A Ben Graham Net-Net doing Leveraged Buyouts: Acacia Research Group $ACTG

so I herd you liek Mudflapz

If you can’t beat em, join em.

I have had so many incredible opportunities snatched away from me by private equity firms, it is an ever-present threat which truncates the gains from my winners and takes away my asymmetric returns.  Sometimes I wish that I could find a publicly traded, undervalued, small cap, leveraged buyout firm of my own, but what are the chances?

Acacia Research Group (ACTG), is a publicly traded value-oriented opportunistic acquirer of public or private business.  And they currently have $449 million of net current assets  compared to their $453 million market capitalization.  It isn’t quite a Ben Graham Net-Net, but it’s 99% of the way there.

ACTG has three ongoing business segments, soon to be four with the October 21st leveraged buyout of Deflecto, a business that is so aggressively not sexy, my often-wrong instincts tell me that it must be a cash cow.  In the search for catalysts, however, adding Deflecto’s $130 million annual revenue to ACTG’s trailing twelve month revenue of $110 million, should have an impact on the stock price.  The acquisition was done for $103 million, with $48 million of that coming from a loan guaranteed not by Acacia, but by Deflecto.  God, I love leveraged buyouts, it feels like I’m joining the winning team.

But back to one of the least sexy businesses I have ever seen.  Do you like mudflaps and floor mats?  If so, you’ll love Deflecto; Indianapolis based, Deflecto is the world’s leading manufacturer of chair mats, bicycle reflectors, and dryer venting, among other things.  Deflecto was previously private, so we have no idea what kind of margins they have on their 2023 $130 million of revenue, but the acquisition is for less than 1x price to sales, half funded with debt that is non-recourse to Acacia, and 2023 was a bad year for consumer durables.  My best guess is that normalized revenue could easily be 30% higher than 2023 numbers.

Acacia Research Group claims that their operational expertise will allow them to streamline Deflecto and increase profitability.  Of course all private equity groups claim that, but with a new CEO since 2022, we’ll just have to wait and see if they really do have any capability of adding value operationally.  At least the new CEO believes in himself with about $250,000 of insider buying since he took the job.  

If ACTG can add value operationally, that would be helpful for another of their business segments, Printronix.  This business might be even less sexy than the last.  Acacia paid $33 million, or 3.6x adjusted 2021 EBITDA for the business.  The transformation strategy includes a new focus on printer consumables, and according to management, the transformation is going well.  According to the numbers, EBITDA is still down from 2021 levels, but I have no idea how robust or cyclical the market is for industrial line matrix printing.

The third business segment is Benchmark Energy, an Anadarko Basin focused oil and gas explorer and producer with 150,000 net acres, 6,500 barrels of oil equivalent production per day in a low decline, oil heavy basin, and a projected $45 million annual free cash flow estimate.  Acacia owns 73.5% of Benchmark Energy, and the strategy is to focus on streamlining the efficiency of the asset with field optimization in a capital light way.  For risk management, over 70% of production is hedged for the next three years.

With Acacia Research Group selling for less than book value, and selling for less than net cash, it feels like I’m getting the oil and gas production for free, which is exactly how much I want to pay for more oil and gas exposure these days.  But the slow decline assets ensure that whenever the cycle on oil prices reverts from the supply destruction boundary to the demand destruction boundary, Acacia will still have production to benefit, which is not guaranteed in the fast turnover shale basins.

The final business segment of Acacia is arguably their core business, arguably because the company has so much cash for acquisitions, within a short period of time this might not be their dominant business anymore.  But this segment is patent trolling.  I believe patent troll is the pejorative term for a financial firm which acquires patents and seeks out infringement lawsuits to generate returns.  Acacia acquires patents and licenses out the intellectual property as well, but the infringement lawsuit revenue is much greater than the licensing revenue, and so I call them patent trolls.  

I have mixed feelings about owning a patent troll, on the one hand, we have a precedent based legal system, and every court case makes our system better by bringing us closer to a better interpretation of justice.  On the other hand, our intellectual property structure is incredibly flawed, and patent troll behavior more often than not seems like a mafioso shakedown where firms pay to settle because it is cheaper than the legal fees, even for cases with little to no merit. I would vote yes on tort reform, but in the meantime, I would buy ACTG.

From a financial perspective, litigation income is completely uncorrelated with market returns, which can eventually fetch a high multiple.  At the moment it appears that Acacia is of such a small scale that their revenues are incredibly lumpy due to the intermittent nature of lawsuit payouts.  A scale large enough to smooth this revenue would potentially make ACTG an incredibly valuable company.

Acacia Research Group is 61% owned by Starboard Value LP, a 22 year old activist firm with an 84% success rate on their activism, and a 15.5% annual return history.  This should prevent ACTG from making any capital allocation decisions which are too destructive to shareholder value.

Why is this opportunity available now?  ACTG was run into the ground by past management, who was fired for misappropriation of funds.  Starboard Value LP converted their preferred stock to common, took complete control of the company, and sacked the old management team.  The new management team has only been in place for a little under two years, and since that time have made two very impressive acquisitions.  

The current financial statements are a little underwhelming, last quarter had $14.2 million in revenue from energy, $6.3 million in revenue from Printronix, and $5.3 million in revenue from licensing.  Income from Deflecto does not appear on statements yet, and the patent litigation money comes sporadically, but when it last came in Q4 of 2023, it was a $75 million nugget.

The current EBITDA was not even enough to cover the corporate level expenses, however, the enormous cash horde generated $10 million in interest income, more than enough to make up the difference.  There is a previously authorized share buyback program for $20 million, roughly 4.5% of the float at these prices, but nothing has been spent yet.  Management says they are waiting for the right timing to execute the buyback.  But will the stock price fall below 0.83x price to tangible book value when next quarter should show the uplift in revenue from Deflecto?

ACTG has $6.07 of tangible book value per share, and is currently trading at a price of $4.52.  The incentives are aligned by strong control from a successful activist fund, and they have $400 million of dry powder to spend on acquisitions.  Those acquisitions will come from their stated categories of competence, technology, energy, and industrials.  I like all of those sectors.

Synergistically, management mentioned how much of a great fit Deflecto was for ACTG.  But it’s hard to imagine that mudflaps and chair mats fit in with printers.  I suspect the synergy comes from Deflecto’s 100 patents that Acacia can now use to fuel their patent trolling machine.  This adds a new angle for value addition from any acquisition.  

Time will tell how much operational efficiency management can really bring to the table.  But I find ACTG very intriguing, and I am planning on starting a placeholder position early next week.  Perhaps when the Q4 2023 $75 million patent revenue rolls off of the trailing twelve month financials, the price has some room to fall and management is being prudent by waiting to pull the trigger on the share buyback.  Or maybe the Deflecto revenue will compensate for this and the stock price will rise from here.   

I will be looking forward to following this one over time, and I hope I have the time to build a position slowly. As much as I like Burford Capital (BUR), I just love buying things below tangible book value.