share price of $1.51.

Yes, the business has a low overall capitalintensity. There isn’t much more to it than a room full of salespeople onphones and the occasional (it is Canberra after all) dinner and drinks with ahiring manager. Then they just send out the IT pros to the job and start takinga cut. That’s the labour hire business model in a nutshell, right?

Now, there have been concerns raised aboutthe overall pay the leadership team receives at HiTech so it is important thatwe look further into this.

So there are two key people within theleadership of HiTech, Raymond and Elias Hazouri. Raymondo is the chairman whileElias is the CEO. Raymond earns $511,190 a year while Elias earns $504,865 ayear. Well, that seals it. I’m going to go out and find myself a chairperson'sjob as soon as I have a chance. No day-to-day BS and a better pay deal. Sweet!

So we have our two key people being paidthe better part of $1m a year. This is probably a good time to point out a fewthings about HiTech. In the last full year (and it would appear this last halfyear things are only getting better) HiTech pulled in $33.3m in revenue andmade $3.3m in after tax profit. So their combined wages came to 3% of revenueor 30.3% of profit.

But wait, there is more. Between Raymondoand Eli, they own (and remember here; this doesn’t include partners or family)64.35% of the company. They really have put their money where their proverbialmouths were and if they reduced their own wages it would all really add cashback into their own, largely family controlled, business.

Here comes the contrast.

Nuheara. Ah, my old friend… To be honest,I’m as big a fan of a scam story as the next guy so I can’t even really beangry at them. I enjoyed John Carreyrou’s Bad Blood so much (the story ofTheranos in case you were wondering) that I wish he would take a look atNuheara so I could read that book.

First things first, you’ll be happy to knowthat if you did take out a short sale contract on Nuheara shares when they weregoing bananas (WA is truly the home of the shit company) and the share price wasaround 7 cents you would still be well in the green. But hey, they operate adifferent kind of business; one built more on hopes and dreams than any actualfunctional business model.

Now you might remember but the two keypeople at Nuheara are Justin “I look like a massive prick in a jacket over at-shirt” Miller and David “some random guy who lives in the US and collectsbulk cash” Cannington.

You’ll be happy to know that, even thoughNuheara has a larger total market capitalisation than HiTech that the senior leadershippay also reflects this. In fact, you’ll find that Mr Cannington pulled in $303,527last year and Mr Miller earned $391,749. Hey, it ain't cheap living thatWestern Suburbs lifestyle yo! Note: The Western Suburbs in Perth are very well-to-do.

While they are earning about the same, thatis pretty much where the similarities end between these two firms. Nuhearahasn’t ever made a profit and it certainly doesn't look like that is going tohappen this year. In fact, they diluted (yet again) their existing shareholderswith another equity raising. Such cool guys.

Meanness aside, I really want to know howgood a communicator Justin Miller is because, f* me, some people have thrownserious amounts of money at this investment cul-de-sac.

Keeping on track, Nuheara last year reported$1.7m in revenue and about $11.7m in losses. So, together, this $690k powercouple consumes 40% of total revenue and an infinite amount of non-existentprofit (dividing by zero has wholesale f*ed 3 of my calculators by now so Ijust stopped).

To be fair, these cool cats have gone intobusiness with a low margin retail product that faces severe competition fromwell financed competitors so of course it is hard. In fact, put like that itmakes me wonder if they are very bright at all… Anyhow; maybe they own most ofthe company shares and they are very much invested in the continued success.Let us have a look, shall we?

So David and Justin own less than 15% ofNuheara combined. This is still a lot (less impressive when you think it was areverse takeover and they put very little actual money in) but it is nowherenear the ⅔ ownership the main two people have at HiTech. But even with their sub15% ownership there is a catch. With this shit company of course there is acatch…

So, Nuheara (as predicted by everyone)realised it was going to run out of cash, again. What they did next was bothsuper sensible, totally stupid and utterly inevitable. They went out andmanaged to get some smooth talking investment banker dickhead to give them afat stack of cash as a convertible note. What is a convertible note? Basically,it is a loan or bond but it has the right to ‘convert’ (Yeah, I know, financepeople aren’t that original) into shares if the lender wants to.

Anyway, Nuheara has now got $2.4m in cash,minus expenses, and they gave up the ‘potential’ for 15% of the shares inNuheara. This is classic ‘backed into a corner stuff’. The lender got all ofthe guarantees and got their % interest. Then, if things work out because ofthis cash injection, they collect a bunch of the upside by converting to now‘valuable’ shares. Meanwhile, the existing shareholders continue to assume theposition.

Not only that, but this will mark about themillionth time that David and Justin have not purchased even one extra share inorder to help out their own business. In fact, this convertible note could pushdown their ownership even further upon full conversion. Yep, solid leaders.

So basically, we have two differentmanagement groups getting paid quite well, although, the advantage definitelygoes to the HiTech duo. One group owns two thirds of the business that is worththe same amount, earns 19 times the revenue, pays huge dividends and growstheir business. The other runs Nuheara.

Management is just one part of the overallpicture when you are looking at investing in a business but it can be a veryimportant one. If you only learn one thing, try and learn how to spot dodgyoperators. Conversely, it makes the good operators REALLY easy to spot.