Liquidity Service Inc. (LQDT) is a current selection of GuruFocus’ Historical Low P/S Screener. The company’s shares have experienced a wide range of valuations since its IPO and are currently trading near all-time lows.
While analyst expectations are for revenues to dip this year (ending a period of impressive top-line growth), the shares currently trade at a level last seen when the company had 80% lower sales.
Meanwhile, profitability doesn’t look too out of line with historical results. Clearly, there has been a rapid re-rating of LQDT’s ability to continue growing revenues at previous profitability levels. Let’s take a look at the business and analyze the reasons for the current depressed valuation. The compression in valuation may be overdone and/or the downgraded expectations for future financial performance may be too dire.
The business:
The company began operations in 1999 as an online auction marketplace for surplus and salvage assets. Unlike major consumer auction sites such as eBay (EBAY, Financial), LQDT operates within much more fragmented and nascent markets. LQDT believes it is still in the early days of growth, with multiple large markets still in the early stage of online adoption. They estimate the online surplus management market may be $150 billion, with LQDT still representing just 2-3% of that market.
The company owns a variety of sites that target these underpenetrated markets. M&A has been a primary contributor to their growth in networked sites: GovDeals (2008), Network International (2010), TruckCenter.com (2011), Jacobs (2011), GoIndustry (2012), NESA (2012).
Not just anyone can buy on LQDT's sites. For instance, buyers of DoD goods (much of what LQDT sells) must have U.S. Trade Security Controls clearances.
Our govliquidation.com marketplace enables selected federal government agencies to sell surplus and scrap assets. In addition to goods sold on behalf of other federal agencies, the surplus and scrap assets we sell as the exclusive contractor of the Defense Logistics Agency Disposition Services of the U.S. Department of Defense are sold in this marketplace. To satisfy the requirements of U.S. federal government agency sellers, this marketplace incorporates additional terms and conditions of sale, such as U.S. Trade Security Controls clearance for the sale of export-controlled property.
Because of these specialized marketplaces, LQDT is able to offer value-added services not offered/needed in more generic transaction websites such as eBay or Amazon (AMZN, Financial). These services include ad-hoc, negotiated direct sales, utilization of individual brokers or sales agents and live on-site auctions. The company believes these solutions are typically highly fragmented, geographically dispersed and poorly integrated with supply chain operations.
However, this dynamic has shifted recently, contributing to the latest share price collapse.
Uncertainty Revolving Major Revenue Streams:
The company has two major contracts with the DoD: "Scrap" and "Surplus." Combined they made up 41.2% of revenues in 2013 (down from 55.8% in 2011). The company's Surplus contract with the DoD expired recently and negotiations were prolonged and suspended at one point. The latest is that LQDT received a six-month extension of its previous contract, now good through August 2015 (source). Still, its DoD business has seen “significant changes in the volume and mix of property we handle, which has reduced sales values.” Fiscal year 2015 will be a transition year for the company as they reset their legacy DoD contract.
Walmart (WMT, Financial) also recently terminated a major contract with the company (they acquired the contract through their 2011 Jacob’s acquisition). Walmart said that LQDT failed to comply with deal provisions related to service level requirements and restrictions on the disposing of merchandise. There was a court battle, but eventually Walmart settled for ~$7.5m and the contract was ultimately canceled.
Valuation:
Investors have clearly priced in significantly less growth in the coming years due to the major revenue stream losses. At current levels, we can estimate that ~4% of annual EPS growth is factored into the valuation (using GuruFocus’ Reverse DCF Tool).
We do have a bit of visibility in the direction of EPS over the next year or so. While management has avoided providing specific guidance, EPS should decline in the near-term as a few of their major contracts roll off. Consensus estimates has FY15 EPS falling to $0.68 and FY16 EPS falling further to $0.41
Even ignoring discounting issues (which would skew the estimates even higher), using FY16’s EPS estimates as this years current base would have investors pricing in ~17% annual growth. If it takes the company two years to reach this trough level of EPS, the shares would require an even higher growth rate to justify the current price.
Conclusion:
Even with a massive correction in the share price, investors would still need to expect the company to at least match historical EPS growth levels to make the shares attractive. With the loss of major customers, an M&A binge inflating past growth rates, and assuming more penetrated markets (even if its still low), this would be an impressive feat. Investors are probably better off elsewhere.
For more ideas like this one, please see GuruFocus’ Historical Low P/S Screener.
